Dear Subscribers,
We at Hedgeye must address misconceptions and the erroneous allegations published by third-parties resulting from our coverage and research related to REIT battleground stock and Active Short, Medical Properties Trust (“MPW”).
Hedgeye is not engaged in any market manipulation. Period.
This idea is complete nonsense. Hedgeye provides independent and objective investment research on a subscription basis to our institutional subscribers and to mass market subscribers of our newsletter and media platform. Hedgeye has no assets under management (AUM), takes no positions, long or short, in our research ideas, and employees are prohibited from trading stocks in the Firm’s coverage by way of Hedgeye’s strict personal trading policy. Hedgeye’s policies and compensation structure are designed to eliminate the inherently compromised nature of market research by heavily-invested participants, or “book pushers.” Hedgeye’s subscription-based model, removed from any self-dealing interest in the underlying stock, is conflict and compromise-free.
Hedgeye initiated a short recommendation on MPW on April 12, 2022. This view remains in-place today. We believe our thesis is well-researched and well-supported by the FACTS and MATH as we observe them. Thus far the thesis has proven correct, with market participants sending the share price of MPW 60%+ lower since we became involved. This is nearly ~3,500bps worse than a comparable short position in the XLRE index on a total shareholder return (TSR) basis.
Our short thesis can be summarized by the following key points:
- The cash economics generated by MPW’s fee simple real estate, mortgage loan, operator loan and operator equity investments are inferior and well-below the company’s past, present and future costs of capital. This means the company has unequivocally been a poor allocator of capital and is actively destroying shareholder value. This is readily observable from MPW’s own financial statements.
- A significant portion of MPW’s underlying tenant credit is comprised of hospital systems that are actually or effectively insolvent, or experiencing severe financial distress. Moreover, MPW has demonstrably extended loans to its largest tenants, who in turn owe contractual rent back to MPW as their landlord. There is ample publicly-available evidence to support the former belief, and the extending of loans to top tenants is a FACT. In our view this exposure leaves MPW’s rent and mortgage interest payments at-risk and perhaps unsustainable, and deserving of an appropriate risk premium in the market.
- MPW’s earnings quality is poor. This is clearly observable from MPW’s reported financial results. This poor earnings quality disqualifies certain traditional REIT valuation metrics, in our view, and should not be used for evaluating dividend coverage and leverage.
- MPW is not covering its dividend payments with cash flow and the current distribution is unsustainable. As a matter of fact, using the company’s own reported financial results, MPW has not supported its dividend payments with internally generated cash flow in any year since 2011. This means that the company relies upon external capital, i.e. borrowing in the debt markets or selling stock, to pay its shareholders dividends. This is circular and unsustainable.
- To further evidence Point #4, a simple examination of MPW’s own financial statements shows the company’s leverage on a cash EBITDA basis is relatively high and has increased secularly since 2011. This increases the financial risk to common shareholders.
- Finally, the stock is not “cheap” using appropriate cash-based valuation metrics. In fact, application of an appropriate risk-adjusted cash capitalization (or “cap”) rate implies significant downside in the stock from current levels, even after the 60%+ decline in the share price over the past year.
For those seeking more in-depth support, let’s examine these points one-by-one.
Point #1: Since its inception, MPW has demonstrably and repeatedly pushed back against analyst and shareholder requests to disclose its acquisition cash cap rates, a metric that is non-proprietary and routinely disclosed by REITs broadly across all real estate subsectors. This metric represents the Year 1 cash net operating income (“NOI”) dividend by the purchase price, and is critical towards understanding the actual cash returns generated by a REIT’s investments. As a matter of fact in a June 6, 2011 correspondence letter with the SEC, while again resisting enhanced disclosure, MPW wrote that “Readers of our financial statements are also able to calculate our weighted average periodic return on our acquisition costs by reference to information readily apparent in our GAAP-basis financial statements.” We performed that exercise using the company’s own reported financial statements and arrived at an estimated ~5.8% (range of ~5-6% depending on the methodology used) against the cumulative gross capital invested by the company (see Figure 1 below). We prefer the cash EBITDA-based metric, as it includes the impact of MPW’s corporate cash overhead which is a true cost of being a publicly-traded company.
Figure 1: MPW's Assets Generate 5-6% Un-Leveraged Yields
Source: Company Reports, Hedgeye Estimates
Moreover, it is critical to understand that returns will remain at this level for the foreseeable future, given MPW’s long terms on its lease and loan agreements. MPW disclosed in its 2022 10-K filing that its leases and loans have a weighted-average remaining initial lease term of ~17.6 years. Using basic MATH we estimate that it will take approximately ~7 years to reach just a ~7% cash yield-on-cost, assuming +3% compounded annual lease escalations, no additional capital invested and no tenant defaults. And unlike all other triple-net REITs, MPW makes significant capital expenditures each year. This means that, unless MPW’s blended cost of capital is ~5% or lower, the company is mathematically destroying value. We would argue that the true cost of capital was perhaps never at that low level, and that the company only grew via the issuance of very low-cost debt. MPW’s in-place cost of debt is sub-4%, but with its bonds yielding 12%+ and a dividend yield above ~14% at the time of this writing, the cost of capital math is “broken” and the model no longer functions. The MATH is irrefutable. MPW will very likely never achieve an attractive cost of debt capital so long as the company borrows to pay its dividends, as bondholders will demand to be compensated with a higher interest rate while their collateral is impaired.
