| 2020 | 2021 | ||||||
| Price: | 15.47 | EPS | 0 | 0 | |||
| Shares Out. (in M): | 521 | P/E | 0 | 0 | |||
| Market Cap (in $M): | 8,060 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | 7,911 | EBIT | 0 | 0 | |||
| TEV (in $M): | 15,971 | TEV/EBIT | 0 | 0 | |||
| Borrow Cost: | General Collateral | ||||||
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Medical Properties Trust (“MPW”), one of the largest owners of for-profit hospitals, is an attractive short. The company enables some very bad practices in the healthcare market; a large number of tenants have been stripped of assets by their private equity owners, levered up and milked for fees while operating performance and capital reinvestment plummets. I’m not going to devote much space in this write-up to the wider issues in the healthcare market like surprise billing, etc. as I assume reader familiarity.
At ~12.5x 2020 AFFO (pre-COVID w/ generous add-backs) and a sub-7% dividend yield, the stock does not reflect the true fundamentals within healthcare real estate and MPW’s troubled, politically-toxic tenant base. MPW’s bull case was predicated on significant asset growth at breakneck speed funded by cheap debt and an inflated share price. Acquisitions at a scale necessary to move the needle are not happening this year.
If one values MPW based on its current assets, the stock has considerable downside, even before factoring any negative impact from COVID. MPW’s current ~5% implied cap rate represents a steep premium to private market cap rates of 8%-10% for the company’s highly specialized hospital portfolio. Moreover, the risks inherent in MPW’s business model are not well understood. While limited disclosure has obscured trouble in the past, cracks are starting to appear in management’s embellished track record. MPW loves pro forma and as-adjusted figures and this information is duly regurgitated by everyone following the stock, contributing to the misperception.
I believe the pandemic is a key catalyst in highlighting MPW’s precarious tenant base. As many are aware, the delay of elective surgeries (which generate most of profitability) has put many hospitals in a financial crisis, including many of MPW’s tenants. The federal government has promised significant aid, but it remains to be seen if this will be enough and whether private equity-backed companies will be eligible for all of the benefits (it is not hard to imagine the potential political backlash). Should one or more of MPW’s highly leveraged tenants require significant rent relief, the whole house of cards could come falling down.
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My price target of $8 represents ~50% downside. Without assuming a diminution in rent, this would pencil to ~6.5x AFFO and a 13% dividend yield. Notably, the ~7% implied cap rate at $8 is much closer to the private market value of MPW’s assets (~8%). You can play with the implied NOI loss and dividend capacity figures a bit and adjust the multiple, but if my thesis plays out, I think the stock will end up below $10.
I am not banking on a dividend cut in the near term. While it would be prudent, MPW has ~$1.5 billion of liquidity and the debt is pretty well termed out. Management has shown in years past that it is comfortable paying out a dividend that isn’t fully covered by cash flow. Longer-term, I think a dividend cut is certainly a risk given the precarious financial status of MPW’s tenants.
If you are long the stock, what are you playing for here? Street estimates still need to come down. Current dividend yield is not very attractive relative to alternatives and there is so much that can go wrong. Stock price declines from the big three makes multiple expansion here much less likely. I believe the Bull case for MPW relies heavily on false premises.
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MPW has been written up three times on VIC. Most recently as a short by Fat_Tony in Feb. 2019. My thesis is similar to Fat_Tony’s, but I believe this is a timely idea and have a few things to add.
I pulled the below bullets directly from Fat_Tony’s write-up to save people time:
-MPW is a hospital REIT trading near their all-time high multiple of AFFO despite a potential problem at their largest tenant, Steward Healthcare (37% of Net Operating Income).
-On the surface and what you’ll read in sellside research is these are well covered hospitals with guarantees with stable and predictable cashflows. The reality is different.
-The landscape of healthcare in the US is constantly evolving and difficult to predict.
-The tenant quality of MPW is also suspect. HCA, arguably the top healthcare operator in the country, does not do sale leasebacks on their assets. They finance themselves with debt and equity. The hospital operators that choose to do sale leasebacks are ones that cannot efficiently access the debt markets. MPW’s operators are mostly owned by private equity…
-MPW’s valuation is expensive compared to history.
-MPW has significantly grown EV over the past decade, but that has not translated into FFO or AFFO per share growth.
-Any slip up with a tenant will cause another miss and I would expect if their numbers come down so will their multiple.
-As Fat_Tony later notes in comment section…’This is a catastrophic incentive system MPW shareholders have set up. Edward Aldag is highly incentivized to do deals. But far worse if the deals go bad and he is fired he gets $72m.... yes that is the correct amount.’
