09/05/22 11:17 AM EDT

MONDAY NIGHT REIT READ | INVH ADDED TO S&P 500 + MORE MPW THOUGHTS | 9.5.22 (INVH, MPW)

Rob Simone, CFA

Takeaway: MPW is a "broken" stock; adding other NNNs to the Position Monitor

Hedgeye Cartoon of the Day: Grave Mistake

It is 9.5.22, and Active Short MPW is overvalued by approximately ~$14.32/share. By the way whenever we write this, what we mean specifically is as currently structured we view MPW as having little-to-no equity "value" owing to: (1) a complete reliance on external financing to both grow and support its operators, (2) a collection of large operator tenants who cannot stand independently without MPW's support, and (3) MPW's own high leverage levels. MPW obviously does still have a price. Some more thoughts below following the clear beginnings of an MPW marketing campaign.

Ticker: INVH

Company: Active Short Invitation Homes

Subsector: Single-Family Rentals (SFR)

Headline: Near-term pain likely as INVH added to S&P 500 index

On Friday S&P announced that INVH will be added to the S&P 500 index. While it had been on several sell-side watchlists for addition, we thought it was unlikely this year as CPT had already been added earlier in 2022. It is very rare for two REITs to be added in the same year. We were wrong.
There will likely be some near-term pain for shorts as funds rebalance and are forced to add shares.
The fundamental short case remains, however, as the RoC is slowing for SFR broadly and newly constructed homes are being converted to build-to-rent (BTR) units in several key markets as new and existing homes sales slow broadly. So we will need to risk manage this one and pay attention to Keith's signals. Generally we would "sell on green" here and utilize the index addition as an exit.
One thing to note - we think that that lower occupancy and increased turnover in 2Q22 could be indicative of "buying up" leasing spreads, as rent increases to new tenants outpace rent increases to in-place tenants. Aka INVH may be opting to non-renew tenants so as to push rental rate increases to the max. This is likely only sustainable for a quarter or two, however, and on the backside of doing that a landlord is typically left with higher vacancy and declining rent growth/increased bad debt expense as the consumer slows.
Admittedly, this one has been frustrating. If you told us back in February that the situation would evolve as it has, including a highly damaging story in the WaPo re: the non-permitting issue and increased congressional scrutiny with INVH mentioned by name (here and here), on top of a weakening macro backdrop, we would have told you the stock would be ~20-30% lower than it is right now. Yet it is not.
We still await the judge's decision in the qui tam lawsuit in CA, and expect complaints to be filed in additional states under the same case.

Ticker: MPW

Company: Active Short Medical Properties Trust

Subsector: NNN Hospitals (MPW standing alone)

Headline: There is no reason to own MPW + it is not "cheap" + some other thoughts/observations

MPW's cost of capital is completely broken, so even if there are no tenant issues and management can "thread 1,000 needles" as we like to say, the company here (1) cannot grow earnings and (2) offers inferior economics to other triple-nets with better tenant credit/diversification and lower leverage. MPW is now "in the REIT box," which is very difficult to get out of. There is no reason to be long the stock here outside of the yield, which is not sustainable.
The stock is not "cheap!" Many investors look at the single-digit earnings multiple and near-8% dividend yield and see a "cheap" stock, but ignore the high leverage and other structural factors. Consider the following:

