2024-01-06 09:07:41 ET
Summary
- Shares of Medical Properties Trust plunged 29% after management announced actions to recapture value from their largest tenant, Steward Health Care.
- The market overreacted to the news, leading me to more than double my position in the company, expecting a short-term upside upon a partial recovery.
- Steward's financial struggles and potential bankruptcy pose risks, but even in a worst-case scenario, Medical Properties Trust still has significant value.
The market can get truly absurd from time to time. Instead of being this efficient machine that many believe it to be, it can create scenarios that logically do not make sense. A great example of this can be seen by looking at what occurred on January 5th. Shares of Medical Properties Trust ( MPW ), a REIT that owns and leases out medical properties, plunged, closing down 29%. This massive move lower came after management announced that they were taking some actions aimed at recapturing some value from their largest tenant, Steward Health Care, and simultaneously working to further reduce exposure to that tenant moving forward.
Those who follow my work closely know that I have owned shares in Medical Properties Trust for some time. After carefully evaluating all that transpired and all that the press release issued by the company implies moving forward, I more than doubled the size of my position in the business in response to this plunge. To be clear, unless some really good news comes out, I am unlikely to hold all or even most of this increase in holdings. I believe that the market severely overreacted, so I view this as a short-term strategy to capture some quick upside upon a partial recovery of the loss experienced on January 5th. This is because, while I am bullish on the business in the long term, the increase in stake that I initiated makes me more exposed than I would like to be. And at the end of the day, some degree of diversification is imperative for investors to adopt.
A lot of pain that is unwarranted
There has been a tremendous amount of speculation over the past year or so regarding the future of Steward. Concerns about the operator’s ability to survive have been based on legitimate developments that some investors have observed quite closely. More recently, for instance, in the third quarter earnings release issued by Medical Properties Trust, the company revealed that Steward delayed paying some of the rent that it was supposed to for both September and October of the 2023 fiscal year. To shore up its own financial condition, the business has even resorted to some planned hospital shutdowns. As an example, in early December of last year, the company announced that it would be shutting down its New England Sinai Acute Long-Term Care and Rehabilitation Hospital Early April of this year. Citing low reimbursement rates from Medicare and Medicaid, the company stated that it lost around $22 million from that facility alone, though they did not specify over what time frame that loss occurred.
In the press release issued by Medical Properties Trust on January 4th, management revealed that it would be stepping up its plans to recover uncollected rents and outstanding loan obligations from Steward. Management even admitted to hiring both a financial advisory firm and a law firm so that it can explore its options as thoroughly as possible. This comes after Steward has continued to make only partial monthly rent payments, resulting in total unpaid rent under its master lease with Medical Properties Trust growing to roughly $50 million as of the end of 2023. That is on top of another $50 million that was previously deferred associated with the reconstruction of Medical Properties Trust’s Norwood Hospital.
Obviously, details of this plan are still being worked out. But we do have some data at this time. For starters, Steward does appear to be pursuing potential strategic transactions that could include the sale or re-tenanting of some of its hospital operations, as well as the sale of assets that are considered non-core to its business. Steward is also looking at a potential third party capital partner related to the managed care business that it has, with the idea that any proceeds coming from an arrangement would be paid directly to Medical Properties Trust with the hope of covering all outstanding obligations that Steward has to Medical Properties Trust.
As part of this initiative, Medical Properties Trust has gone so far as to fund a new $60 million bridge loan that is secured by its existing collateral, as well as by new second liens on the managed care business owned by Steward. To make things easier on Steward, Medical Properties Trust has also agreed to the deferral of unpaid rent up to this point, as well as to the additional deferral of an estimated $55 million of rents for 2024 until either some sort of asset sale occurs or June 30th of this year, whichever comes first. This does not mean that the company won't receive any rental payments during this time. In February, management is expecting rents to recommence, with a total of $9 million to be paid in the first quarter in its entirety. This should be followed up by $44 million in payments in the second quarter.
Clearly, this is not a pleasant situation for any party involved. The management team at Medical Properties Trust even went so far as to say that they cannot be assured that Steward will make all of its scheduled lease payments for the remainder of its 22-year master lease agreement. This has convinced the firm to record a non-cash impairment for the final quarter of the 2023 fiscal year associated with the $788.76 million of straight-line rent receivables on its books. The charge in question will be somewhere around $225 million. This would be in addition to another $25 million of straight-line rent receivables related to an unconsolidated partnership in Massachusetts, as well as the aforementioned $100 million in deferrals the company has now made available to Steward.
These kinds of developments are certainly painful and they do impair the value, likely permanently, for a company like Medical Properties Trust. In early 2022, approximately two years ago, shares of Medical Properties Trust were trading at just above $20 apiece. While investors have received some nice distributions over that window of time, those distributions have not come even close to covering the gap between where shares were and the $3.55 that units closed at on January 5th. I would also argue that the chance of units ever getting back to that $20 range is very small. That is why those who are bullish on the business would be wise to dollar cost average lower. Even though the very first units that I purchased of the enterprise were at a price of $18.55, a price that we may never see again even under good circumstances, the timing and size of my purchases over the past two years have brought my weighted average cost down to $5.83. As you will see shortly, getting from where we are today to somewhere north of that is unlikely to be a big stretch.
