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Funding Thesis
At first look, Medical Properties Belief (NYSE:MPW) looks like an undervalued dividend choose. It owns and leases 420 hospitals/clinics underneath “triple-net” contracts that move all property-related prices (and tasks) to its 54 tenants, permitting it to run a formidable $18.3 billion portfolio with solely 131 workers. As a REIT, it distributes most of its earnings to shareholders, making it a lease conduit that hyperlinks “economy-proof” hospitals to income-oriented buyers.
However once I final coated MPW in 2022, I used to be waving crimson flags concerning the CEO’s extreme wage, the three company jets purchased on the shareholder’s dime, Social and Governance shortcomings, and conflicts of pursuits in a debt-fueled progress technique that screamed hassle. I ended up saying buyers may be higher off parking their cash elsewhere.
Since then, MPW’s missteps drew extreme criticism, not simply from market analysts, but in addition from governors and members of Congress. Some have even referred to as for the corporate and its tenants to depart their states.
The time has come to maneuver previous our many months of discussions and start executing a protected, orderly transition of your seven licensed amenities in Massachusetts to new operators as quickly as attainable – Massachusetts Governor Maura Healey’s letter to Ralph de la Torre, Steward’s CEO, Dated February 20, 2024.
Here is the factor. MPW’s progress technique is deeply intertwined with a controversial development: the rising involvement of personal fairness in healthcare. Extra to the purpose, MPW is not centered on the normal hospital operators that many individuals affiliate with monetary stability. Its hospitals may be shielded from financial downturns, however they’re nonetheless weak to monetary mismanagement, which we focus on within the following paragraphs.
Non-public Fairness Greed
Within the US, solely 24% of hospitals are for-profit, and inside this phase, MPW zeroes in on a good smaller area of interest: these for-profit hospitals funded by non-public fairness. This specific area of interest is witnessing fast progress, making it an ideal match for MPW’s formidable progress technique. Primarily, MPW’s major tenants are, or have been, non-public fairness companies.
Operator Non-public Fairness Backer (present & previous) % Actual Property Portfolio Steward Cerberus Capital 19.2% Circle Apollo International Administration 11.6% Priory Waterland Non-public Fairness 7.6% Prospect Leonard Inexperienced Companions 6% Lifepoint Apollo International Administration 4.4% Complete 48.8% Click on to enlarge
The issue is that some non-public fairness methods conflict with the nationwide shift in direction of value-based healthcare.
Non-public fairness companies wish to purchase going issues which are capable of tackle debt and generate income within the quick run. These monetary pressures can create perverse incentives favoring revenue over sufferers – Harvard Medical Faculty whitepaper, dated December 2023
As insurance coverage and authorities insurance policies more and more minimize healthcare bills, discovering margins that meet non-public fairness expectations grew to become powerful. This supplies context to MPW’s monetary challenges.
Hospitals are extremely regulated and depending on a posh system of presidency and personal insurance coverage. That makes it more durable for private-equity companies to rapidly increase revenue margins – WSJ article, dated February 2022
Cerberus Capital Administration engaged in complicated monetary transactions with Steward and MPW, which ended with Cerberus quadrupling its cash whereas leaving Steward and MPW in a deep debt gap, whose repercussions have prolonged to MPW’s shareholders, as evident in MPW’s dividend cuts and share worth efficiency.
Cerberus and its associates actually stripped out and offered the property from beneath these hospitals, creating a whole bunch of tens of millions of {dollars} in income for personal fairness executives, whereas leaving the amenities with long-term liabilities. […] The online results of these transactions seems to be an unfolding tragedy. Cerberus and its non-public fairness executives obtained $800 million in income, whereas hundreds of Massachusetts well being care staff’ jobs are in danger and ten communities within the Commonwealth face the potential closure of hospitals which are debt-ridden, unable to pay their payments, and teetering on the monetary brink – Letter from Congress to Cerberus CEO, dated February 2024
MPW tied its progress technique with the non-public fairness playbook, emphasizing the usage of leverage and piling it up on the operator’s stability sheet.
Non-public fairness usually buys an organization, overhauls its operations, and tries to make it develop. Usually this technique entails piling on a number of debt—however, crucially, that debt sits on the books of the goal firm, not the non-public fairness fund. Bloomberg Article dated August 2020
MPW’s position was to supply the true property for Steward’s progress, in some instances by means of sale-leaseback transactions or outright buy of property on behalf of Steward. This allowed non-public fairness bankers to dump vital monetary danger to MPW.