On our numbers, MPW is currently trading at a ~7.1% implied net effective cap rate inclusive of cash G&A expenses and is ~8.7x levered on a net debt/cash EBITDA basis. We have suspected that "true" leverage is actually higher, as management is "liberal" with pro forma adjustments as well as reported straight-line rent + interest adjustments and rent deferral figures. For example, on page 8 of the 2Q22 supplemental MPW makes a ~$564 million adjustment to net debt (which we think refers to the Prime purchase option) but does not appear to make a corresponding downward adjustment to EBITDA for the rent "sold" back to Prime.
On a stand-alone basis, if MPW is earning ~5.5-6% unlevered yields on new investments for the foreseeable future owing to very long lease terms and no value creation potential (see Figure 1 below), then raising capital at that ~7.1% cost of capital is by definition dilutive to earnings and value. This is the "earnings spiral" for triple-net REITs where the "cheap" REITs become quasi perma-shorts (see GNL, former ARCP/VEREIT, etc.). For the non-REIT dedicated investor, this is the equivalent of an acquiring company trading at ~14x EBITDA buying a target trading at ~18x EBITDA with no synergy potential. The only productive use of capital from any equity raise would be to de-lever.
Then on a relative basis, the question becomes "why buy MPW?" with its very clear and potentially existential tenant issues, inappropriate end industry focus in hospitals, and destructive lending relationships to significant rent-paying tenants? This being compared to similarly-priced triple-nets with diversified tenant/industry sectors, less credit risk and lower leverage. Just to name a few alternatives:

National Retail Properties (NNN): ~6.4% net effective cap rate, 5.4x leverage
Getty Realty (GTY): ~6.6% net effective cap rate, 4.9x leverage
Essential Properties (EPRT): ~6.5% net effective cap rate, 4.6x leverage
And then perhaps SRC/STOR, although we have them on the Passive Short list. Even they are superior alternatives at mid-7% cap rates and mid-5x leverage

There is no bull case for MPW as a triple-net REIT.

Changing the narrative?:

On 8.25.22, after meeting with MPW management on 8.23.22 (we believe), a competitor wrote and we quote verbatim: "The stock attracts controversy, we believe, because it is unlike most REITs. MPW's primary business is funding operators that rehab underperforming hospitals."
We found this to be highly credible (versus incredible) and probably truthful, as this is the argument that we have been making from the beginning: That MPW actually does not invest in hospital real estate, rather the entire hospital system via direct equity and debt investments in key operators along with purchasing the real estate. In some cases, MPW funds the entire purchase price. And in the process of doing so, MPW removes the "arbitrage" from the "PropCo-OpCo arbitrage." We tweeted about this on the evening of 8.25.22 upon reading the note, because we thought it was both extremely meaningful and validated the short thesis.
Then on 8.26.22 the above language was recast in a note re-write: "The stock attracts controversy, we believe, because it is unlike most REITs. MPW's primary business is purchasing and then leasing hospitals to operators that work to stabilize underperforming assets."
Really? Which one is it? And we ask this because those are two VERY different things. What is MPW's primary business? Does management know what MPW's primary business is? Do the analysts know what MPW's primary business is? Are they trying to come up with that on the fly and on a reactionary basis? And perhaps more importantly, should you as an investor have any trust in this situation?
Coincidentally a few days later MPW itself issued a press release on the LifePoint/Springstone transaction that advertised "WholeCo" transactions.
Keep in mind that the best hospital systems are valued at ~6-8x EBITDA while MPW is levered 8.7x on a cash EBITDA basis.

More on the $150 million Steward loan facility:

Another competitor wrote last week on 8.26.22 that "...the company provided the operator a $150 million loan in April 2022 in order to help it through temporary cashflow pressures." Presumably this was disclosed by management to the analyst in a 1-on-1 meeting.
MPW held its 1Q22 earnings call on Thursday, 4.28.22.
That would mean that (1) either the loan facility was originated on Friday, 4.29.22 or Saturday, 4.30.22, or (2) MPW opted not to disclose this very material loan to a ~25-30% tenant along with 1Q22 results. It for sure means that MPW did not disclose the loan as a subsequent event in the 10-Q filed on 5.10.22. It also means for sure that MPW waited ~3 months to alert the investing community, including bypassing NAREIT and analyst meetings in Birmingham during an earnings quiet period.
The loan was disclosed verbally on the 2Q22 earnings call held on 8.3.22, but not in printed materials.

