2024-01-07 23:15:57 ET
Summary
- Medical Properties Trust has plummeted in value due to concerns about its struggling tenants, most notably Steward.
- MPW is taking bold steps to recover uncollected rents and outstanding loan obligations from Steward.
- If Steward successfully secures strategic investors or raises adequate funds from asset sales, the issue will be resolved, allowing MPW to continue receiving full rental payments.
- If Steward files for Chapter 11 bankruptcy, MPW is likely to recover significant dues, thanks to the robust structure of master net lease agreements, as seen with other REITs.
- In the worst-case scenario, such as Chapter 7 bankruptcy, where the Steward stops all rent payments and vacates, and with no re-lease of properties, the dividend is still covered with an AFFO payout ratio in the 70% zone.
Medical Properties Trust ( MPW ) is currently experiencing a phase of pronounced pessimism. In the last three years, the company has seen a substantial loss of 75% in its value, markedly underperforming compared to major stock market indices, all of which have yielded positive returns.
In other words, MPW has been a poor investment. Due to concerns about some of its tenants, particularly Steward Health Care System ("Steward"), the company shifted to a defensive mode by cutting its dividend nearly in half. This move aimed to bolster its balance sheet and lower its cost of capital. The quarterly dividend was reduced from $0.29 per share to $0.15 per share. This reduction marks the second in MPW's history, with the first occurring during the 2007-2008 financial crisis.
MPW's Dividend History (Seeking Alpha)
In other words, MPW has been a stable and attractive dividend-paying REIT throughout its history, except during periods of extreme turbulence. These periods include the Great Financial Crisis and the current period, which is characterized by high interest rates, high inflation, and geopolitical tensions, among other things. This leads me to conclude that MPW emerged from the 2007-2008 financial crisis bruised. Subsequently, things improved significantly with growth, international expansion, including into Germany and the United Kingdom, and increasing dividends. This was facilitated by a period of ultra-low interest rates. However, the company became somewhat complacent again by overextending itself. In a sense, history is repeating itself. Fifteen years later, the company is once again facing challenges as some of its key tenants struggle.
However, I believe we are finally nearing the bottom, as indicated by recent news I read stating that MPW is intensifying its efforts to recover uncollected rents and outstanding loan obligations from Steward. To facilitate this, MPW has engaged financial and legal advisors. These advisors will assist the company in exploring various options to recover both uncollected rent and outstanding legacy loans. However, my bullish sentiment is not solely due to the hiring of advisors. It stems from the company's newfound directness in communication.
Note that over the past few months, the CEO has been quite vocal in asserting that the market is mistaken. This was particularly evident in a video titled "Message to Shareholders - October 2, 2023," which was posted on MPW's homepage. In the video, the CEO discussed the company's time-tested and proven business model, among other topics. Furthermore, the company directly addressed the "False Claims" made by critics in its June 2023 Investor Presentation . The relevant slide from this presentation is depicted below.
June 2023 Investor Update (Medical Properties Trust)
This communication is quite bold and is welcomed by shareholders, who have witnessed a significant drop in the value of their shares along with a substantial dividend cut. It addresses the growing concern among investors that the situation could worsen.
However, something was lacking in the aforementioned communication initiatives. In my opinion, they painted a rosy picture without adequately addressing the negative aspects. On January 4, 2024, after the market closed, we received a more direct communication that allowed us to better price in the potential adverse scenarios.
We have been informed that Steward may not be capable of fulfilling all scheduled rent obligations. Consequently, in accordance with GAAP (generally accepted accounting principles), MPW now expects to record a non-cash charge in Q4 2023, which will include writing off consolidated straight-line rent receivables totalling ~$225 million. Furthermore, MPW has warned that it might need to carry out additional impairment of assets. While this is never a desirable situation, it represents a first step in resolving this dilemma. Importantly, it should be noted that these are non-cash charges .
We have also been informed that Steward is struggling, and its liquidity has further deteriorated essentially as a result of increased pressure from vendors. Reading between the lines, vendors are demanding quicker payment cycles. For this reason, Steward has opted to continue with partial payments of its monthly rent. To be fair, this is already priced in; there is nothing new here. What is new here is that MPW has also agreed to postpone the collection of overdue rent payments as of December 31, 2023, and has also agreed to a phased deferment of ~$55 million for rents due in 2024. This deferral will continue until either June 30, 2024, or until the expected asset sales are completed, whichever comes first. Partial cash rent payments are expected to resume next month, February 2024.
Additionally, as previously noted, MPW has engaged consultants to address the Steward situation. We were informed that these advisors will help devise a plan aimed at enhancing Steward's liquidity and stabilizing its balance sheet. This, in turn, is intended to maximize MPW's ability to recoup outstanding rent payments, and, by achieving this, minimize its financial risk associated with Steward. It is important to note that our information about Steward is quite limited since it is a private company. The ideal scenario for resolution involves Steward raising equity, followed by asset sales or even an MPW-controlled Chapter 11 bankruptcy filing, enabling us to resolve this situation once and for all and pave the way for a prosperous decade ahead. It's important to note that in many instances involving triple net lease investments, tenants filing for Chapter 11 can actually be a positive outcome for landlords. It is a misconception that a tenant entering Chapter 11 dissolves all master lease obligations to landlords; in fact, often the opposite is true.
