Ventas will spin off most of its skilled nursing facilities, and will acquire Ardent Health Services, a hospital operator.
Portfolio reorganization is to create skilled nursing facility ‘pure-play,’ and to enter a business ripe for consolidation (hospitals).
Ventas remains a solid buy at these prices.
Ventas Inc (NYSE:VTR), a leading real estate investment trust in the medical field, is doing a little portfolio reorganization. The company is spinning off the majority of its skilled nursing facility portfolio. At the same time, Ventas is adding some high-end hospitals to its portfolio by acquiring Ardent Health Services, a hospital operator. If comments in my last article on Ventas are any indication, some remain dubious on the company’s prospects and prefer to stay on the sideline until the dust settles. Current Ventas shareholders will get one share of Care Capital Properties for each four shares they own of Ventas. This article will examine Ventas’ acquisition of Ardent Health Services and its spinoff of Care Capital Properties. This article will also look at the rationale of these transactions, and will specifically look at why Ventas would spin off some properties and yet acquire others.
For those who don’t know, Ventas is a fairly well-diversified medical REIT with a special concentration in senior housing. Pre spinoff, about 48% of Ventas’ asset value was in senior housing. Pro-forma, Ventas will be 54% senior housing. Ventas currently owns 803 properties, most of which are in the US, but some are in Canada and the UK. Ventas is not an operator, but is rather an owner of the land. Ventas collects rent on hospitals, medical office buildings, and senior living communities. In most cases, the operator is responsible for maintenance, insurance and property taxes.
In acquiring Ardent and spinning off skilled nursing facilities, Ventas is getting into a business where a wave of consolidation could be coming (hospitals). Ventas is also allowing the new skilled nursing facilities REIT, Care Capital Properties, to focus on skilled nursing facilities. Management believes that the spinoff of Care Capital Properties will unlock financial value, and that the acquisition of Ardent will accelerate FFO growth. I tend to agree.
Ventas will spin off its skilled nursing facilities while adding hospitals.
According to management, the two companies should grow FFO at 9% per year going forward, versus 8.2% currently. Ventas also said it would raise the collective dividend by 10% at the time of the spinoff.
The spin-off of skilled nursing facilities will create two companies. Ventas will continue to be the diversified medical REIT focused on senior housing. Meanwhile, Care Capital Properties will be a near pure-play on skilled nursing facilities. About 90% of Care Capital’s net operating income will be from skilled nursing facilities. Although this will be a new company, Care Capital will be new in name only. Management will be staffed entirely from Ventas’ experienced bench. Care Capital’s property contracts aren’t new, either. The weighted average lease term has another ten years remaining on it, and only about 5% of annual net operating income is on a lease that rolls over from now through 2019. Debt will be about 4.5 times EBITDA, with the possibility of a lower debt ratio as Care Capital benefits from, on average, 2.3% rent escalators each year.
Now for some ‘back of the envelope’ calculations. Funds from operations in 2015 are expected to be $240 million. Care Capital will get one share for each four shares of Ventas. That means 82.5 million shares. That gives us $2.90 in FFO per share. Assuming a share price identical to that of Ventas, the valuation will be 23 times FFO. Even in this long-visibility growth industry, I believe Care Capital will have some downside at that valuation.
The expected midpoint dividend of 54 cents, which I assume would be paid quarterly, gives us a yield of 3.3%. That’s not too bad, but 3.3% is significantly below Ventas’ current yield of about 4.7%. Of course, this all assumes an opening share price of $66.50 per share. Is the spinoff a good way to unlock value? Yes, it sure is. Will Care Capital Properties be a buy? Not if share prices are identical to those of Ventas.
What about the acquisition of hospital operator Ardent Health Services? Ardent owns and runs three hospital systems, one in Amarillo, TX, another in Albuquerque, NM, and one more in Tulsa, OK. Ventas is acquiring Ardent for $1.75 billion. Is that valuation reasonable? Well, Ardent is a privately-held company, and so valuations are not readily available for this one. However, this deal will be accretive to the tune of eight to ten cents per share. The expected capitalization rate (which is calculated by dividing revenueby price) is greater than 7%. Generally, that’s a pretty solid ‘cap rate.’ Ardent is a top-ten hospital system, and over 80% of revenue is from high-quality, private-pay sources (non Medicare – Medicaid).
Ventas will definitely not be a hospital operator. Instead, Ventas will leave operations to Ardent, and Ardent will pay rent to Ventas. This will be a triple-net lease agreement, so Ardent will be responsible for insurance, property taxes and maintenance.
Charts on hospital expenditures in the United States. Courtesy of Ventas Investor Relations.
Ventas is getting into the hospital business because of the consolidation opportunities there. The US hospital industry is very fragmented, and more and more hospitals prefer not to have capital placed in their real estate. Therefore, Ventas figures that it will have many more acquisition opportunities in this industry going forward. Not to mention, Americans are spending more and more on hospital services one way or another, as the above charts indicate.
Although it might seem like Ventas is just spinning its wheels by acquiring some businesses and letting go of others, Ventas is actually setting itself up for accelerated FFO growth. Ventas is also unlocking value by splitting off its skilled nursing facilities business. I believe that these moves will wind up being prudent ones for Ventas in the long run. As I mentioned in my previous article last month, Ventas is a solid buy right here. However, I will take a ‘wait and see’ approach to Care Capital Properties. While Care Capital will be a solid business, it is not to be bought at just any price.
Disclosure: The author is long VTR. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.