The Steward/HCA Utah purchase price:

Our understanding is that MPW also disclosed verbally to another covering analyst that the purchase price for the OpCo in the scuttled Steward/HCA Utah deal was ~$850 million, or roughly ~5.5x EBITDA.
If that is the case, then Steward for sure has negative equity value.
Consider that Boston + Utah + Miami are Steward's best markets and very likely account for over ~100% of the system's profitability. Therefore, it would not be appropriate to extrapolate this valuation multiple across the entire system for one.
Then consider that the PV of Steward's operating lease liabilities is roughly ~$3 billion as we have show previously. If we made the heroic assumption that the system was valued at ~5.5-6x EBITDA (let's use ~6x to be generous and for round numbers), that would mean that Steward would need to be generating >~$500 million of EBITDA (not EBITDAR!) to have any residual value.
Steward is not generating anywhere close to ~$500 million of EBITDA. As a matter of fact, even if we took the aggressive and unlikely ~$800 million EBITDAR run-rate provided by MPW management and netted ~$500 million of annual lease payments against it, EBITDA would obviously be ~$300 million. As we have said and written, we do not think that ~$800 million is close to the EBITDAR real run-rate.
Steward's credit facility matures on 9.29, it is in the process of selling its most valuable Medicare receivables to CMAX, it is still likely burning significant cash, and MPW is increasing its loan exposure to the OpCo with negative equity value.

We found another inconsistency from the 2Q22 earnings call. There are so many, they keep popping up!

R. Steven Hamner, CFO: "Notwithstanding Steward's strong recent and improving facility level EBITDARM performance across its portfolio, the most recent quarters have suffered from cash pressures. These were caused by, for the most part, the investment of more than $200 million in last summer's acquisition of five hospitals in the Miami area..."
But MPW funded the ~$200 million, or just under ~20% of the total $1.1 billion purchase price, back to Steward in the form of "capex" before the end of 2021.
As a reminder in a triple-net arrangement "capex" is the responsibility of the tenant (Steward), not the landlord (MPW).
So what are we talking about here? The amount paid by Steward to Tenet for the OpCo was essentially refunded back to Steward by MPW, aka MPW took all the risk. So not only did MPW front the entire purchase price for the deal (asymmetric risk) to stuff Steward with more hospitals, but definitionally this ~$200 million could not contribute to "cash pressures."
We view this as nothing short of a gross misrepresentation of the facts.

So how does this get fixed? In the interest of keeping this productive we would like to make some suggestions for how MPW's Board can work to fix this situation. We are not sure that MPW's share price can be saved, or that the business model (triple-net hospitals) is even sustainable, but here is what we would do:

MPW cannot survive without access to capital, and MPW cannot gain access to that capital without restoring investor confidence. First, we would appoint 1-2 new and truly independent Board members with financial restructuring and turnaround experience. It will likely be needed.
Second, we would remove and replace the existing Section-16 officers who no longer have the confidence of the REIT-dedicated investing community. We have heard this several times directly from multiple of these investors. We are not sure how possible this is given the level of entrenchment, but we do not see how this company survives and thrives without a leadership change.
Third, and this is an easy one, separate the CEO and Chairman roles.
Fourth, immediately end the practice of making sizeable equity and debt investments in significant triple-net tenants. "Incubator" investments to smaller tenants with the hope that they eventually take additional space in the future is one thing. The current model is unsustainable and value destructive.
Fifth, de-lever the balance sheet through a combination of asset sales where possible and selling equity to repay debt. Longer-dated maturities are yielding >7% right now, and the benefits of reducing any potential financial distress far outweigh any breakage costs in our view. This will obviously damage the share price in the near-term, but would set up a more sustainable long-term path going forward.
Sixth, gradually deploy capital to different healthcare asset types that are more sustainable and offer better cash economics. This will be a long haul effort.
And lastly seventh, reform the company's compensation arrangements to de-emphasize non-cash metrics and deal volume in favor of long-term value creation, cash returns, TSR, etc.