08/09/22 09:03 PM EDT

FOLLOW-UP THOUGHTS TO MPW'S 2Q22 RESULTS & CALL | 8.9.22 | (MPW)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Our conviction on this short call has STRENGTHENED over the past week

Hedgeye Cartoon of the Day: Pinocchio

Ticker: MPW

Company: Active Short Medical Properties Trust, Inc.

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

Headline: We still see an overvalued stock and equity that will ultimately prove next to worthless

We were waiting for the 10-Q filing, which just hit today, to do a full review of the quarter. In summary: not much has changed to our thesis, and if anything additional questions have been raised. At its core, we see an over-levered pile of poor credits that should be trading at a discount to "book" today. The key question for longs, in our view, is does it make sense to wager all one's capital in this investment on Steward's solvency, only to "win" the right to continue holding that bag? We don't think it makes sense. The next catalysts are resolution of Steward's revolver maturity on 9.29, 3Q22 results, the CMAX deal vote prior to closing, and then any potential Steward or Prospect rent reduction between now and 1Q23 under a "soft default."
"The Loan" #1: On the call management disclosed a ~$150 million secured loan facility provided to Steward "early in the second quarter," carrying a 5-year term, cross-collateralized with the master lease, and mandatory prepayment from any sale of Steward OpCos. The "market rate" comparable to current lease rates was not disclosed, nor was a component of additional interest upon repayment (make whole?).

We want to be very clear, this move is consistent with and affirms our thesis: (1) a healthy, cash-flowing tenant able to operate on its own would NOT require this type of support from its landlord, to whom Steward now owes something approaching ~$500 million in annual rent + interest, and (2) as we have written and talked about, we expected that MPW would make a loan directly to Steward, both because it cannot afford to let Steward fail and Steward would have significant difficulty finding a third-party source of financing. We said such a move would be a significant "red flag." We received significant pushback over this idea but it has proven to be correct, and we think investors should consider Steward at or near "the zone of insolvency."
This comes on top of: (1) ~$200 million being channeled directly to Steward via the int'l JV, (2) MPW acquiring a direct ~9.9% interest in Steward, (3) MPW directly financing Cerberus' exit and receiving additional Steward equity pledged as security, (4) MPW funding an additional ~$200 million to Steward Florida, which equaled Steward's purchase price for the OpCo, and (5) MPW paying ~$60 million in April for a vacant Steward hospital in Florida that will not open and begin cash flowing until ~2024. Are you following along here? If Steward needed ANOTHER loan in 2Q22 to address struggling cash flow, on top of all of these "investments," then how could Steward have ever paid MPW its rent absent all of this support?
This very material, related-party transaction with a ~25-30% tenant relationship was not explicitly disclosed anywhere in the press release, presentation or supplemental, all of which were released several hours before the earnings call which itself occurred 3.5 hours into market trading. It appears that the "other loans" balance on the BS increased by about ~$150 million, so that would appear to account for it. We would just question why this was not made known front-and-center, as it is such a critical part of the MPW story right now.
Contingent on the outcome and structure of Steward's credit facility, MPW indeed does now own more of Steward's cap stack. Again, MPW is NOT just underwriting and investing in the real estate as they claim to do, they are investing directly into a distressed operator. It is as clear as day.
Finally, we now fully expect MPW to be the party to most likely provide any ABL facility upon Steward's revolver maturity. What credible third-party lender would originate a loan to a counterparty without an audit (see below)? It is also unclear what the amount and composition of Steward's A/R balances will look like assuming the CMAX deal closes, as Steward has financed all existing and sold all future Medicare receivables. It is possible that Steward pledges CMAX shares as collateral for a loan, but this is contingent on close. None of these things address the ongoing rent liability back to MPW.