All of these points ring true today (although % from Steward is lower). After its acquisition binge and bullish acquisition guidance pushed the stock to highs of $24, it has come in significantly since early March.
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MPW has a ~$9 billion market cap and trades about 6mm shares per day. Short interest is under 3% of the float. MPW is the only large healthcare REIT that is exclusively focused on hospitals. The company IPOd in 2005 at $10.50 and has been relatively range-bound since while paying out a healthy dividend. US investments represent about 67% of the total, with UK at 16%, Germany at 7%, Australia at 5%, Switzerland at 3% and 1%+ in others. Over 80% of assets are general acute care, with 11% IRF, 2% LTACH and 5% Other.
Management has been consistent over a number of years. CEO Ed Aldag founded the company and took it public. He was paid $13mm in 2018. The CFO and COO, both long-tenured, each made over $6mm in 2018. They are highly incentivized to grow. The founder/CEO only owns a small amount of stock (under 0.50%, despite annual grants, etc.), with mgmt. and board together only owning ~1.2% as of 2019 proxy. The board grants about 1% of shares per annum to executives. Index funds own a large portion of the float. Over the past year, mgmt. has sold ~$9mm of stock and has not purchased any shares in the open market.
MPW is more highly levered than investors realize. I calculate leverage at 7.5x vs. 6.0x disclosed. Mgmt. uses one-sided adjustments to get to a more favorable number. The two most significant items that increase actual leverage are excluding non-cash SLR from EBITDA and including MPW’s pro-rata portion of JV debt. Leverage has generally run 5.0x-6.0x based on mgmt.’s pro forma EBITDA. Currently, mgmt. points to 6.0x leverage, adjusted for recent deals and some other stuff (without transparency). If you are a bit more conservative in pro forma EBITDA interpretation (remove SLR, no add-back for SBC., etc.) and adjust the debt for pro-rata share of JV third-party debt, leverage is actually 7.5x. Due to M&A at end of the year and beginning of 2020, trailing EBITDA is less informative, but it is worth highlighting that MPW generated CFO of $494mm in 2019 on that ~$8 billion of debt. 2019 CFO of $494 million is fairly modest growth compared to $449 million in 2018. Again, acquisitions and dispositions make this less meaningful. I don’t think leverage causes any immediate stress absent rent concessions or tenant defaults because MPW has a lot of liquidity and debt is termed out pretty well.
MPW grew total pro forma gross assets by 64% last year relative to 2018. Since 2015, assets have grown 158% from $5.6 billion to $14.5 billion. Meanwhile, AFFO/FFO per share growth has been anemic.
“Nonetheless, we want to reduce the overall parent exposure. And we do this by making -- continuing to make acquisitions away from Steward. Remember, the chart I showed you just a few minutes ago, where we've grown the portfolio 40% compounded annually over the last several years.” -CEO Ed Aldag, June 2017
As an investor with a focus in financial institutions/real estate, I view hyper-charged growth stories with great skepticism. Especially when we are talking about something with exposure to credit. Buying assets hand over fist is no great feat by itself. All too often, a company is incentivized by the market to grow without regard to risk. Many companies grow rapidly to reduce asset concentration or obscure credit problems. I think each of these elements are at play here. And none of these potential negatives are factored into the current stock price, in my opinion.
In a sober analysis of the company’s track record one will find that an alarming percentage of tenant defaults over time. MPW’s poor disclosure hides this simple fact. The company provides little information of its actual tenant base and discloses even less on troubled tenants. Given the leverage and business risk, it is not surprising that so many tenants have to restructure. The standard party line from MPW is that they don’t lose any rent when a tenant defaults. They also contend that they can replace a tenant if the lease is not assumed in BK at the same rent. I believe this part of the story is false, as explained in further detail below.
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Why Now?
COVID has put a microscope on our healthcare system. Might people rethink the wisdom of for-profit hospitals? Prior to COVID, there was an increasing awareness of the for-profit abuse within healthcare (see link below), particularly driven by private equity backed companies. While the surprise medical bill was cut down by lobbying efforts, this was just the start. Our healthcare system is broken and it is costing everyone a lot of money. At the very least, it is imperative to find some of the root causes of surging costs. Based on several studies, for-profit hospital chains and medical groups are a part of the problem.
https://prospect.org/health/how-private-equity-makes-you-sicker/
Steven Feingerg is again in the news with speculation that he will be named to a senior position in Trump’s admin. Might this draw further scrutiny upon Steward and thus MPW? Have already seen a backlash (see below) from the bailout Steward demanded in PA in order to stay open for the next few months.
https://www.nytimes.com/2020/04/16/us/politics/stephen-feinberg-trump-intelligence.html
https://www.axios.com/easton-hospital-pennsylvania-4c540358-5cdf-45d3-913f-2b04741a8aa5.html
I think all of these bailouts are going to cause social disruption that will make the Tea Party look like a warm-up act. For-profit healthcare operators will be at the forefront, especially as the stress on hospitals from COVID eases.
