Medical Properties Trust (NYSE:MPW) has traveled a bumpy road over the past year, but I think that company management has done an excellent job of dispelling relevant fears surrounding the company's portfolio during that time. Healthcare REITs in general have been under pressure, and any time an REIT has a key tenant file for bankruptcy, investors have a tendency to run for the exits. In a further build of pressure, the recent credit outlook cut to negative from S&P (following a major acquisition announcement) likely did not help either. Is the recent haircut in share price enough, or would investors be better suited waiting for a better price?
Medical Properties Trust acquires and develops healthcare facilities, leasing those assets to operators under long-term triple net leases, as well as making mortgage loans to operators collateralized by their real estate assets. Bear in mind the company does take advantage of the RIDEA structure in some situations, a law which allows REITs to benefit from underlying operating performance of the asset via equity investment, equity-like loans. Cash flow and returns from these investments are going to be more volatile than triple-net leasing. Total RIDEA investment totaled $106M at the end of fiscal 2016 - not a large investment by any means, but it is an aspect of operations investors should be aware of.
While more than three quarters of revenue comes from the United States, the company is starting to nibble overseas, particularly within the German market. The United Kingdom is a likely focus point, as well as Spain (new facility just opened there in Valencia). Management has expressed continued interest in overseas expansion, such as CFO Steven Hamner's comments that the company will be back in Europe to "complete what we started" in 2017. However, both domestically and overseas, property type emphasis is on General Acute Care Hospitals ("GACH"), which have grown from 60% of revenue in 2014 to 64% in the most recent period. Inpatient Rehabilitation Hospitals ("IRH") have seen growing emphasis as well. The company has been moving away from Long-Term Acute Care Hospitals ("LTACH"), or facilities that require specialty care with longer stays and intense special treatment for patients (5% of assets). Generally, these facilities are higher margin for operators, but usually see significantly more volatility in earnings. GACH, which provide in-patient care for acute conditions as well as ambulatory care through hospital outpatient departments and emergency rooms, are performing well and are generally viewed (rightly in my opinion) more safely. In a similar vein, company properties have been converting to hospital outpatient departments ("HOPDs"). In general, rates come down after HOPD conversion, but margins stay within spitting distance just from increased volume. The added benefit is that higher patient traffic creates a more stable revenue base, so any downtick in margin is made up for in volume. The impact of this (weak LTACH results, strength from GACH, HOPD facilities) can be seen in the most recent reported quarter, where LTACH EBITDAR coverage fell 1.3x, compared to 3.9x coverage at GACH. It wouldn't be a surprise to see these LTACH facilities eventually cut off from the operation and sold - if the price is right.
Adeptus Bankruptcy Implications
Texas-based Adeptus, the nation's largest free-standing emergency room operator, officially announced bankruptcy in April of this year. The company blamed a tight regulatory market, as well as vendor PST Services botching its revenue cycle management services for the company, which caused nearly $100M in write-offs. The court has approved the company's restructuring plan, which involved affiliates of long-term shareholder Deerfield providing interim funding, which follows the move by Deerfield buying out $212M in bank debt early in April. The newly capitalized Adeptus will assume 80% of master leased facilities at current rates, with the rest either being released to the prior venture partner and the rest (15%) being either sold or re-leased to new operators. Medical Properties Trust will provide a one-time credit of $3M during the twelve months post-bankruptcy. There are thirteen facilities being released from the Adeptus master lease, six of them within ninety days of bankruptcy existence and the rest after one year; Medical Properties Trust has the option to sell or re-lease sooner. Until they are separated from the master lease, Adeptus will be responsible for 100% of current rent throughout bankruptcy and all the way up through the release date. Management has stated interest is "very high" from multiple operators on these thirteen properties, and the company believes it can either sell or re-lease without any material adverse impact. Medical Properties Trust management has done a solid job of spinning this story as positive; despite 7% of NOI having been caught up in a tenant bankruptcy, the story has instead been shown as a testament to the strong underwriting and underlying value of the company's real estate. I can't say I disagree. Over the company's thirteen-year history, during which the company has owned more than 250 hospitals, there have been no signs of the company ever taking what I would call a material real estate impairment. Even missed rental payments have been few and far between.