[…] By financing acquisitions by means of property gross sales, private-equity companies switch a few of the danger to the hospitals and MPT. The ensuing leases can lengthen for a few years after the private-equity companies unload their stakes, as Cerberus has achieved with its Steward funding – WSJ article, dated February 2022
MPW additionally purchased Cerberus’s $355 million mortgage to Steward (which Cerberus swapped for its fairness share in Steward in 2021 with a gaggle of physicians working the hospital chain) on what turned out to be a flawed progress premise. When requested concerning the rationale of shopping for Cerberus mortgage to Steward, MPW said that the transaction:
higher align us with the Steward methods, with progress alternatives – Steven Hammer, Q1 2021 earnings name.
For sure, this technique failed, leaving Steward struggling to afford fundamentals like ambulance gas and emergency room provides and MPW struggling to gather lease.
Leonard Inexperienced did the identical with Prospect, and when issues received powerful, they made the operator promote its buildings to MPW and lease them again, leaving Prospect with the burdens of curiosity and lease funds.
Prospect had used proceeds from real-estate gross sales to MPT to pay down debt it had incurred partly to fund a whole bunch of tens of millions of {dollars} in dividends to its buyers, together with Leonard Inexperienced. Supply: WSJ article, dated February 2022
Cerberus exited Steward in 2021 after quadrupling its cash, whereas Leonard generated no less than 100% revenue on Prospect after exiting not way back, all whereas leaving MPW not solely with struggling tenants but in addition with a whole bunch of tens of millions of {dollars} in fairness and mortgage publicity to those operators.
Within the decade since Leonard Inexperienced & Companions, a non-public fairness agency primarily based in Los Angeles, purchased management of a hospital firm named Prospect Medical Holdings for $205 million, the homeowners have achieved handsomely. Leonard Inexperienced extracted $400 million in dividends and charges for itself and buyers in its fund — not from income, however by loading up the corporate with debt. ProPublica article, dated September 2020
The underside line is that MPW’s progress technique raises doubts over its claims that its dividends are supported by dependable hospital lease earnings as a result of its tenants aren’t conventional operators however private-equity-backed hospitals with distinctive dangers.
This autumn Outcomes Reveal Aggressive Accounting
This autumn was a catastrophe for MPW. Their income, EPS, and FFO have been all unfavorable, exhibiting a large lack of worth, as MPW wrote off its investments and accounts receivables in Steward, Prospect, and different operators. AFFO was down 15% as the corporate continued promoting property to pay down debt.
MPW, creator’s estimates
Extra importantly, This autumn outcomes revealed that MPW’s accounting was on the aggressive aspect. When their debt-laden tenants wished to develop, MPW stepped in with actual property offers. They minimize lease for the primary few years to assist out till their operators received again on their ft. However MPW recorded the lease as if it have been getting the common anticipated quantity over your complete lease time period, which was greater than the precise money coming in.
In principle, this could have evened out over time, with greater money lease exceeding the lease billed. However now, auditors are waving crimson flags, doubting these tenants will final lengthy sufficient to pay up as anticipated. That led to a giant write-off for Steward in This autumn, dragging MPW’s reported gross sales into the unfavorable.
So, while you hear administration discuss “lease escalators” and such, take it with a grain of salt. Because the adage goes, money is king. Additionally, the entire write-off factor comes solely three months after MPW mentioned that Steward’s financials have been enhancing, casting a shadow over their insights and understanding of their operators.
Valuation
At the moment, MPW’s major purpose is to slash debt and regular its earnings, however even when it succeeds, this does not translate to a simple enhance in worth.
Reducing Leverage
MPW took out loans when it was low cost to borrow. Now, they should refinance, however rates of interest have gone up, and their tenants are in a tough spot, making lenders hesitant to lend to them. Administration even admitted that they can not get unsecured loans anymore.
I don’t assume the unsecured market is accessible to us proper now – Steve Hammer, CFO. Q3 2023 earnings name.
Observe: Common curiosity on time period loans/revolver is between 6% – 7%. Efficient rates of interest on senior unsecured loans are between 1.3% – 5.75%. MPW’s cap price, outlined as lease billed over actual property belongings, stands at about 5.5%. This excludes straight-line lease.
