06/17/22 07:34 AM EDT

REITS DAILY BRIEF | 6.17.22 | (MPW - MORE BAD NEWS)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Steward/HCA scuttle Utah merger after FTC moves to block transaction

Hedgeye Cartoon of the Day: Still No Regrets

Investing Ideas: Most Recent Trend Ranges

Longs

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Ticker: MPW (Active Short)

Subsector: Healthcare / NNN Hospitals (really just MPW standing alone)

Headline: Steward/HCA walk away from Utah deal

Last night the FTC announced that Steward Health Care System and HCA Healthcare (HCA) had opted to scuttle their proposed Utah merger involving 5 Steward-operated hospitals owned by Active Short Medical Properties Trust (MPW), which would have been a source of much needed (in our opinion) liquidity support for Steward operations, including supporting over ~$400 million of total annual rent + interest as per Steward's 2020 financials. MPW is Steward's landlord, a 9.9% equity owner and largest unsecured lender.
This is an unequivocal negative for MPW, despite what MPW’s management team may or may not try to sell us, and as we wrote HERE was the most likely outcome after the FTC chose to challenge the merger on anti-competitive grounds. MPW was confident that this deal was likely to close despite completely obvious concerns the FTC would try to block it.
Steward is MPW’s largest operator relationship and represents ~25-30% of MPW’s annual revenue between rental revenue and interest income. We would love to be able to say “largest tenant,” but MPW’s direct investment in and support of the operator complicates what should be a simple lessor-lessee relationship in a negative way. This transaction would have shaved about ~10 percentage points from MPW’s exposure, but is now obviously off the table.
This was the second time this week that hospital systems opted to back down from a proposed merger after being challenged by the FTC. All else the same, it seems transactions like these are much riskier and less likely to proceed going forward.
MPW has now lost its access to capital via the put option on the hospitals to HCA, which was contingent upon closing.
The question should now be, “what will be the next rabbit that Steward/MPW attempt to pull out of their hats?” As we have written, and this involves reasonable assumptions given the lack of 2021 Steward disclosure at MPW’s option, we believe: (1) Steward likely has something close to ~$200 million of available cash following the Caremax deal, (2) Steward is burning through an estimated ~$200 million per year after operator capex, (3) Steward is not covering its rent/interest on a recurring EBITDAR/EBITDARM basis and including capex makes it worse, (4) Steward has negative working capital and essentially no remaining financeable assets, (5) Steward must refinance its credit facility on 9.29.22 and (6) Steward is very likely near the point of insolvency.
Given that MPW is essentially sitting on both sides of the Steward transaction as both landlord, but also unsecured lender and 9.9% equity owner, we believe a lease restructuring is the most likely outcome to avoid a Steward default. Assuming a ~2x coverage ratio on recurring EBITDAR/EBITDARM, this would imply a ~$200 million reduction in annual cash rent paid to MPW.
As MPW is ~10x levered on a net debt / cash EBITDA basis, such a reduction in cash revenue from Steward would (1) for sure require an MPW dividend cut and (2) very likely send MPW’s stock price into the mid-single digits or lower. This is just one tenant, and we believe there are multiple stressed tenants in MPW’s portfolio. We have used the words “potential zero” to describe MPW, but lets be honest, a ~75-80% decline in the share price from the mid-$20/share range + a dividend cut is effectively a “zero” for a NNN REIT.
Selected MPW management comments on Steward/HCA in Utah:

Edward K. Aldag, CEO: "Like the Macquarie transaction, this transaction provided reinforcement of the value of MPT's real estate by sophisticated third parties, along with the validation of the strong performance of these Steward hospitals. Upon the closing of these two transactions, Steward's concentration for MPT will have been reduced to approximately 18%. More importantly, no stand-alone Steward regional market will represent more than 6%, and no single Steward-operated property will represent more than 2% of our pro forma assets." - 3Q21 earnings call
R. Steven Hamner, CFO: "Upon completion of these transactions, and completion is not assured, MPT will have access to approximately $1.3 billion in attractively priced capital, greatly diversified its tenant mix, introduced HCA as a top five tenant in the MPT portfolio of world-class hospital operators, and accretively recycled JV proceeds into these irreplaceable hospital facilities in the country's seventh largest metropolitan area." - 3Q21 earnings call
R. Steven Hamner: "... there's a put option that we have. We haven't disclosed the total details of it. But at a minimum, that we can put the properties to HCA at no less than fair value. There's actually a floor that we're unable to disclose, but it's a very attractive option for us..." - 3Q21 earnings call
Edward K. Aldag: "The other previously disclosed transaction that we announced in 2021 that we expect to close later this year is the agreement to lease substantially all of our Utah hospitals to HCA Healthcare. This will place HCA as one of MPT's five largest tenants and reduce the percentage of MPT's portfolio represented by Steward to just below 19%. As we have pointed out before, but it is a good reminder, no Steward regional market will represent more than 6% of our total portfolio and no single Steward property will represent more than 2% of our pro forma assets." - 4Q21 earnings call
Edward K. Aldag: "And just as a reminder, the HCA Utah transaction is projected to close by the end of the second quarter of this year." - 1Q22 earnings call
R. Steven Hamner: "And second, recall that MPT has a put option that, subject to FTC approval and closing of the transaction with Steward, allows us to sell these assets to HCA at fair value. It is currently not our expectation or our plan to exercise that option in the foreseeable future. But when compared with an alternative that would contemplate funding our growth with common stock sales at recent prices, it should make clear to anyone that it is highly unlikely that there will be any such common issuances." - 1Q21 earnings call
And then finally, the closer given the clear FTC stance against these transactions, R. Steven Hamner: "So for example, let's just take Utah because Steward has already agreed to sell Utah. What if something bad happened at the Steward parent level 12 months ago and we had to start taking back our facilities where we would capture those Utah assets and any others we wanted. Presumably, they would be generating strong profitability based on the local coverage that we've just reported. And we would be able to call HCA or Intermountain or some other large operator who wants to get them to Utah and tell them we're the landlord, we have these businesses. It's not just empty shell buildings. We have these businesses that are generating substantial profitability, recurring profitability. We'd like to give them to you." - 1Q21 earnings call

How will management respond? Or will they just pretend this did not happen on the next earnings call and move on to the next narrative? We would bet on the latter, but shareholders should hold them to account and want to know what plan B is for capital availability at both Steward and MPW.