Hospitals of all kinds are losing money. Government funds are certainly forthcoming, but I have yet to see an actual backstop for highly leveraged operators or the REITs that effectively lend them money. Quorum Health recently filed a prepackaged bankruptcy. Envision is reportedly preparing to file. It isn’t hard to imagine one of MPW’s tenants as next in line.
“The sagas of Community Health Systems (CHS), Quorum, Steward Health Care System, and IASIS Health Care most vividly illustrate what has become of the hospitals acquired by private equity in the 2000s—and what that has meant for the stability of health care markets and the community’s access to acute care services. The hospital chains’ faced major challenges in meeting loan obligations accumulated through LBOs of add-on acquisitions; and local health markets experienced instability caused by the pressure of high levels of debt in these national hospital systems and by the imperative to earn high returns for investors.”
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Bull Case
MPW is misperceived in a number of areas, specifically: i) risk profile of its asset base; ii) the coverage/growth potential of the dividend; and iii) management’s track record.
I tackle several of the misconceptions below.
1-Hospitals are protected in this environment, less risky than other Healthcare segments.
Rebuttal:
-Hospitals are bleeding money right now and the COVID-related utilization is not very profitable. -The lost elective surgeries are not all going to come back.
-As noted above, there is elevated political risk for any bailout that helps private equity.
-While the Bulls rely on a Federal backstop, little mention is made of the International portfolio.
2-MPW has long term triple net leases so they don’t care about financial performance of tenants because they get paid either way. Plus, assets are critical so someone else could take over the lease.
Rebuttal:
-Ultimately, if the hospital cannot be operated on an economic basis, rnet will need to be cut.
-Unit-level financial performance over the long-term drives the rent, especially when there is little/no credit support from a well capitalized parent.
-If a tenant must reorganize, risk of a rent cut or lease termination, even under master lease. See recent Adeptus and Alecto examples. The current environment makes re-tenanting even more unlikely.
-Hospitals are highly specialized and carry a heavy cost per square foot. Difficult to adapt to other uses and costly to retrofit.
-MPW’s disclosed rent coverage is bogus because the numbers are heavily adjusted. This is discussed in detail below.
Longs seem to believe that all of these esteemed PE firms would never let their portfolio companies default. They don’t understand that the money has already been extracted and little skin is left in the game. Steward is discussed in detail below and in prior write-up. Prospect is perhaps more telling b/c Leonard Green is selling out for only $12mm. They have no intention of supporting Prospect and this also suggests very little cushion between lease obligations and first losses.
3-MPW is poised to continue its rapid growth, cheap financing enhances earnings accretion.
Rebuttal:
-Hospital M&A market is closed for time being. Will take at least 6 months to sort out the financial devastation.
-Capital is more expensive now and likely going forward as tenant financial difficulties come to the fore.
-For similar reasons, accretive capital recycling is also unlikely.
4-Attractive dividend yield on well covered dividend with room for growth.
Rebuttal:
-Recent run-rate NFFO incorporates all closed deals and development. Suggests little capacity to increase from $0.27 run-rate.
-Current payout ratio of ~85% based on generous pro-forma AFFO estimate ($1.25).
-Pay-out on 2019 AFFO is 102%, if more conservative on treatment of SBC/amortization/financing fees, payout ratio is 2019 AFFO is 119%.
5-Cheap relative to peers on FFO multiple.
Rebuttal:
-Big delta between FFO, NFFO, AFFO due to straight-line non-cash rent.
-With recent deals, impact is even more pronounced.
-Although MPW includes AFFO in earnings releases, they don’t show it in the 10-K/10-Q, they prefer FFO (higher) and NFFO (even higher).
Due to MPW’s long-term leases, a large percentage of rent comes from GAAP straight-line rent, which is non-cash. Essentially, if you have a 20 year lease with 2% increases, your GAAP rent is significantly higher than the actual rent you collect. The lease term is only meaningful if it is backed by a strong credit so that the owner can count on the income rain or shine. If not, then it is effectively a call option for the tenant. With junk credits, the effective lease term will be a lot shorter than the stated lease term, hence MPW is booking revenue which they won’t actually collect. Taking this to an extreme to prove a point. Suppose I buy an empty hospital from a friend who says he will lease it back for 50 years. The lease calls for rent of $100k escalating 10% per year for the next 50 years. The GAAP straight line rent would be $2.3mm in year 1, while the actual cash received is only $100k. And since the tenant is essentially a paper entity, there is little assurance that I will get my rent in year 5 or year 10. In the real world there are limitations, this is just to highlight the accounting convention and how it can distort.