Management made it clear that the company had plenty of dry powder over the last several years. Post equity raise, pro forma debt to EBITDA of 4.5x was well below the company's target of 5-5.5x, as well as below Medical Properties Trust's peer group. The company's quarterly press release stated the company believed it had the ability to make up to $1.5B in additional investments without the need of additional equity, all while keeping the debt ratio within self-imposed levels. That should have been a clear sign what was on the horizon.
This is essentially a three-way deal, with Steward Health Care acquiring IASIS Healthcare operations, with Medical Properties Trust stepping in to control IASIS real estate via sale/leaseback and mortgage transactions. Total consideration is $1,400M, roughly two thirds split between rental income and mortgage interest income (in line with current consolidated company breakdown). Medical Properties Trust has quickly been building a relationship with Steward, which is now the largest private for-profit hospital operator in the United States. Back in October of last year, the company closed on a portfolio of nine acute care hospitals in Massachusetts for $1,250M ($600M sale/leaseback, $600M in mortgages, $50M RIDEA investment). Given that this prior transaction pushed Steward to the company's top tenant by gross assets (17.5%), after this deal, that will now be above 30%. Tenant concentration concerns are likely on the minds of many, particularly given the consolidated Steward 2018 EBITDAR coverage estimate of 2.83x is slightly below the total Medical Properties Trust portfolio (3.35x). While Steward is private (controlled by Cerberus), it did provide some pro forma estimates of Steward's balance sheet that pin net debt/EBITDA leverage in the 3.8x range, well below peer averages. While the knee-jerk concern is concern over whether Steward could be the next Adeptus, both companies operate in different markets and having the backing of Cerberus ($30B in private equity AUM) will always give Steward an edge if things do turn south. Nonetheless, management is looking to get Steward's exposure down below 25%, either by joint ventures or straight growth. This likely isn't a speedy way to reduce exposure, particularly given leverage is now in the target range, so growth via acquisition is not going to be aggressive over the next several years.
Valuation, The Final Word
Medical Properties Trust does not break out net operating income ("NOI") that I can see, but backing into it from 2016 GAAP ($342M GAAP operating income - $46M gain on property sales + $7M impairment charge + $94M depreciation) gets us to $397M in NOI. Based on current enterprise value, the gut reaction is to figure that the implied cap rate is 5.1%, but the company has been making substantial moves as of late. Medical Properties Trust recently priced a substantial equity deal to raise cash after Q1 close to fund the $1,400M Steward/IASIS acquisition, funded by that equity raise ($547M), a substantial portion of cash on hand ($447M) and a likely senior unsecured debt issuance (~$500M). If investors assume a 10% cap rate on acquisition (current guidance), expectations should be for $140M in additional net operating income, along with ~$20M in natural NOI growth this coming year. After the impact on enterprise value from the Steward transaction, it appears the entirety of the portfolio will trade at a 6.5% cap rate, assuming no real change in market value of the company's shares by the time all the pieces fall into places. This points to a slight premium to net asset value ("NAV"), given historical sales history of similar free-standing emergency room properties. For instance, Medical Properties Trust divested several assets associated with the Capella Healthcare merger from early 2016 recently, receiving roughly 7.5% cap rates on those sales. Such a premium (~15%) to NAV would not be outlandish in the healthcare REIT space, but for those that love fishing for REITs trading at or below NAV, a share price in the $11.50/share range would be where you should start nibbling.
I think that is the way to place this one. Medical Properties Trust is going to trade around yield, and I think the distribution isn't going to see any outsized growth in the short term, given the likely focus on reducing leverage back down. Fair value is my estimate in the $14.50/share range, which would put the yield at 6.6%, a little bit of a discount to historical levels given overall market sentiment, fresh counterparty risk, and a more worrisome balance sheet. Picking up shares in the mid $11s/share builds in 25% upside, a minimum level that I personally look for before considering a purchase. With that said, holding at current prices likely isn't going to hurt anyone. The company is well-run, has excellent growth opportunities, and is a clear leader in this space; it is worth watching for anyone looking for income-based REIT plays.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.