Point #2: As per page 11 of MPW’s 4Q22 earnings supplemental, Steward Health and Prospect Medical Holdings accounted for ~26.1% and ~11.5%, respectively, of 4Q22 GAAP revenues (~38% combined). This combined total will move to roughly ~29% if and when Steward closes on the sale of the Utah OpCos to Commonspirit. We estimate that Steward and Prospect Medical together will account for ~30-35% of MPW’s annual cash EBITDA pro forma for this transaction. We estimate that Pipeline Health comprises a further ~1.5-2% of annual cash EBITDA. There is ample publicly-available data that shows these entities are stressed financially and poor credits.
Steward Health, per the company’s audited financial statements filed by MPW via 10-K/A reports, was not profitable in any year over 2017-2020 and generated cumulative pre-tax losses excluding asset sale gains totaling ~$1.3 billion over that time. In 2021 MPW funded over ~$200 million in additional capital towards the 5-hospital Steward portfolio in Florida, an amount roughly equal to what should have been Steward’s share of the purchase price for the OpCos from Tenet Health. In 2022 (1) several vendor lawsuits and liens were filed against Steward for non-payment and totaling north of ~$100 million, (2) a ~$50 million deposit on the Wadley Regional development in Texarkana remained outstanding for a year with no development activity, (3) MPW lent at least ~$150 million directly to Steward as its largest tenant in 2Q22, (4) Steward effectively “factored” a portion of its A/R via its sale of the Value-Based Care business to CareMax (CMAX), (5) Steward filed for an “extreme” financial hardship extension with CMS in October 2022, and (6) Steward required an “interim extension” from its lenders before securing just a one-year extension on its ABL credit facility, in a process that was anything but “normal.” In 2023 we learned that Steward’s CFO, President and Chief Physician Executive all departed the company. The CFO was with Steward for little over one year before departing. Additionally, an MPW-owned and Steward-operated hospital in San Antonio is currently at-risk of closing. In addition to the $150 million loan above, we estimate that MPW has another ~$550 million of “mezzanine” debt outstanding and secured by the equity in Steward, as well as a direct 9.9% ownership interest in the tenant.
Regarding Prospect Medical Holdings, MPW lent ~$100 million to its second-largest operator tenant during 2Q22. Prospect did not pay rent in November and December 2022, and further did not pay at least some portion of its rent in 1Q23 per MPW’s own disclosure. Our understanding is that the Connecticut OpCos are being sold to Yale for ~$300 million in cash + a “deficiency note,” and in the process another ~$100 million in cash appears about to be deposited at the operator in exchange for an obligation back to MPW. There is a good chance that the Pennsylvania portfolio could result in a large impairment and perhaps even a total loss to MPW.
Pipeline Health just emerged from Chapter 11 bankruptcy protection. The bankruptcy filings revealed that the four California hospitals, which are the assets that MPW owns, generated trailing EBITDARM before corporate overhead of just ~$3 million as of August 2022. This compares to annual cash rent due to MPW of approximately ~$18 million. MPW acquired the portfolio in July-2021, and the operator filed for bankruptcy protection just one year later in October 2022. MPW was required to invest additional capital over and above what was in the initial lease agreement to help secure Pipeline’s exit from Chapter 11 protection.
Again, a significant portion of MPW’s underlying tenant credit exposure is distressed or effectively/actually insolvent. This definitionally means that MPW’s own income streams carry additional risk and should be treated as such by investors.
Point #3: MPW’s reported “Normalized FFO” earnings and “Adjusted EBITDAre” are of poor quality. We came to this conclusion based upon several metrics and using the financial results reported by MPW itself. First, both of these are “GAAP-based” metrics in REIT analyst parlance, and include the benefit of non-cash straight-line rent and interest income. As can be seen in Figure 2 below, MPW has secularly increased the portion of non-cash revenue via the prices it pays for its acquisitions and the long agreement terms it strikes for its lease and loans (referenced above). Second, and as can be seen in Figure 3, MPW’s portion of non-cash revenue is much higher than that reported by other Triple-Net and Healthcare REITs. As a matter of fact, it is off the charts and multiple times larger. For these reasons, MPW’s metrics inclusive of straight-line revenue are wholly inappropriate, in our view, for evaluating valuation, leverage, profitability, growth, returns or credit.