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Portfolio Health
MPW’s stated rent coverage is heavily adjusted and should not be trusted. We know this only because we have financials for Steward, whom management calls one of the most innovative and successful operators. Management has frequently opined on how well things are going at Steward, but if one were to actually read the financial statements they would come to a completely different conclusion.
MPW disclosed Steward’s coverage at 2.85x. Steward’s actual coverage on EBITDAR is 1.2x. The add-backs are almost laughable and are greater than Steward’s $308mm in EBITDAR. Of course, there was no transparency so investors took coverage levels from MPW at face value and it turns out these metrics were juiced. Leverage at the Steward corporate level is off-the-charts high. In 2018, the company generated ~$95mm in EBITDA. Net Debt/EBITDA was over 16x. You may wonder how on earth MPW’s 9.9% stake is still held at cost ($150mm).
Management has improved the optics of rent coverage by moving from EBITDAR coverage to EBITDARM coverage in the past few years.
The reported coverage metrics are on a lagged, trailing twelve month basis, so it takes some time for recent results to filter through.
It should also be noted that these coverage metrics do not capture capex, which is the tenant’s responsibility. Heavily indebted systems are likely to skimp on capex, meaning MPW will ultimately bear the cost, which runs counter to the party line/consensus view on these leases.
The portfolio is littered with troubled, low quality hospitals. Lots of 1 and 2 stars from CMS. Many are involved in litigation.
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Management’s Acquisition Track Record
I point to rapid asset growth with much less improvement in underlying cash flow. I also highlight acquisitions that have gone sour. But Bulls can point to a few deals that have been successful (European JV, Ernest, North Cypress). I believe going forward that the bad deals will overwhelm any strong performers, but I could be wrong.
Many of MPW’s deals (Adeptus, Alecto, Florence/Gilbert) have gone south within the first few years of acquisition. Something is wrong with the underwriting process if this happens.
MPW’s disclosure is important to note here because management is quick to give details on the few successful deals, but avoids discussing many of the losers. In its 2018 annual report, MPW even provided unlevered IRRs for a few of the realized investments. This was nowhere to be found in formal filings. I’ve yet to see an IRR for other, less successful realizations. Or for the vacant assets that have been marked down but not sold.
When MPW has disclosed unlevered IRRs, they have generally been in the teens, which is not very impressive considering the risks involved (many of the opco loans carry interest rates above 10%).
“Now we've had to do this in a rare number of times in our roughly 14-year history. Again, we own now close to 300 different hospitals. And across that 14 years, 300 hospitals, $9 billion in assets, we've had to change operator, because of stress at the operator level, about 6 to 8 times. In each of those times, because our leases give us this power, we're able to take remedies, recapture our asset, those businesses before there is a payment default and transition the operator to a new operator. We've never lost money doing that. It's not a fun thing. It's painful. It's distracting. But we have the power, and we have, as a management team, the specialized knowledge, experience and skill that comes from having operated hospitals ourselves to be able to make that transition.” -CEO Ed Aldag, June 2017
I don’t believe the statement that they have never lost money changing operators. And it certainly is not true today. Why doesn’t MPW release detailed information to support its case? Investors have no basis with which to judge management’s statements due to lack of disclosure.
We now know the Adeptus master lease excluded 15% of the properties following bankruptcy.
Court filings for more recent troubled tenants (LifeCare) indicated that the tenant stopped paying rent in April/May 2019 and MPW terminated the lease. Although the restructured tenant eventually assumed the lease and cure obligations, rent wasn’t being paid for several months and it is unclear if lease terms were changed. This is the second time LifeCare has restructured during MPW’s ownership. There was no disclosure of the default or lease termination. The first time around, mgmt. Said LifeCare continued paying rent throughout.
Meanwhile, it smells a little fishy when a related party (Steward) in which MPW owns a 9.9% stake, takes over a lease for a defaulted tenant. This was the case for 8 of the 16 rejected Adeptus properties as well as the Florence property in Arizona. Similarly, Prime, one of MPW’s largest tenants, took over the Monroe facility which had defaulted and was not paying rent in early 2010s.
In order to maintain this track record, I believe MPW has relied on non-credit or related party tenants that will agree to assume what could be an uneconomic rental rate. The re-default rate is very high, so MPW is simply pushing these losses out to the future.
