12/06/22 06:31 AM EST

THE (DIS)TRUST SERIES | VOLUME XXXI | THE STEWARD ABL SAGA CONTINUES | 12.6.22 (MPW)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Still waiting... guess the ABL extension wasn't imminent after all?

Hedgeye Cartoon of the Day: Dumpster Fire

It is 12.6.22, and Active Short MPW is overvalued by approximately... whatever the current share price is.

Ticker: MPW

Company Name: Active Short Medical Properties (Dis)Trust

Subsector: NNN Hospitals

Headline: Some thoughts ahead of the pending 12.15 "outside date" on Steward's ABL extension

It should be abundantly clear to investors that what MPW's management said at the November NAREIT conference about Steward and its ABL credit facility was and is not accurate and makes no sense. Here is what was discussed, as we understand it, and our reactions:

First: Investors were told in the strongest language that the ABL facility would be extended "imminently" and "well before" the interim maturity date of 12.15. Based on our discussions, investors expected this to be dealt with immediately after NAREIT, aka some bought the narrative. NAREIT was held in SF on 11.14 to 11.16, or three weeks ago. We now sit less than two weeks away from the outside date.

Our Take: This was not true (barring an announcement today or later this week). The CMAX deal and related financing mechanism supported a likely extended timeline to complete the audit.

Second: MPW's management told investors on the 3Q22 earnings call that a 1-year ABL extension was pending additional "documentation" from Steward. During the conference they finally admitted that Steward's 2021 audit was not yet complete, yet downplayed the significance. We suspected the audit was not complete back in August, based on language used by CEO Ed Aldag on the 2Q22 earnings call. This obviously begged the question: why was the 2021 audit not yet complete in August and now December 2022?

Our Take: We found this to be remarkable, and indicative of likely serious issues at Steward. Under what circumstances would Steward not have a completed audit for the prior year, this late in the year? We suspect it relates to going concern issues and language. We continue to view Steward as very likely insolvent with the ABL essentially fully-drawn and the company burning ~$200-300 million of cash per year. As a reminder, MPW (1) lent ~$150 million directly to Steward in 2Q22 to deal with cash flow pressures, (2) pre-funded ~$50 million for the Texarkana development for which no work was performed, (3) misrepresented that Steward's ~$200 million spent on 5 Florida hospitals was a drain on Steward cash (impossible, as MPW refunded that portion of the purchase price as "capex"), and (4) spent ~$60 million in 2Q22 to buy a vacant Miami hospital from Steward not slated to open for ~2 years. This alone equals ~$460 million sourced from MPW over the last ~12 months. More on that amount shortly.

Third: MPW's management told investors that the audit was being held up by a "technical issue." Later, they more fully explained that this issue stemmed from a new partner at KPMG questioning Steward's accounting treatment of the original sale-leaseback transaction, following Steward's 5-year extension of the lease term which triggers new accounting treatment for private companies as of 1.1.22.

Our Take: Every discussion we have had with current and former auditors indicated that (1) this makes no sense and does not explain a hold up, as this issue "could be resolved within a week," (2) no auditor would hold up the completion of an audit over this issue ahead of an existential debt maturity, thereby putting their client in jeopardy, and (3) presumably this issue was known for at least most of 2022, during which it could have been quickly resolved and meanwhile MPW both spoke of improvements at Steward and made no mention of the lack of audit. The conversations we have had indicate that this makes no sense whatsoever, and that "something is very wrong at Steward."

Fourth: MPW somehow convinced several sell-side analysts to treat the repayment of the ~$440 million of 2020 MAP payments in late-September 2022 as an immediate boost to Steward's EBITDAR / cash flow. MPW has said several times Steward's monthly cash flow will improve post-MAP. What?

Our Take: Twofold: (1) the MAP payments flowed outside of EBITDAR via the cash flow statement, demonstrably per Steward's 2020 financials, and (2) as we show above, over the last year MPW provided Steward with liquidity at least approximating (and likely more than) the use of cash to repay the ~$440 million Medicare liability. If we wanted to be generous (kind of) by strictly attributing the ~$200 million to 100% finance the 5-hospital Florida acquisition, that would mean MPW effectively financed ~55-60% of Steward's MAP repayment. Then again, Steward also held on to Tenet's receivables and did not pay under the TSA, so working capital was likely boosted by ~$50-100 million. Meanwhile over that time Steward was very likely borrowing and roughly maxing out its ABL facility, otherwise MPW would not have had to fund. We also suspect that Steward has stretched additional A/P to vendors and employees well-above the ~$1 billion shown on the balance sheet as of the end of 2020. So someone please explain to us how this frees up cash flow, since it was not being funded out of Steward's cash generation in the first place? Cash here is fungible...