Figure 2: Non-Cash Revenue Up Significantly Over Past Decade
Source: Company Reports, Hedgeye Estimates
Figure 3: Off the Charts vs. Comparable REITs
Source: Company Reports, Hedgeye Estimates
Moreover, we have raised questions over MPW’s reported “Adjusted Funds from Operations” (or “AFFO”), which for REIT analysts and investors is supposed to represent true cash flow and exclude the impacts of non-cash revenue and expenses. After all, you cannot pay dividends or service your debt with non-cash revenue! First, demonstrably and using its own reported financial results, MPW changed the definition of AFFO over three consecutive quarters between 1Q22 and 3Q22 from deducting “non-cash revenue” to deducting just “straight-line rent.” This is critical, in our view, as several of MPW’s outstanding loans appear to be accruing non-cash interest income, implying that AFFO may not be reflective of true cash flow. It was also done immediately before Prospect Medical, subject to a financing lease and recording revenue as “Income from Financing Leases” versus “Rent Billed” or “Straight-Line Rent,” stopped paying rent amidst its own financial distress in 4Q22. We have reason to believe this unpaid rent was accrued for and included in reported 4Q22 AFFO. We await proof showing that belief is incorrect.
Point #4: Demonstrably and using its own reported financial statements, MPW is not covering its dividend payments with internally generated cash flow. In Figure 4 below we define and calculate “Excess Cash Flow” as cash from operations less capex and dividends for MPW and two other Triple-Net REITs, EPR Properties (EPR) and Realty Income (O). In MPW’s case we generously give them additional credit for a ~7% return earned on their significant capital spending. If this metric is negative that means a company is effectively dependent upon external capital to support dividend payments, i.e. tapping debt or equity markets to fund those payments. Not only has this metric never been positive for MPW since 2011, it is worsening secularly. Without a right-sized dividend payment, and given the mathematically dilutive transactions that MPW is currently contemplating, our view is that MPW will likely continue to see its leverage increase as it effectively borrows at higher and higher rates to pay dividends to its shareholders. The markets are clearly beginning to recognize this, given the current implied yields on MPW’s debt and the stock’s implied dividend yield.
Figure 4: Not Covering Dividend with Internally-Generated Cash Flow
Source: Company Reports, Hedgeye Estimates
Point #5: This point is irrefutable, and demonstrated by Figure 5 below. MPW’s leverage on a net debt-to-cash EBITDA basis has increased from ~4.5x in 2011 to ~8.8x today. This is materially above most other Triple-Net and Healthcare REITs, and has occurred secularly over a decade along with negative and worsening internal cash flow generation. It also means equity multiples, both FFO and AFFO to the extent you can rely upon those metrics, are not appropriate for valuing the company as much of the “value” in the real estate portfolio is being absorbed by the debt load outstanding. This enhances financial risk to the common equity. The assets MUST be valued independent of capital structure in this case.
Figure 5: Cash-Based Leverage "Up and to the Right" Secularly
Source: Company Reports, Hedgeye Estimates
Point #6: The stock is not “cheap” when the assets are valued on an unleveraged cash basis. While the bulls on the stock have argued that the stock is undervalued based on P/FFO or P/AFFO multiples, those metrics in our view are useless for the purposes of valuing MPW for the reasons mentioned above. In fact, on an unleveraged basis and using a “net effective cash cap rate” which gives effect to cash overhead and capex, at the time of this writing MPW is trading at a ~6.8% implied cap rate. Using the same metric and methodology, several higher-quality Triple-Net REITs with healthier underlying tenant credit are trading “wide” or roughly in-line with this number, including EPR (~8.7%), SRC (~7.1%), EPRT (~6.3%), NNN (~6.6%) and NTST (~6.1%). The same can be said for several Healthcare REITs including CHCT (~6.8%), CTRE (~6.9%), HR (~8.0%), and GMRE (~7.7%). On an absolute basis the stock is currently trading at a ~12.5x implied EV/Cash EBITDA multiple when its return, growth and cost of capital profiles warrant approximately ~7-8x at best. At 7-8x cash EBITDA, and given the amount of leverage in the structure, there would be zero value available to MPW’s common shares. The stock is not cheap. In fact, we believe a stronger argument can be made for it still trading “expensively.”
This is the basis for our short thesis and recommendation to our subscribers, which remains in-place today. It is well-supported by FACTS and MATH, and relies almost entirely upon MPW’s own financial filings and disclosures. We of course welcome alternative opinions and debate, including from and with the company itself, and are open to and reserve the right to change our view on the stock as the facts change. In fact, we invite the company, its representatives, and any other interested parties to have a civil and fact-based conversation with us regarding the short thesis on HedgeyeTV.
However, to this day our view is that a satisfactory rebuttal has yet to be provided by MPW or any other party in the market. In the interim we will not stand by and be accused of ANY unethical, or even criminal, behavior when our work is fact-based and uncompromised by any self-interest other than to make the best call for our subscribers.
We look forward to hearing from our subscribers, MPW, and anyone else who would like to engage on this topic. In the meantime, we will continue our work towards delivering objective and independent macro and company-focused research to our subscribers.
Sincerely,
The Hedgeye Team