The company line for events like this are that the defaulted assets only represent a small % (after impairments were taken) or that the rent loss is included in guidance (lots of moving pieces each quarter helps mgmt. hide the ball).
The disastrous Alecto deals are instructive. The first deal with Alecto was a $20mm acquisition in California. In 2014, MPW expanded the relationship through a $40mm acquisition of the Wilson Jones RMC in Texas and $25mm for the Fairmont RMC in West Virginia. They also did a working capital loan for Alecto. In June 2017, MPW acquired two more Alecto assets for a total of $40mm plus $20mm in capital improvements. These properties were leased under 15 year leases with 2% annual bumps with cross-defaults on all other Alecto deals. MPW also obtained a 20% interest in the opcos. The cap rates on these deals and interest rates on working capital loans were 10%+. Two years later, both of the properties acquired in 2017 were shut down and MPW terminated both leases, losing $5mm in rent for part of 2019. As detailed below, one of the 2014 acquisitions is in process of closing and a fourth property in Texas has not been paying property taxes and appears to be in trouble. In 2018 and 2019, MPW wrote down the Alecto properties by $50mm. They may have more to go.
Consensus opinion skews heavily to the “strong track record camp” and that is what seems to be priced in currently.
At the end of the day, MPW’s poor disclosure speaks volumes. The lack of detail is comical compared to peers. If the underlying details were positive, they would disclose them like they do for the realizations which have worked out.
In the past month, MPW has removed a detailed asset listing from their website. Why?
There are several enlightening SEC comment letters where management sparrs with the SEC over disclosure of Steward financials. The comment letters are enlightening in that MPW jumped through hoops to avoid timely disclosure. Why weren’t Steward’s 2017 financials disclosed? When will MPW release Steward’s 2019 financials?
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Tenant Profiles
This is by no means an exhaustive list. As mentioned, MPW does not provide investors with much useful information. I think this is intentional. Many of the names here are controversial and almost all are for-profit operators and backed by private equity.
Over half of MPW’s revenue comes from related parties where MPW owns a stake.
“Lease and interest revenue earned from tenants in which we have or had an equity interest in during the year were $451.1 million, $501.4 million, and $422.4 million in 2019, 2018, and 2017, respectively.” -MPW 2019 10-K
In its financial supplement, MPW discloses large tenants by % of total assets (this likely understates the size of Steward b/c of higher lease rates vs. international deals). Steward was ~25% of pro forma assets and ~38% of 2019 revenue. Circle was 13% of pro forma assets and only 0.4% of 2019 revenue b/c large deal closed in 2020. Prospect was 9.5% of pro forma assets, LifePoint was 7.3% and Prime was 6.9%. The remaining 36 operators were 33.4%. Other assets represented 5.4% of the total.
Adeptus:
This was one of MPW’s prized tenants back when they spoke at MPW’s investor day in 2015. Adeptus was once a high flying IPO after its private equity owner listed shares in the free-standing emergency room operator. MPW’s extension of ~$500mm for new development enabled rapid growth. Things quickly fell apart due to collection issues, outlandish/surprise medical bills and mismanagement. Adeptus filed for BK. For more on what happened, see links below.
“Unfortunately, while they were cashing out, Defendants sold Adeptus to the investing public based on a false story of stable growth and financial health. Starting in November 2015, a series of stunning disclosures gradually revealed that Defendants had misstated the profitability, costs, and financial risks associated with Adeptus’s all-important joint ventures, engaged in improper billing practices that hampered the Company’s cash flows, and concealed crippling internal control deficiencies. As investors slowly learned about Adeptus’s true financial state, the Company’s stock price plummeted, losing over 95% of its value and erasing nearly a billion dollars in market capitalization. Investors suffered enormous losses.” -Lawsuit
Following Chapter 11, even though MPW held master leases (which mgmt. says tenants must assume in court unless they liquidate), 16 of the 56 properties were rejected. The new owner agreed to pay rent on those properties for a tail period of 6 months to 2 years. MPW’s master leases were obviously much longer.
Releasing on this portfolio was better than it could have been because many JV partners took over the leases. MPW received a boost in its efforts from Steward (an entity in which MPW owns 9.9% of the equity and is its largest landlord) took over 8 of the 16 vacant assets. This also happened with a hospital in AZ and raises red flags.
Despite management’s comments that they wouldn’t take an impairment, they ultimately did. A few vacancies were sold (likely for a loss) and several remain vacant.
“As the private equity firm Sterling Partners LLC prepared to market a 2015 equity offering for Adeptus Health Inc., an emergency room operator Sterling partly owned, insiders joked about the deal being lucrative enough to buy them a private jet.
