Big 3 REIT Merger: Now’s the Time to Strike

If there’s going to be a merger among the “Big 3” healthcare REITs, now’s the time to strike while the proverbial iron is hot, says a recent Bloomberg article.

The Big 3 REITs—Ventas, HCP, and Health Care REIT—have played starring roles in many of the past few years’ senior living acquisitions, spending billions on (or with) well-known operators and even other REITs.

Formerly the largest of the healthcare REITs, HCP’s market cap is just under $17.1 billion with shares plunging 24% in the past 12 months. Ventas has grabbed the top spot with a nearly $17.6 billion market cap, with Health Care REIT valued at $17.05 billion.

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Potential $34 billion-plus pairings, whether past negotiations or current rumors, include Ventas acquiring HCP or merging with HCN. And whether or not a deal actually happens, “now is probably the time” to strike, reports Bloomberg citing John Leslie, a  money manager and analyst at Miller/Howard Investments, Inc., as shares for each of the Big 3 have dropped anywhere from 12-24% in the past year.

“HCP’s been lagging for a long time and it seems like the logical candidate, as long as it’s accretive,” Jeung Hyun, a portfolio manager at Adelante Capital Management, a dedicated REIT manager with $1.8 billion under management, told SHN. “HCP used to trade at a big premium, and no longer does.”

There are two likely reasons for losing that premium, he says: HCP hasn’t been as acquisitive as Ventas and HCN, and former CEO Jay Flaherty and the board had “differences.”

HCP’s last acquisition was the $1.7 billion purchase of 133 senior housing communities in October 2012, according to Bloomberg data. In comparison, Ventas and HCN have remained active since then—including major deals with Atria Senior Living, Holiday Retirement and Sunrise Senior Living—although their activity levels have also decreased compared to prior years.

“There’s been a lot of pushback on all the REITs because they missed out on the Emeritus deal,” says Hyun. “They’re trading at premiums compared to the break-up value of their real estate. They have to use that currency and demonstrate growth. If they miss out on [an opportunity], they have to look elsewhere.”

Flaherty was abruptly fired in October 2013 during a management overhaul at HCP, with the board of directors citing “lost confidence” in Flaherty’s leadership and leadership style. When a CEO leaves and is replaced by a new CEO who doesn’t have the same depth of experience, it’s “sort of natural” for people to speculate, Hyun says.

With all three REITs at similar market caps, a merger would be more about scale than anything else.

“It’s rarely a valuation story,” says Steven Marks, associate director at Fitch Ratings, of company-to-company transactions. “It’s more like, what can a larger company achieve [through a merger] that two companies can’t achieve individually?”

REIT-to-REIT mergers typically hinge on social issues such as who’s going to run the company and where the headquarters will be located, he says. “It’s typically hard within REIT-to-REIT mergers to arbitrage a lot of value because of a fairly active private market such that it’s fairly easy to value these companies.”

But when it comes to REIT growth, “you dance until the music stops,” Hyun told Bloomberg. “As long as it’s accretive and as long as the companies are getting rewarded for growth, I think they have to do it.”

In the past few years, most of the large senior living portfolios have already been bought in mega acquisitions, with growing competition among public traded REITs, nontraded REITs, private equity, pension funds, and other acquirers. At the same one, capital costs have grown, while cap rates have stayed roughly the same or even declined for some senior housing assets, Stifel Nicolaus analysts wrote in a January update on large-cap healthcare REIT mergers.

“As a result, investment spreads have narrowed,” said Stifel in a note written prior to the Brookdale-Emeritus announcement but following reports of an ended merger discussion between Ventas and Health Care REIT. “We believe that in a constrained spread environment, cost of capital rises in prominence. Increased scale and decreased tenant concentration, potentially resulting in a credit upgrade and lower capital costs, could facilitate more and larger accretive new investments.”

These market factors all may put pressure on the big-cap REITs to merge, analysts have told SHN, even if it’s not the best route to take.

“In our view, the benefits of lower cost of capital are likely outweighed by the potential for low accretion and impact on future growth from the law of large numbers,” wrote the Stifel analysts. “A merger among two large cap healthcare REITs would likely foment investor anticipation of additional company-to-company activity, lifting shares of smaller healthcare REITs and senior housing operators.”

While it’s unknown whether or not Ventas is actually interested in any merger—investor relations director Lori Wittman refused to comment on market speculation to Bloomberg—CEO Debra Cafaro “probably isn’t opposed,” Hyun says.

The biggest impediment to M&A is often the management teams’ or boards’ ego, he says. “What we’ve found, historically, is that deals happen when there’s a willing seller. There are always willing buyers.”

The question, therefore, is whether or not HCP—or any of the Big 3 REITs, for that matter—are willing to put themselves on the acquisition block.

“Each of the Big Three already has big presence and are very competitive with each other,” says Britton Costa, director at Fitch Ratings. “It would raise the bar in terms of overcoming the typical social issues present in every REIT-to-REIT merger.”

Written by Alyssa Gerace

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