Finding ‘Method in the Madness’ of HCP’s Overhaul

After announcing it would spin off its struggling skilled nursing portfolio and introduce a new leadership team, HCP Inc. (NYSE: HCP) is marching on, calling its new phase “HCP 3.0.”

“They have a purpose,” Mike McKee, executive chairman of HCP and interim president and CEO, said of the recent major changes at the real estate investment trust (REIT) during an earnings call Tuesday. “It’s a renaissance of sorts.”

The “third generation” of HCP will soon be defined by an absence of 338 skilled nursing properties, most of which are operated by the REIT’s troubled tenant, Toledo, Ohio-based HCR ManorCare. HCP announced its plan to spin off its skilled nursing assets into a separate publicly traded REIT in May.

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In July, the Irvine, California-based HCP announced CEO Lauralee Martin was stepping down immediately amid the creation of the new skilled nursing REIT, dubbed Quality Care Properties (QCP). As the spin-off process continues, HCP is simultaneously searching for the executives who will lead the company’s new strategy, including a new, permanent CEO and president.

“The team that will take us forward is coming together very well,” McKee said. “We have some new folks, an encore appearance and those that have been around for many years. In assembling the team, there is a method to our madness.”

Regrets, I’ve Had a Few 

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Following a “relatively quiet quarter” in terms of transactions, HCP is underway with major portfolio changes, and is on track to complete $1.25 billion in dispositions. Of the $350 million that have closed to date, two-thirds have been skilled nursing assets, CIO Justin Hutchens said Tuesday. Additionally, about two-thirds of the company’s recent investments have been within its life sciences segment. These changes are in line with the company’s new strategy, as 95% of its portfolio post-spin will be private pay assets.

The company’s transition out of skilled nursing mimics Ventas Inc.’s (NYSE: VTR) spin off and other REITs that worked to reduce their concentration in this asset class.

“Lessons learned. One large transaction that we all take responsibility for was our purchase of HCR ManorCare in 2011,” McKee said. “At the time, this company [ManorCare] was widely acclaimed as best in class, but it was also heavily reliant on government reimbursement. Over the last five years, the post acute care space has been rocked by numerous challenges.”

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HCR ManorCare has faced the same challenges seen across the skilled nursing space, in addition to being investigated by the Department of Justice (DOJ). Its underperforming assets have weighed down HCP’s overall portfolio and affected its stock price when compared against its industry peers. The DOJ charged the provider in April 2015 for allegedly submitting false Medicare claims. Another major skilled nursing tenant, Genesis Healthcare, recently settled its charges by the DOJ for $52.7 million.

Telling Its Story

Although the call was heavy on rhetoric around a re-booted company and comparatively light on specifics as to strategy or leadership changes, this may simply be natural given where HCP is at right now.

“It’s a first step in outlining what’s a greater strategic plan,” Kevin Tyler, analyst at Green Street Advisors, told Senior Housing News. “The first logical step is clearing the decks and getting the spin done. As the financing gets more done and comfortable on the lending side, HCP will be better able to tell the story.”

While HCP 3.0 will largely be defined with a new team in a post-QCP world, its remaining portfolio—75% of its current portfolio—will be centered around senior housing, life sciences and medical office buildings. The company is currently working on reducing its exposure with Brookdale Senior Living (NYSE: BKD), which was a “drag” on the rest of the portfolio during the second quarter of 2016, according to Hutchens. Post spin, Brookdale’s concentration will jump to 34% of HCP’s triple net portfolio. HCP is working with Brookdale to find a mutually agreeable solution, including offloading 25 communities.

“What they need to be mindful of is that Brookdale will be their largest tenant once [HCR] ManorCare is gone,” Tyler said. “They will have to work closely with Brookdale to ensure the portfolio is positioned as best it can be. There will be a choppy period in terms of the competition. New supply is getting delivered in a more material way, and HCP will work with Brookdale to continue to discard some of the underperformers and manage and right-size the portfolio to the best of their abilities.”

Oversupply remained somewhat of a concern during the start of the year, affecting about 15% of HCP’s total senior housing communities, and 20% of its RIDEA portfolio.

During the second quarter of the year, HCP reported earnings per share of 64 cents and FFO of 71 cents. Earnings beat analysts expectation for the quarter, and HCP’s shares were up on Tuesday.

Written by Amy Baxter

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