“No doubt in my mind that it will be a successful trip,” Daniel Rosenberg, co-head at the time of Sterling’s health care practice, wrote to Thomas Hall, who was chief executive officer at Adeptus. “Only question is if you want red stripes or blue and yellow on your plane,” according to email excerpts included in a court filing.
Less than two years after that banter, Adeptus was bankrupt. Now, Sterling affiliates and former Adeptus managers are being sued by a trustee for Adeptus’s estate for allegedly crippling the business in pursuit of their own gains. According to a complaint filed in Delaware May 17, the company’s owners spurred its collapse through a mix of self-dealing and aggressive growth, netting an “obscene windfall” at Adeptus’s expense.”
http://securities.stanford.edu/filings-documents/1059/AHI00_02/20171121_r01c_17CV00449.pdf
https://prospect.org/health/the-emergency-room-hustle/
Steward:
Through two transactions, MPW paid $150mm for preferred stock for 9.9% of Steward. This investment is held at cost. In 2018, Steward lost $269mm from operations. EBITDA was $95mm.
Have seen multiple reports (missed tax payments, Glassdoor employee comments) that Steward is not paying its bills.
https://khn.org/news/already-taxed-health-care-workers-not-immune-from-layoffs-and-less-pay/
MPW owns 9.9% of Steward marked at $150mm (I believe this is senior to common) which implies $1,500mm of equity value on top of the ~$1,600 in net debt or total EV of $3,100mm. This is relative to $95mm in 2018 EBITDA. The transactions back and forth are also interesting as Steward has taken over several of MPW’s vacant assets while MPW has financed ~100% of some of Steward's acquisitions.
MPW also holds promissory notes to Steward which there are no details on. This was a new disclosure in 2019 10-K.
In addition to the master lease and mortgage loans, we hold a promissory note which consists of three tranches with varying terms. The three terms end in December 2023, December 2024, and October 2031.
Steward’s heavy losses have caused them to close down a number of hospitals. Recently, the company was in the news after demanding an immediate bailout from the state in order to keep Easton Hospital open during the pandemic.
https://prospect.org/economy/hospital-bailouts-begin-for-those-owned-by-private-equity-firms/
There is also some odd news regarding Steward’s management of hospitals in Malta. In one news report, MPW is listed as a potential buyer of the hospitals.
Prospect:
Prospect was acquired by Leonard Green in 2010 and has been put on the block for sale without success several times. A 2015 article pegs EBITDA at $100mm and a potential sale price at $700mm-$1 billion. After buying the company for $363mm, they did a $325mm dividend recap in 2012. A few bolt-ons along the way plus another recap in 2018 (was $600mm but believe it was reduced). Prospect was recently downgraded in March 2019 to B3-Negative. Leverage is almost 10x before this deal and 7.3x with a bunch of pro forma adjustments.
More recently, Leonard Green accepted an offer to sell its majority ownership stake in Prospect for $12mm to members of management. Prime came in with a higher $50mm offer, which Prospect rejected on the grounds that it had already accepted and approved the previous offer.
As part of the 2019 deal, MPW provided a $113mm term loan which is expected to be converted into an acquisition of two acute care hospitals. The total deal size was $1,550mm, but includes a future purchase price adjustment of up to $250mm depending on EBITDAR performance over the next three years. The Prospect Asset Purchase Agreement is an interesting read (included in 3Q’19 10-Q). Even at the incentive Adjusted EBITDA threshold three years out, Prospect is still very highly levered on a lease-adjusted basis. They have also been closing facilities in San Antonio.
Lifepoint:
LifePoint is a hospital rollup owned by Apollo, whom MPW bullishly describes as, …”one of the largest, if not the largest, most sophisticated, well-funded private-equity fund in the world.”
MPW was involved with several systems that have merged into this entity, including RCCH and Capella.
This is actually one of MPW’s star credits with an actual credit rating (B2). Pro-forma Debt/EBITDA of 6.0x per Moody’s.
Per Moody’s:
“With respect to governance, LifePoint's ownership by private equity firm Apollo Management will result in the deployment of aggressive financial policies. While LifePoint may pursue an IPO longer-term given its large scale, Apollo may take dividends if the company achieves its cash flow and deleveraging goals. Since the November 2018 merger between LifePoint and RegionalCare, the combined organization's financial performance has tracked reasonably in line with its guidance. As a for-profit hospital operator, LifePoint also faces high social risk. Moody's regards the coronavirus outbreak as a social risk under Moody's ESG framework, given the substantial implications for public health and safety. To prepare for a surge of coronavirus patients, acute care hospitals are postponing or cancelling non-essential elective surgical procedures. Further, alternative care settings for such elective procedures, such as ambulatory surgery centers (ASCs), are having to do the same in an effort to conserve valuable surgical supplies (e.g., personal protective equipment). Losing these procedures, which tend to be more profitable than treating sick patients, will result in significant headwinds to hospital companies' earnings. Beyond the coronavirus, the affordability of hospitals, price transparency, and the practice of balance billing have garnered substantial social and political attention. Additionally, hospitals rely on Medicare and Medicaid for a substantial portion of reimbursement. Any changes to reimbursement to Medicare or Medicaid directly impacts hospital revenue and profitability. In addition, the social and political push for a single payor system would drastically change the operating environment.”
