10/26/22 12:31 PM EDT

THE (DIS)TRUST SERIES | VOLUME XIX | 3Q22 PREVIEW | 10.26.22 (MPW)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Sharing our thoughts on how tomorrow could proceed + updating some numbers

Hedgeye Cartoon of the Day: Still Burning

Ticker: MPW

Company Name: Active Short Medical Properties (Dis)Trust

Subsector: NNN Hospitals

Headline: Its really up in the air how tomorrow may go, but sharing our thoughts

Our Thoughts on 3Q22:

First, the equity is still worthless. More to come on that below, but let's just establish it upfront AGAIN.
Second, at this juncture it's important to distinguish between "Are we correct in our fundamental view that MPW is a broken company?" versus "What will the stock do?" We feel very strongly that we have sufficiently demonstrated that the answer to question #1 is "yes." It is simply irrefutable at this point, based on the data and evidence. But to recap, here are some of the issues as we see them in what is in no way meant to be an exhaustive list:

A broken and uneconomic business model
Adverse selection
Distressed and insolvent operators
Poor capital allocation
What we believe to be entirely inappropriate and less than "arm's length" transactions
A company that exists solely for the purposes of enriching management
Questionable management work histories
Poor disclosure and outright misrepresentation
Insider dealing and nepotism
Misuse of shareholder assets, such as maintaining a private jet fleet and leasing premium, unnecessary Manhattan office space
Lack of Board independence and poor corporate governance
Lack of ability for whistleblowers to raise concerns
Excessive financial leverage

With all of that said, here are our thoughts on the quarter. It will probably proceed along one of two paths:

Path #1: More of the same. Management will tout "accomplishments" from the quarter (that likely do not exist) and paint a rosy picture around its operator performance and the impact of its planned transactions. This would represent a non-event. We know the operators are not performing well, and we have demonstrated (see PDF below) that the announced transactions are dilutive, do not sufficiently delever the company and place additional pressure on MPW's unsustainable dividend payout.
Path #2: They come out swinging and launch a "Hail Mary." This is the more interesting path, likely intended to create a significant squeeze in shares near-term but will require follow-through which we are confident the company cannot produce. To be clear, each of the below would likely cause shares to rise near-term:

It's possible, but very unlikely in our view, that they announce Steward fully extended its ABL facility (see numbers presented in Figure 1 below). The key follow-on questions there are whether MPW had to participate in a syndicate, whether it had to make other loans concurrent with an extension, or whether MPW had to guarantee the facility.
It's possible that they take an adversarial stance against Hedgeye, given how vocally bearish we have been on the name. We believe the facts and math are on our side, and think this would ultimately prove destructive for the company.
It's possible that they announce that Steward's Utah portfolio has been sold or is under contract, which would provide near-term liquidity to Steward and "kick the can down the road." The questions there, as with all MPW-related transactions, would be what role did MPW play in order to get it done? What did it have to offer to the buyer to get the transaction closed? Also of note is that the prior buyer, who struck the deal well over a year ago under a very different macro and capital markets regime, is no longer involved. Finally, what are the after-tax use of proceeds? We believe they are all spoken for in the form of debt repayment, and meanwhile Steward will have meaningfully impaired its go-forward profitability.
In summary: Along this path analysts and investors would need to dig deeply beneath the surface and ask "How?"

The Questions We Would Ask on the Call/Things We'd Look For:

There are too many to mention here, but here are a few key ones:

Why will you not disclose the backup/support to the ~$800 million of annual run-rate EBITDAR at Steward, an impossible scenario in our view, which was mentioned on the 2Q22 earnings call? You claim that it would create issues with your tenant, but in section 39.6 of the master lease Steward agrees to furnish financial data including audited financial statements to MPW, and upon our read also consents to disclosure of that information in regular-way communication with analysts including on earnings calls.
Why did you not disclose the ~$150 million loan to Steward, apparently funded in April 2022, on the 1Q22 earnings call or for several months thereafter? All while representing to analysts and investors that things were "fine" and Steward was improving?
Why, in response to a direct question from an analyst, did you claim on the 2Q22 earnings call that you would not need to lend to Prospect Medical? Meanwhile, a $100 million loan had apparently been funded to Prospect in May 2022, was not previously disclosed anywhere, and then later mentioned in a footnote in the 2Q22 10-Q filing.
Why did you not file an 8-K related to Pipeline Health's bankruptcy filing? GMRE promptly filed an 8-K alerting investors.
Why did the CEO mention previously undisclosed terms of Steward's interim ABL extension in a printed interview, after MPW had claimed to analysts/investors on or about 9.30.22 that it was not aware of the terms? And then why did the CEO reference lines of disclosure in the Steward ABL press release that literally did not exist?
Why did MPW extend a ~$335 million loan to an individual? What is the rationale behind that and how is it a good use of shareholder capital? We have written on our view that this loan is highly problematic.
Is MPW's Board of Directors aware of the issues that Hedgeye has raised in the course of its research?
Is the gap between reported AFFO and Cash from Operations (CFO) on the CF statement continuing to widen? How are rent deferrals trending, and who is deferring?
Did you make loans to any additional operators in or after the close of 3Q22?

The Steward Financials:

We do not expect MPW to present financial information for Steward, although it is possible they do so. If they do present financial data, they MUST be heavily scrutinized in our view.
With that said, given Steward's obvious criticality to the situation and the unreliability of MPW's numbers, we continue to be of the opinion that we must have a view on Steward's financial condition using reasonable assumptions.
Fortunately, several of Steward's uses and sources of cash are either known or contractual. The "swing factor" is really the level of cash EBITDAR being generated by the system.
We ascribe a near-0% probability to MPW management's prior claim of ~$800 million of annual run-rate EBITDAR.
We believe that Steward's current annual run-rate EBITDAR is no better than ~$300-350 million. If anything, we believe that we are being generous and that Steward's financial condition is much worse than we first believed.
Using our best estimates, the red figure in Figure 1 below represents our best estimate of the balance outstanding on Steward's ABL facility if we were to carry numbers through to year-end 2022. This is the figure that would theoretically need to be repaid by Steward, rolled by Citi or refinanced all or in part by MPW. It's a big number.
Obviously, we believe Steward is both not covering its rent with EBITDA or cash flow, is hopelessly overlevered and is insolvent.
Note that this analysis gives no effect to Steward's regular-way A/P balances with vendors (excluding repaid MAP payments), which we believe have likely increased very materially over the ~$1 billion reported in 2020.
The attached PDF below puts all the key pieces together on Steward and MPW as we see them, and serves as an update to the math first presented in our July presentation.