Maturity ($ hundreds) Senior Unsecured Notes Time period Loans/Revolver Complete Debt 2024 – $ 453,648 $ 453,648 2025 $ 551,950 $ 891,170 $ 1,443,120 2026 $ 1,688,500 $ 1,514,420 $ 3,202,920 2027 $ 1,400,000 $ 200,000 $ 1,600,000 2028 $ 763,860 – $ 763,860 2029 $ 900,000 – $ 900,000 2030 $ 445,585 – $ 445,585 2031 $ 1,300,000 – $ 1,300,000 Totals $ 7,049,895 $ 3,059,238 $ 10,109,133 Click on to enlarge
As a REIT, MPW should distribute most of its earnings to shareholders. So, paying off debt with out promoting belongings is hard.
Promoting belongings will lower FFO, so frequent valuation ratios similar to P/FFO and P/AFFP needs to be used with warning. These ratios may recommend that MPW is undervalued whereas failing to include the anticipated decline in earnings. Making issues worse is the fluidity of the state of affairs, with nobody really sure how a lot MPW’s earnings will decline or the form of its stability sheet within the coming quarters. I doubt even MPW’s administration is aware of as a result of all of it depends upon the negotiations with their lenders, debtors, and potential patrons of their properties.
When price-to-NAV ratios, MPW appears low cost, however what’s included of their e book worth? This brings us to administration’s second goal.
Stabilizing Earnings
So as to preserve its greatest tenants from going underneath, MPW injected no less than $1.8 billion (9.7% of whole belongings) in loans and fairness stakes into its struggling operators.
The worth of those investments is unsure. In This autumn, MPW wrote off a whole bunch of tens of millions of {dollars} of those belongings, rendering their worth unreliable in NAV calculation.
One other account that carries a giant query mark is the Hire Receivables, which primarily encompasses straight-line lease accounting to issue within the discrepancy between lease billed and money lease obtained. MPW additionally wrote off a good portion of this account as a result of its auditors are actually elevating the crimson flag that a few of its tenants will not survive lengthy sufficient to pay this determine.
Factoring this within the calculation of NAV and including again depreciation for a conservative method, we see that MPW’s adjusted NAV per share is $8.7, a lot decrease than the said $11/share.
I consider MPW’s worth low cost over NAV ($8.7 vs $4 on the time of this writing) elements two dangers.
the chance that MPW will be unable to promote its actual property properties, no less than at a good worth. In the event that they resort to elevating fairness to pay debt, outcomes will probably be extraordinarily dilutive. MPW continues to supply capital injections to its operators, however recouping these investments is unsure.
So, NAV figures, whereas extra sure than FFO/AFFO numbers, are nonetheless removed from being fully dependable, given the dynamic nature of the state of affairs.
How I May Be Fallacious
A part of Steward’s drawback is that it would not have working capital to carry out providers, similar to surgical procedures, which might be very worthwhile. By lending Steward, MPW may deliver it again on observe. Administration is assured that Steward will probably be paying full lease and curiosity by June.
I am a bit skeptical. The factor is, Steward is buried underneath a mountain of debt, so except a basic recapitalization happens, these ‘momentary’ fixes may not be sufficient to deal with the basis drawback. Bear in mind, MPW has beforehand prolonged fairness and debt to Prospect, and though this initially appeared to stabilize the state of affairs, Prospect ended up requesting a further $700 million in December 2023, with MPW changing lease receivable to fairness in PHP Holding, Prospect’s mum or dad firm.
The information that Steward was promoting its doctor community to UnitedHealth (UNH) is a welcomed growth. The main points of the deal are but to be introduced, but it surely brings some optimism that Steward will repay a few of its debt to MPW, or no less than halt additional borrowing.
The underside line is that MPW is in a tough spot. The state of affairs is sort of fluid, with many shifting elements and uncertainties. Issues can get higher or a lot worse, relying on MPW’s negotiations and developments with its tenants, debtors, lenders, and regulators.
Abstract
MPW is unlikely to completely get better. Earnings buyers may wish to depart the ticker for vulture buyers to choose over. Its tenants are extremely leveraged and do not symbolize the everyday hospital operators that one associates with monetary stability.
The corporate is in a race towards time, as debt maturities loom and the debt market shuts its doorways to refinancing, leaving MPW with arduous choices to both promote its property or increase fairness at suppressed costs, risking dilution.
Our maintain score balances the dangers and potential rewards to buyers. A score improve is conditional to enhancements in MPW’s debt construction and, by extension, the continued sale of its belongings at favorable costs. That is additionally the case for its tenants. A score downgrade is probably going if MPW fails to pay its 2025 debt or fails to safe refinancing at rates of interest beneath its cap charges.