Another piece of information has been negatively interpreted, possibly to an extreme degree. As we all know, MPW has historically invested in some of its tenants. Other innovative REITs, such as Simon Property Group ( SPG ), a long-term investment of mine, have also engaged in similar practices by investing in struggling retail tenants to ensure they continue occupying Simon's malls. This strategy has been quite successful for SPG, which has actually profited from these deals. MPW is adopting a similar approach to protect the value of its assets , giving Steward time and additional breathing space to implement its strategic plan. We learned that MPW has agreed to finance a new $60 million bridge loan, secured by all of MPW's current collateral and further backed by second-liens on Steward's managed care segment. Importantly, a part of MPW's earlier unsecured loans to Steward will now be additionally secured by these same second-liens. In other words, they are converting them from unsecured to secured. This means that MPW is much better positioned should Steward file for Chapter 11 bankruptcy.
Importantly, we have been informed that MPW's non-steward portfolio continues to generate solid revenues, as illustrated below.
MPW Press Release (Seeking Alpha)
More importantly, in the context of stress testing cash flows, we have been informed of the following, which is highly valuable for investors moving forward:
The complete removal of all contributions from Steward-related investments, including that from the Massachusetts partnership, would have negatively impacted third quarter 2023 reported adjusted funds from operations (AFFO) by approximately $67 million ($0.11 per diluted share), resulting in a reported AFFO payout ratio in the high-70% range.
In other words, if Steward is removed from the equation (i.e. MPW generates zero revenue from Steward), and MPW does not re-lease the Steward properties to new tenants, the current dividend is still comfortably covered with an AFFO payout ratio in the 70% zone . If this isn't considered a worst-case scenario, I don't know what is. In the press release, MPW saved the best for last, but investors focused more on the headlines than the substance, leading to the share price dropping almost 30%.
One could argue that other tenants might be in trouble, but in my view, this possibility is somewhat accounted for in the above scenario. It's unrealistic to assume that all properties leased to Steward will become 'ghost hospitals'. Perhaps they will generate lower revenue, and some other tenants within MPW's portfolio might also vacate properties, but the net worst-case scenario will be something similar to assuming that Steward goes to zero, which implies an AFFO payout ratio in the 70% range.
Whenever there is a crisis, there is an opportunity. There are risks, such as Steward going to zero, other tenants collapsing, or the Fed not lowering interest rates, but in my view, these risks are already reflected in the current valuation. MPW has been on my radar for a very long time, and the most recent developments have led me to conclude that it is time to go long. I am considering the worst-case doom and gloom scenario where, without Steward paying any rent, the AFFO payout ratio will be in the high-70% range. This provides a significant margin of safety. Now, whether the dividend will be maintained is another question, but my expectation is that it should remain intact. I anticipate the CEO and his management team will attempt to replicate the comeback MPW made after the 2007-2008 financial crisis. I believe that history repeating itself is quite a realistic scenario, potentially aided by interest rates that are expected to be lowered this year.
In closing, these are the following scenarios that I am contemplating in my investment thesis.
- If Steward successfully secures strategic investors or raises adequate funds from asset sales, the issue will be resolved, allowing MPW to continue receiving full rental payments.
- If Steward files for Chapter 11 bankruptcy, it is highly probable that MPW will recover a substantial portion of its dues, thanks to the robust structure of master net lease agreements. This scenario is not unprecedented; similar outcomes have been observed with other REITs in the past. Additionally, as previously mentioned, MPW has strategically converted its legacy loans to Steward from unsecured to secured status. This strategic move significantly strengthens MPW's position in the event of Steward's potential Chapter 11 filing.
- If Steward files for Chapter 7 bankruptcy, a challenging circumstance, it is expected that new tenants will be sourced for these hospitals in due course. This ensures that these facilities will not become vacant or 'ghost hospitals.' However, this transition would likely result in the most significant disruption to MPW's cash flow. Additionally, this situation is likely to have the biggest impact on MPW's loan covenants.
Overall, this situation is not ideal for MPW, but it seems the market is overlooking a crucial aspect. Again, even if Steward pays no rent, the current dividend can still be sustained, with an AFFO payout ratio in the high-70% range. This is attributable to MPW's considerable diversification across tenants and geographies, spanning several countries from the USA and Colombia to the UK, Germany, and Portugal. If Steward ceases rent payments and MPW opts to further reduce its dividend for added prudence, that's a separate discussion. However, I believe the outlook is more optimistic than the current prevailing pessimism suggests. In fact, I prefer a more assertive stance from MPW's management to expedite the resolution of this issue.
For further details see:
Medical Properties Trust Has Likely Bottomed Out