The "~$800 million of run rate EBITDAR at Steward:" We have little to no reason to believe or take this number seriously. It is nowhere close to what we would consider to be a reasonable estimate. Recall we recently estimated close to ~$400 million of recurring EBITDAR today, and this number implies a 2x and 4x from 2019 and 2020, respectively. Here is why we don't believe it:

First and foremost, we don't have the actual 2021 audited Steward financials so there is no way to verify it. Speaking of which, it would appear that Steward doesn't even have a completed audit for 2021, which is pretty incredible considering it is August 2022. We can infer this given that MPW management cited unaudited and unadjusted 2021 EBITDAR of more than ~$450 million. Should we believe that number as well?
They are annualizing just the two most recent monthly results to arrive at ~$800 million, presumably June and July.
We don't know how much CARES Act grant activity is included in the June month, and thereby potentially being annualized by a factor of x12 as grants are set to burn off. For example, CYH was still booking CARES Act grants in 1H22.
Why did MPW not put these numbers down on paper in the deck? Why in the same deck did they hint at a "cash flow reset" and "positive cash flow in 4Q22?" If Steward was actually generating that level of income currently, wouldn't they already be cash flow positive by definition? (Hint: they would, and would not have needed the $150 million loan!)
MPW footnoted (again) that they have not independently verified the Steward information. Ok... it's just your largest tenant and relationship! I guess we'll all just take each other's word for it and keep on trucking!
And then finally, and perhaps most importantly, just thinking through that math - Steward reported a ~6.3% unadjusted EBITDAR margin for 2019. If we make a reasonable assumption for run-rate revenues including the impact of the 5 former Tenet Miami hospitals at ~$7-7.5 billion, ~$800 million of current run-rate EBITDAR implies that Steward's margins have nearly doubled to somewhere around ~11%. None of THC, CYH or UHS have shown anything close to that level of margin improvement since 2019, with both CYH and UHS showing margin deterioration. The last two quarters, specifically, have been brutal for public hospital operator margins, and we fully expect that private operators performed worse.
So perhaps Steward is just a standout performer? While at the same time hasn't been paying vendors, took essentially a ~$200 million loan from MPW via the international JV (our interpretation), was essentially reimbursed by MPW for its share of the Tenet Miami OpCos, and was just extended another ~$150 million loan from MPW in 2Q22. Makes sense...

"The Loan" #2: MPW disclosed on page 14 of the 10-Q filing that it increased its mortgage loan to Prospect by an additional $100 million. It was originated in 2019 and is secured by a first lien in a CA hospital, and is anticipated to be repaid in the fourth quarter. As we mentioned post-quarter, Prospect looks to be performing worse than Steward but is just a smaller portion of MPW's pie at ~8% of revenue. Again, reported coverage metrics exclude the PA and CT hospitals, which are the worst in the portfolio. Prospect looks like a disaster.
MPW has another ~$130 million of remaining development commitments through 3Q24 (10-Q page 16).
Question - Is the loan used that was used to finance the Cerberus buyout by Steward's management PIK'ing? There is an "initial cash pay" of 4% plus a participation, and each quarter the balance appears to be increasing. Not clear based on the disclosure, but the more Steward appears insolvent, the more that loan is really "equity" vs. debt. Also, who is servicing that loan, Steward or Steward's management team? If the latter, what is the source of that ~$14 million in annual debt service?
Regarding Steward's financial statements, MPW wrote (10-Q page 20): "At June 30, 2022, the assets leased under triple-net leases to Steward (our largest tenant), including our share of assets leased through the MAM partnership discussed above, represented less than 20% of our total assets." Someone, anyone, please ask management to provide this calculation. Its too important not to track down, and MPW's own reported numbers indicate that Steward is and has been >20% of gross assets. This includes at year-end 2021, prior to the MAM transaction closing in 1Q22.
New acquisition subsequent to quarter-end (10-Q page 26): "On July 29, 2022, we acquired a general acute care facility in Colombia for $26 million. This hospital is leased to Fundación Cardiovascular de Colombia pursuant to a long-term lease with inflation-based escalators."
We think MPW may be understating its leverage in the supplemental, accounting for a leverage reduction from the Prime purchase option but not reflecting a corresponding reduction in EBITDA from the sale. We calculate MPW's leverage on a cash basis at nearly ~9x EBITDA inclusive of its share of UJVs.
MPW's combined pool of lease + loan assets is still generating roughly a ~6% unlevered cash yield on total gross investment, which again given the cost of capital likely warrants a discount to the book value of that invested capital. We estimate ~.75x or so versus 1x book today, which translates to a ~$10/share stock price. MPW is NOT cheap, and again is a pile of poor credit risk.
On the positive side, the incremental disclosure around the real estate UJVs is appreciated and helpful.