Healthcare Trust Of America: Benefits Of Healthcare Realty Trust Merger Do Not Necessarily Justify A Buy

Summary

  • HTA’s historical price performance has been extremely poor despite it being the largest dedicated owner and operator in the lucrative MOB segment.
  • HTA shares seem to be overvalued in the merger deal with Healthcare Realty Trust.
  • Post-merger, HTA’s shareholders are expected to get a cut in quarterly dividends.
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Healthcare Trust of America, Inc. (HTA) is a United States based mid-cap healthcare real estate investment trust (REIT). This REIT was founded in 2006 and was listed on the New York Stock Exchange in 2012. It has a market capitalization of approximately $7 billion, and enterprise value of $9.8 billion. HTA has been paying regular quarterly dividends for the past 10 years. The company has generated a current yield of 4.6 percent and it has a four-year average yield of 4.5 percent.

As of December 31, 2021, HTA is the largest dedicated owner and operator of Medical Office Buildings (MOBs), with $7.8 billion investments in MOB and approximately 26.1 million square feet of gross leasable area (GLA).

[HTA's] investments are targeted to build critical mass in 20 to 25 leading gateway markets that generally have leading university and medical institutions, which translates to superior demographics, high-quality graduates, intellectual talent and job growth. The strategic markets HTA invests in support a strong, long-term demand for quality medical office space. HTA utilizes an integrated asset management platform consisting of on-site leasing, property management, engineering and building services, and development capabilities to create complete, state of the art facilities in each market.

Its strategy focuses on stable cash flows with relatively low vacancy risk, high levels of tenant retention, rental growth and long-term value creation. The company also considers merger and acquisition to supplement its organic growth strategy.

Among REITs, historically, the MOB focussed REITs like Physicians Realty Trust (DOC), NorthWest Healthcare Properties Real Estate Investment Trust (OTC:NWHUF), Global Medical REIT Inc. (GMRE), and Universal Health Realty Income Trust (UHT) have performed much better than the skilled nursing facility (SNF) and senior housing operated portfolio (SHOP) focused REITs like National Health Investors, Inc. (NHI), Sabra Health Care REIT, Inc. (SBRA), CareTrust REIT, Inc. (CTRE), LTC Properties, Inc. (LTC) and Diversified Healthcare Trust (DHC).

However, Healthcare Trust of America failed to generate positive price growth over the short and medium term, despite operating only in the MOB segment. HTA's market price has dropped by 11 percent, 17 percent and 0.5 percent over the past 1 month, 6 months, and 12 months respectively. This REIT also recorded negative growth of 6.6. percent over the past five years. And the price growth over the past three years, though positive, was a minimal 3 percent.

However, Healthcare Realty Trust Incorporated (NYSE:HR) and Healthcare Trust of America have entered into a $18 billion merger deal to become the largest medical office building REIT in the United states. The combined company will have an equity value of $11.6 billion and enterprise value of $17.6 billion. This merger will have tremendous economic synergies, such as $33-$36 million in savings of total administrative cost and reduction of dollar amount of dividend, as the combined company is expected to maintain HR's current dividend.

96 percent of HTA's common equity is held by institutional investors. 10 big assets management firms - Blackrock Inc., Vanguard Group Inc., Principal Financial Group Inc., State Street Corporation, Canada Pension Plan Investment Board, Bank of New York Mellon Corp, Geode Capital Management, LLC, Charles Schwab Investment Management Inc., FMR Inc., and Legal & General Group PLC - together own around 40 percent of the common equity shares of Healthcare Trust of America. Incidentally these 10 firms own almost 52 percent of Healthcare Realty Trust. Thus the merged entity is expected to be controlled by the same group of investors.

Besides these 10 firms, Apg Investments Us Inc., and Cohen & Steers Inc., have some major stakes (around 21 percent) in Healthcare Trust of America, Inc. These two firms don't have any significant stake in HR. However I don't think that these two institutional investors will create any hindrances in the proposed merger deal, which is subject to the approval of shareholders of both these entities.

HTA's shares are currently trading at $28.65, at an 8.7 percent premium over its 52-week low price of $26.36. However, this price must increase as the shareholders of HTA are expected to receive a value of $35.08 per share, including a special cash dividend of $4.82 per share and a 1:1 exchange ratio based on HR's unaffected price of $30.26 per share. This special cash dividend is expected to be funded with proceeds from joint venture and asset sales. The offer values Healthcare Trust of America at $7.75 billion, based on 220.8 million outstanding shares.

As a result of this merger, HTA's market price was expected to rise close to $35.08. However, this did not happen, due to two reasons - i) the cash dividend may be realized as late as fourth quarter of 2022, as it is expected out of proceeds from the joint venture after the deal gets materialized, and ii) the market price of HR itself has dropped to $28.7. As the share swap is happening on 1:1, HTA's share price will be quite similar to that of HR.

In my opinion, a major reason behind the fall in price will be the decision to pay dividends at HR's current level. Unfortunately, the dollar amount of dividend in HTA was higher than in HR. Healthcare Realty Trust has also systematically cut down its quarterly dividends from $0.66 in 2006 to $0.31 in 2022. There is no assurance that this trend won't continue in the coming years.

Another reason for falling market prices may be the overvaluation of the merger deal. The combined market capitalisation of these two firms at present is less than $11.6 billion, while the company has estimated an enterprise value of $17.6 billion. At present the enterprise value of HTA and HR stands at $9.8 billion and $6.6 billion respectively. In my opinion, it will be difficult for the combined entity to achieve an enterprise value of $17.6 billion. Even if this value is achieved, it will only be possible over the long run, say in another 10 years.

Should I buy Healthcare Trust of America, Inc.? I am not confident of significant price growth despite this monstrous merger deal. There are reasons behind it. The company is sure to achieve cost savings. But I don't see much growth in terms of rental income. The dividend will be around 4 percent. In the short term, this merger will hardly generate sufficient value so as to overcome the significant premium that is being offered to HTA's shareholders. Even if I assume that the price of HR and HTA remains the same, the cash dividend will mean that HTA shareholders will be paid a premium in the range of 16 to 18 percent.

Having said so, any shareholder of Healthcare Trust of America, Inc. will anyway gain $4.82 from the special cash dividend. So, even if the price falls by another 12.5 percent to reach $25, shareholders will still gain 4 to 5 percent out of a special cash dividend, which is equal to HTA's four-year average yield. In such a scenario, buying this stock makes sense. However, this benefit will only be obtained by HTA's shareholders possibly for another three months.

In case someone is buying this stock, I'd ask him/her to be careful as there could be chances of steeper downfall, in case the proposed reverse merger deal fails to materialize or generate the desired results. In order to avoid such an unlikely scenario, it'll be wise for investors to hedge their exposure through buying a $25 put option with an exercise date in October, as I am expecting this deal to get materialized by that time. As October 21, 2022 (5 months forward) put option of $25 is available at a very low premium of $1, investors may want to hedge their exposure on Healthcare Trust of America, Inc. so as to restrict their loss at 16 percent of the current investment.

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