This does not mean that I am forecasting rosy times for Medical Properties Trust right around the corner. There are some risks that the company faces. But we need to look closely at the data, the picture is not as bad as the market is making it out to be. For starters, I have long been skeptical of looking at FFO (funds from operations) when it comes to this particular REIT because of the large straight line rents that it collects. When it comes to any measure of FFO, I have long encouraged people to look at the adjusted FFO figure that removes straight line rents from the equation. Management seems to understand the market's feeling when it comes to FFO versus adjusted FFO because, in the January 4th press release, the firm disclosed that, using data from the third quarter of 2023, if the firm were to remove all contributions coming to it from all Steward-related investments, plus the aforementioned Massachusetts partnership that it is writing off for, then it still would have seen an adjusted FFO payout ratio somewhere in the high 70% range. This suggests that, while it may not be a bad idea to reduce the distribution further in order to reduce debt, the distribution as it stands is stable and secure.
Moving beyond this, the picture does become more complicated. And I blame this in large part on management. In October of last year, management came out with a presentation of sorts that looked at its entire relationship with Steward. At the time, I wrote a rather detailed article about it, which I would encourage you to read here. My goal is not to rehash all of the details of that article. But in the table above, you can see a summary of the gross value of the investments that the company had attributable to Steward at that time. As detailed as the actual presentation is, I wish management would have used net asset values as they stand today. That would have been far more valuable. This is especially true because of the $3.30 billion of real estate investments involving the operator.
This does not mean that we are flying completely blind. As you can see in the image above, total net assets as of the end of the third quarter that were exposed to Steward amount to $3.77 billion. That's about 19.8% of the total assets owned by Medical Properties Trust. This includes everything, such as straight-line rent receivables, loans, real estate, and more. On an adjusted basis, this exposure results in about 19.9% of Medical Properties Trust’s revenue coming from Steward, which is significant, but not enough to worry about Medical Properties Trust potentially going bankrupt over.
Now, in the event of a bankruptcy by Steward, which I must admit is starting to look quite likely in the coming months, some of this $3.77 billion, plus any additional value like the $60 million loan that was just announced, could be worth little to nothing. For instance, the $126 million passive equity investment that Medical Properties Trust has in Steward would likely be worth nothing. Any rents receivable would be up in the air, but likely worth little to nothing. Depending on the overall order and amount of debt on Steward’s books, even the loans that should now amount to roughly $638 million, that Medical Properties Trust has issued to Steward could experience a substantial haircut or even a complete loss. In a nightmare scenario, Steward could even reject its leases with Medical Properties Trust, which would mean that, absent another operator coming into the picture, properties could sit empty.
Even if this would have been the development to occur on January 4th, I don't think the plunge in share price on January 5th was warranted. In a hypothetical scenario, I went far and above what even a complete collapse and shutdown of Steward would look like. In the table below, you can see the $8.28 billion of shareholders’ equity that were on Medical Properties Trust’s books as of the end of the third quarter of last year. I then subtracted from this most of the company’s assets. This includes $3.31 billion of investments in unconsolidated ventures and entities, all of the interest and rent receivables due to the business, including those from all other tenants, all ‘other loans’ and ‘other assets’ as they are described in the third quarter earnings release, and even $1.23 billion of gross value associated with the company’s investments in financing leases.
I only left the company's cash and cash equivalents, as well as its properties, mortgage loans that are collateralized by third party assets, and real estate that is currently held for sale. It's worth noting that this hypothetical scenario does not involve any add-back for any depreciation and amortization associated with the aforementioned investments in financing leases that I am excluding from the picture. Even in this kind of scenario, the net asset value associated with Medical Properties Trust would be $1.94 billion. By comparison, shares of the company currently value the firm at $599 million as of this writing. This means that even if we write off several billion dollars of asset value, Medical Properties Trust would still be worth over three times what it is currently trading for, for a share price of roughly $11.24.
Now, a very good argument could be made that medical properties without tenants or medical properties that have struggled might not be worth what their book value happens to be. This is a perfectly acceptable counter argument. However, as management pointed out in a presentation issued in June of last year, the firm has a solid track record of recovering value from its real estate. As you can see in the image below, the market transactions conducted throughout 2022 and 2023 that involved sales or other initiatives involved properties with an original cost basis of around $4.4 billion. But the implied value associated with these transactions ended up being a bit higher at $5.3 billion. I find it very unlikely that such a large decline in value at the properties I have remaining in this scenario would be possible, especially when we are giving absolutely no consideration to all of the other assets we are writing off from the equation.
Takeaway
When there is a great deal of uncertainty in the market, volatility is the end result. Many investors likely panicked and sold their shares in response to this development. And that is because this development does bring with it uncertainty that is likely to end up harming Medical Properties Trust at some point in the not-too-distant future. In all likelihood, Steward will declare bankruptcy at some point. But even a true nightmare scenario seems to indicate significant upside for shareholders of Medical Properties Trust. The stock has been beaten down repeatedly, to the point where those who are bearish about the business have become irrationally so at this stage. Although my own increased stake in the company is likely temporary, or at least some of it likely is, I am planning on continuing to hold the stock because of just how much of a discount shares currently are trading at.
For further details see:
Medical Properties Trust: The Nightmare Scenario Still Offers Strong Upside