Prime:
Private owned by Prem Reddy. Has settled a $65 lawsuit for Medicare fraud after a lengthy battle. After rapid growth, hospitals have experienced operational issues. Practices continue to come under fire.
Alecto:
Alecto is another shoestring operation that MPW financed by purchasing the properties, loaning the opco money and taking a stake in the opco as well. The rates charged were in the teens. Alecto was actually started by a former Prime exec who left under a cloud of trouble. CEO Lex Reddy is the Brother-in-Law of Prime CEO Prem Reddy.
It all seems to be coming apart currently. MPW leases 5 properties in total to Alecto with one structured as debt. The tenant has recently closed two hospitals in WV/OH. Another (Fairmont) is in the process of closing. MPW terminated two of the leases for the closed hospitals in 2019. Over the past two years, the Alecto properties were written down by $50mm. In 2019, MPW buried in public filings that revenue from Alecto was down $5mm due to leases that were terminated. These were “protected” under a master lease.
MPW acquired its first Alecto facilities in 2014 for a total of $65mm. One is in the process of closing and another in Texas is delinquent on property taxes.
Per the link below, one of the Alecto properties is being sold for pennies on the dollar (back taxes plus fees). They bought this property in 2017 for $20mm (plus another one that is now vacant for another $20mm) and agreed to fund another $20mm between the two. The GAAP yield was 10.8% on these 15 year leases. So MPW was booking at least ~$4.3mm per year from them (assuming none of $20mm was funded). Less than two years later, both are closed and the leases have been terminated.
https://www.theintelligencer.net/opinion/editorials/2020/04/considering-ovmc-deal/
“Though OVMC as a hospital and associated facilities was owned by California-based Alecto Healthcare, the land and buildings are the property of an Alabama company, Medical Properties Trust. Transfer of ownership to the city was discussed Tuesday, in part during a session closed to the public and press.
During the open segment of the meeting, the possiblity of a transfer of all the property — except for the former Robert C. Byrd Child & Adolescent Behavioral Health Center — was outlined. Mayor Glenn Elliott said MPT may agree to do that “basically just for the transaction costs for doing so, including back property taxes, legal and brokerage fees and other administrative costs associated with the transaction.”
http://wvmetronews.com/2020/02/21/california-hospital-company-leaves-wv-holding-the-bag/
“In a time when most communities are looking to their local hospitals to be the first line of defense in the battle against the COVID-19 pandemic, Sherman’s oldest operating hospital seems to be battling the bottom line.”
“Alecto Healthcare Services, the company that owns Wilson N. Jones Regional Medical Center, owes the Grayson County Tax Assessor Collector’s office $675,808 for business personal property taxes for 2018 and 2019.”
https://www.modernhealthcare.com/hospitals/unable-find-buyer-west-virginia-hospital-plans-close
“West Virginia's Northern Panhandle was rocked late last summer when Ohio Valley Medical Center in Wheeling and East Ohio Regional Hospital in Martin's Ferry both closed.
The facilities were owned by Alecto Healthcare Services of California, which said it had lost $37 million over the past two years.
Nearly 1,100 employees were affected, with the area losing acute care beds, emergency medical services and mental health facilities.”
Carepoint:
This is yet another thinly capitalized operator that was funded and partly owned by MPW. They took over a bankrupt hospital in NJ. Amid continued losses, there have been some reports that CarePoint stripped the operator of assets, squeezed large fees and left the hospitals in dire straits. Oddly, MPW sold the two hospitals last year, with limited disclosure provided. There is now a lawsuit relating to that sale.
https://www.state.nj.us/sci/pdf/HospitalsReport.pdf
Halsen:
This was a new tenant in 2019 and fits the bill of thinly capitalized operator with little skin in the game. They bought a property that Quorum Health (recent BK) deemed inferior and sold. This tenant has a limited operating history and a loan was made to the opco.
Circle:
In January, MPW acquired a big portfolio of U.K. hospitals from Circle Heath, a small operator with which MPW has an existing relationship.
