CHCT - Update On GenesisCare's Chapter 11 Filing's Impact On Community Healthcare Trust

2023-10-11 12:38:33 ET

Summary

• Community Healthcare Trust's third largest tenant, GenesisCare, filed for bankruptcy, putting approximately 8.0% of CHCT's FFO at risk.
• The research analysts following the stock showed a lack of familiarity with the intricacies of lease rejections in Chapter 11 filings during the quarterly earnings call.
• GenesisCare has already rejected two leases with CHCT, indicating potential further lease rejections and negotiations with new tenants.

On June 1st Community Healthcare Trust’s ( CHCT ) third largest tenant filed for bankruptcy. Since there was no announcement on the filing from the company, I wrote an article titled Community Healthcare Trust's Third Largest Tenant Declares Bankruptcy, Poses Risk , which showed that approximately 8.0% of CHCT’s FFO was at risk due to GenesisCare’s Chapter 11 filing. In my opinion, the questions on the REIT's quarterly earnings call, in August, indicated that the analysts covering the company have limited experience following the impact of a Chapter 11 filing on leases. Below are some illustrative questions and answers from the call.

It shows how few bankruptcies there have been over the last decade that an analyst who has been covering REITs for years would not know the rejection period in Chapter 11.

I believe management’s answer is technically correct as there is no procedure for cramming down a lease. However, nothing prevents the winning bidder for GenesisCare’s assets from coming back to CHCT and saying we are going to reject this lease unless you reduce the rent by x amount. It is a game of chicken. However, if the rent at a property is above market or the asset is in a market where there is not a deep pool of potential tenants, like the tertiary markets that CHCT invests in, it is not a game the landlord wants to play.

There have been some important developments in the Chapter 11 proceedings for GenesisCare that investors should be aware of. First of all, the Auction has been moved from October 4 ^th to October 11 ^th , so CHCT will have to wait to find out who they will have as a new tenant, how many leases they will reject and what concessions they will ask for in exchange for not rejecting leases.

Second, the rejection period has been extended until December 28th.

Third, GenesisCare has rejected a second CHCT lease on a property in Fort Myers, FL.

It should be noted that the Fort Myers lease was rejected on July 31st. Management did not discuss it on the earnings call on August 2nd. While I cannot imagine that management deliberately omitted mentioning the lease, it is odd that they were not aware of a lease rejection that occurred on Monday by Wednesday.

This lease provided 0.85% of CHCT’s annualized rent. The first lease that GenesisCare rejected was a lease in Asheville, NC which accounts for 0.24% of CHCT’s rents.

The filing has already cost CHCT 1.09% of its annual base rent or 2.13% of its consensus FFO for 2023. (This calculation is based on the lost rental revenue, shares outstanding and consensus FFO.)

I believe investors should be worried about the next steps in the proceedings. GenesisCare has rejected two of its nine leases with CHCT before it has even completed its sales process. This means it did not think any bidder would find value in these sites. Perhaps the rents were out of line with the markets, or it’s possible the locations were marginal sites. Either way, it does not reflect well on CHCT’s underwriting or site selection. Once a winner or winner(s) are selected in the bidding/auction process, there are likely to be additional lease rejections and negotiations with new tenant(s) who are under no obligation to honor existing leases until December 28 ^th . The fact that two leases that were originated by same team have already been rejected by the seller leads me to believe it is likely additional leases will be rejected by the buyer or buyers. These rejections may materially lower CHCT FFO in 2024 as 8.0% of its FFO is at risk.

Risk to Shorting CHCT

It is important for readers to understand that despite the problems I believe CHCT faces due to the bankruptcy of GenesisCare, the stock is very volatile. This means any number of things could cause the stock price to spike temporarily. A short seller without sufficient capital could be forced to liquidate their position at a loss in this scenario. It is easy to envision circumstances where the remainder of GenesisCare’s leases are assumed and there is no need for additional announcements. Additionally, CHCT will likely continue to pay its dividend. Not only does the dividend represent a cost to a short seller, I believe the dividend will put a floor on the stock price for some time as there will always be investors who are seeking yield. In other words, I believe someone shorting CHCT needs to have the patience and capital to wait until the market has a clear and informed view of the impact of GenesisCare’s Chapter 11 filing.

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