Our appraisal of the situation:

KPMG is likely concerned about providing Steward with a "clean" audit, given its potential liability if Steward were to file within a year (something we find unlikely, to be fair, given that MPW cannot let this happen and would cut the rent as a failsafe option).
At least one lender in the syndicate likely does not want to extend without that "clean" audit, creating a catch-22 situation.
Based on the situation, we believe that same lender could potentially want an LOI from Steward/MPW evidencing a third-party's intent to buy the Steward Utah portfolio of hospital OpCos, with a likely additional requirement of ~$100-200 million (our estimate) of proceeds to be applied to pay down the ABL balance. The two potential buyers as we understand it, Prime and Intermountain, both (1) lack the capital so would therefore need external financing, and (2) are likely concerned about the FTC blocking the deal. For obvious reasons we view this potential lender requirement as especially challenging right now, although not having a completed 2021 audit this late in 2022 is concerning enough.

What we think happens from here:

Steward outright defaults: Least likely outcome, to be fair, if for nothing else than MPW cannot let that happen and will either lend additional money to Steward or ultimately cut the rent. Both of those are still bad for MPW's equity for obvious reasons, with the former torpedoing whatever is left of management's credibility and the latter sending MPW's stock likely into the low-to-mid single digits. Outright fraud (Texarkana?) would obviously change things and put a Steward default on the table.
Everything falls into place, as Steward furnishes a clean audit + an LOI from a Utah buyer and the bank group extends for a year: Also very unlikely given all the moving pieces, none of them easy, but maybe slightly more probable than an outright Steward default.
Most Likely Outcome: (1) MPW comes in to break the "logjam" by doing some combo of guaranteeing the debt (thereby making it MPW debt), syndicating the ABL or lending on a subordinated basis below the ABL lenders. It is also possible that MPW lends to Prime or Intermountain to finance their acquisition of Utah, although we find it unlikely given the FTC angle; (2) We get a 3-5 sentence press release, most likely from the Steward side, announcing the extension but not providing required details; (3) Sell-side analysts speak with the company, offer no critical thought or ask tough questions, and then publish notes touting a resolution; (4) The stock pops for a time; and then (5) Details begin emerging and the market figures out that nothing is solved and this is still an incremental negative, Steward has one year to "live" while still burning cash, MPW owns more of Steward's cap stack which is terrible, and the only long-term solution is a rent reduction to sustainable levels and probably on the order of ~60-65%.

You can count on this, we will for sure be vocal and attempt to ask the tough questions. As we have said before, we think about this short call as being proven right or wrong by the end of 2Q23.

Prior Notes:

12.4.22 - SUNDAY NIGHT REIT READ | WINTER IS HERE (AGAIN) | 12.4.22 (COLD, PGRE, VNO, AMH, INVH, TCN, MPW)

12.2.22 - REITS WEEKLY VALUATION HANDBOOK | 12.2.22

12.1.22 - REITS DAILY BRIEF | EQT "IN DISCUSSIONS" TO ACQUIRE RADI? | 12.1.22 (RADI)

11.29.22 - REITS DAILY BRIEF | HEALTHSCOPE PUSHED BACK + INDT BID | 11.29.22 (MPW, INDT)

11.28.22 - THE (DIS)TRUST SERIES | VOLUME XXX | PIPELINE BK UPDATE + STOCK IS NOT "CHEAP" | 11.28.22 (MPW)

11.27.22 - SUNDAY NIGHT REIT READ | POSITION MONITOR + VAL HANDBOOK | 11.27.22 (DLR, EQIX, HR, DOC, SBAC, MPW)

11.22.22 - REITS DAILY BRIEF | RESI NEWS ITEMS | 11.22.22

11.20.22 - SUNDAY NIGHT REIT READ | UHAL NUMBERS + POSITION MONITOR UPDATE | 11.20.22 (UHAL)

11.19.22 - THE (DIS)TRUST SERIES | VOLUME XXIX | UPON FURTHER REVIEW... | 11.19.22 (MPW)

11.18.22 - REITS WEEKLY VALUATION HANDBOOK | 11.18.22

11.16.22 - REITS DAILY BRIEF | NOTES FROM NAREIT DAY #1 | 11.16.22