The BMI portfolio which MPW bought has been mired in a lengthy restructuring battle as the opco and prop co fought due to uneconomic rental rates. Ongoing losses created an untenable situation. Ultimately, the owner of the assets recut the leases to lower rents as part of restructuring. I think this is what will happen to many of MPW’s existing leases down the road.
https://www.bmihealthcare.co.uk/about-bmi#gdpr-out
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Official Statement on COVID
MPW’s released the following statement on March 23, 2020:
“The world has been hit with an unprecedented situation with the coronavirus (COVID-19) pandemic. Hospitals around the world are stepping up to the challenge and seeking to meet the urgent healthcare needs created by this pandemic.
Medical Properties Trust owns hospitals in some of the hardest hit countries in Europe and, of course, throughout the United States. We are in frequent direct contact with our largest tenants in these regions. In Italy and Spain, our operators are working with the respective governments to make their beds available primarily to treat non-COVID-19 patients, thereby freeing space in other hospitals. Some of these operators also have a small number of COVID-19 patients at this time. We also own interests in hospitals in Switzerland, another hard hit country. Similar to other European governments, Swiss officials have already established significant additional hospital funding to help pay for the treatment of COVID-19 patients there.
In addition, we own 40 hospitals in the United Kingdom, although our operators there are not yet treating many COVID-19 patients. However, as with the other major private hospitals in the United Kingdom, these operators have reached an agreement with the UK government to provide various services under the direction of the NHS and will be reimbursed their cost.
In every locale our hospitals are in, governments recognize the need for the funding of hospitals for the benefit of their citizens. Here in the United States, our operators are working closely with the Centers for Medicare & Medicaid Services and The U.S. Department of Health and Human Services to meet the needs of the people in our country. They all stand ready to help with any influx of COVID-19 patients or with other patients that have been displaced by COVID-19.
At this time in the United States, hospitals are aggressively deferring non-critical surgeries and treatments to make beds available for a substantial increase in COVID-19 patients. This is what Federal and state governments have requested and our operators have responded. The effect of deferring these treatments is immediate, and includes temporary reduction of revenue. However, the spike in COVID-19 patients for whom those beds have been emptied has not yet occurred and therefore the revenue that would be expected to replace revenue from deferred non-critical patients has not been received. Also, when COVID-19 patients do begin to be admitted, hospitals will have immediate cash needs for the physicians, nurses, equipment, drugs, and supplies that this particular illness is expected to require. Accordingly, the hospital industry is likely to need to draw on cash reserves and government support to “bridge” this disruption in their cash flows.
It is not possible to accurately predict when these expected changes in volumes and patient mix and spikes in cash needs will occur. Certain hospitals may be temporarily challenged in matching patient and other revenue to their immediate cash needs. If this does occur, we would expect normal patient volumes to recover after the world proceeds through the worst of the pandemic. At present there is no certainty about any government financial support to assist hospitals through the pandemic, including for the potential cash flow disruptions resulting from the current deferral by hospitals of non-critical procedures.
Hospitals remain at the center of the delivery system of healthcare in the United States and across the world. Hospitals will play a critical part in getting the world past this crisis and will demonstrate for future generations the irreplaceable role they play in keeping the world safe. We are grateful for the dedication and tireless efforts of all of the employees of our operators in helping to take care of the people of the world.”
I believe there are several near-term catalysts for the MPW short. Most significant, COVID is going to decimate the financials of most tenants due to the loss of elective surgeries and other non-essential revenue. Most tenants are highly levered with little room for error.
When MPW releases quarterly earnings, they will have to disclose more information on rent received, impact of COVID, etc. Are they offering rent deferrals? Management says they have access to realtime information from the hospitals, so investors should ask about the performance. To date, they have not offered much detail. MPW discloses heavily adjusted coverage metrics, so I do not expect an immediate weakness there, especially since they are based on trailing numbers. Acquisition guidance will be interesting. I think some analysts are also not modeling the non-cash rent correctly in future periods. 1Q20 results will provide more clarity on the run-rate. Without new acquisitions, 2Q20 earnings should also shed more light on MPW's core cash flow generation.
The financial results of other hospital operators will also be informative. While the vast majority of MPW's tenants are private, financial results will come out over the next six months. Steward financial statements for 2019 will be particularly interesting. Regulatory decisions and newsflow may apply some sunlight to operations of MPW's other tenants that were discussed in this write-up.
I believe increased scrutiny of for-profit healthcare operators will also be a catalyst, especially given the financial assistance provided by the government. The pandemic has exposed areas of weakness in our healthcare system. It seems that the public is catching on to how some bad actors have abused a fragmented payment system. Many of these bad actors are MPW's largest tenants.
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