[UPDATE] HCP to Spin Off Skilled Nursing Assets into New REIT

HCP Inc. (NYSE: HCP) will be spinning off its portfolio of skilled nursing properties operated by troubled tenant HCR ManorCare into an independent, publicly-traded real estate investment trust (REIT), to be helmed by former Sunrise Senior Living CEO Mark Ordan, the company has announced.

“We believe this transaction gives HCP the ability to re-confirm itself as a blue-chip, innovative and relationship-oriented healthcare REIT,” HCP CEO Lauralee Martin said in a prepared statement. “Post spin, HCP will own a stable, private-pay portfolio that has a track record of delivering consistent, attractive returns.”

The new skilled nursing-focused SpinCo REIT is expected to have a portfolio of about 320 properties with in-place annual rent of approximately $485 million. The new REIT will have a flexible balance sheet and active asset management, enabling it to maximize shareholder value by responding to the dynamic post-acute/skilled nursing environment, HCP Executive Chairman Michael McKee stated.

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“Today’s announcement is the result of an active and extensive process involving the Board, our executive team and our advisors to address our portfolio concentration related to HCR ManorCare in a comprehensive manner,” McKee said.

Toledo, Ohio-based HCR ManorCare is one of the largest skilled nursing operators in the nation, and has been beset by challenges on multiple fronts, including increasingly tight Medicare reimbursements and an ongoing federal investigation into its billing practices. ManorCare posted worse-than-expected financial results in the fourth quarter of 2015, after which HCP announced it would undertake a strategic review of its relationship with the SNF operator, which became a major tenant through a $6.1 billion deal that closed in 2011.

Source: HCP Inc.
Source: HCP Inc.

Its ManorCare woes have contributed largely to a widening valuation gap between HCP’s stock and that of its peers, such as Chicago-based Ventas (NYSE: VTR) and Toledo-based Welltower (NYSE: HCN). This has led to industry speculation about potential strategies that HCP could take to improve performance, including being acquired by a competitor such as Ventas.

Instead, the decision to separate its SNF assets into an independent REIT means that HCP is following in the footsteps of Ventas, which made the move last year to spin off most of its skilled nursing assets into the company now known as Care Capital Properties (NYSE: CCP).

As was the calculus at Ventas, HCP expects to benefit from the spin-off by being able to focus more on core assets such as senior housing and medical office buildings, limiting its exposure to properties that are largely dependent on government reimbursement for revenue. HCP’s anticipated post-spin EBITDA ratio is mid-6x, reflecting cash proceeds raised by SpinCo as well as additional asset sales announced today.

HCP’s post-spin portfolio is expected to consist of more than 860 properties, generating annual portfolio income of approximately $1.4 billion.

The spin-off is expected to be complete in the second half of 2016, at which time HCP shareholders will receive SpinCo shares through a pro rata distribution. Total shares of HCP held by each investor will not change as a result of the distribution, according to the company.

Ordan Returns to Senior Living

While serving as CEO of Sunrise Senior Living between 2008 and 2013, Ordan oversaw the company’s restructuring, which culminated in the major private-pay senior housing company being taken private through a transaction with Welltower, then known as Health Care REIT.

Ordan appears to be keeping all options open in how the new REIT will handle the ManorCare assets that SpinCo is taking on from HCP.

“With a singular focus on SNF and assisted living assets and a flexible capital structure, we believe SpinCo will have the tools and flexibility to unlock value in the HCR ManorCare portfolio, as we own, manage, sell or transition assets as desired over time,” he stated.

Investors and other industry stakeholders are awaiting not only indications about how Ordan might go about managing the portfolio but information about the basic investment thesis of the new REIT, which will be forthcoming at least in part through a Form 10 to be filed with the U.S. Securities and Exchange Commission (SEC) within about a month.

“I think it’s an interesting deal overall, but [HCP] still has a fair amount of work to do in terms of how this will unfold, and a fair amount of disclosure they’ll provide to the market over the next few months,” Green Street Advisors Analyst Kevin Tyler told Senior Housing News.

One piece of information that will not be included in the Form 10 is whether ManorCare’s rent will be reduced once the properties transition to the new owner, Martin told analysts on a conference call Monday.

Many analysts pushed HCP on this point, given that a rent reduction would be necessary to bring coverage in line with the market standard of 1.3 times EBITDAR.

ManorCare’s rent would have to be cut by roughly 30% to bring it to this level, according to Tyler.

But rent cuts may be thinking too small. Ordan and his team will have many more tools and options for how to approach the ManorCare situation than HCP did, executives with the REIT repeatedly emphasized on Monday’s call.

The basic premise is that HCP is committed to being a blue-chip REIT, which means it needs to offer investors stability and also is limited by certain regulatory constraints. That may not be the investment thesis behind SpinCo; in fact, while the company is beginning as a REIT, it may change its stripes and become an entirely different type of entity if that is called for, said McKee.

“I think what they were trying to get at with those comments is they don’t know completely what size or shape this might take on, and they’ll leave all the options open for Mark Ordan,” said Tyler. “[He] could potentially use this is as a vehicle to sell ManorCare, it could be a turnaround play and the strategy shifts down the road, Ordan is known for that.”

Ordan currently serves as an Independent Director at VEREIT, a diversified real estate operating and investment management company, and is a member of the audit committee and the compensation committee. He also has taken leadership roles in shopping center-focused REITs since leaving Sunrise; he is the Non-Executive Chairman of the Board of WP Glimcher, the surviving entity following the closing of Washington Prime Group’s acquisition of Glimcher. Ordan served as Washington Prime’s CEO from May 2014 to January 2015, and also has been one of its directors since May 2014.

Ordan also will serve as senior advisor to HCP, focused on the ManorCare investment, in the run-up to the spin off.

HCP’s Future

HCP announced several other leadership changes Monday, including the promotion of Justin Hutchens to CIO, and the appointment of former Holiday Retirement CEO Kai Hsaio to executive vice president of asset management for senior housing.

Investors responded positively to the news of the spin-off and the leadership additions, with shares up 4% as of late afternoon Monday. That no doubt was gratifying to HCP leaders, who repeatedly drew attention to the fact that, regardless of how the SpinCo REIT plays out, being free of the ManorCare assets is a huge positive for the future of HCP.

Now, the company can focus more clearly on the other three-quarters of its portfolio, which should be a very solid platform to bring the REIT back to an industry-leading position, executives said.

“We’ve got a new team coalescing and strategic initiatives, and 75% of our business that we think can stand up to, and is as good as, any health care portfolio in the world, and we want to grow that,” McKee said.

The addition of Hsaio suggests that HCP indeed is committed to turning the ship around, in the view of Green Street’s Tyler. Still, he continues to put the odds of an HCP takeout at about 30%, which is the same position he saw the company in prior to Monday’s news.

Any buyer would have had to underwrite the ManorCare portfolio, and now that is taken out of the equation, Tyler said. Given that an acquisition could hinge on cost of capital considerations, HCP leadership may still be open to an attractive offer, he surmised.

But he also credits the REIT with the moves it has made to achieve a turnaround on its own, specifically with regard to hiring Hutchens and Hsaio.

“Those guys should be able to execute on a new or changing senior housing strategy,” he said.

Written by Tim Mullaney

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