Medical Properties Trust, Inc. (MPT) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Q2 2015 Medical Properties Trust Earnings Conference Call. My name is Britney and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to turn the conference over to your host for today Mr. Charles Lambert. Please proceed.

Good morning. Welcome to the Medical Properties Trust conference call to discuss our second quarter 2015 financial results. With me today are Edward K. Aldag, Jr., Chairman, President and Chief Executive Officer of the company and Steven Hamner, Executive Vice President and Chief Financial Officer. Our press release was distributed this morning and furnished on Form 8-K with the Securities and Exchange Commission. If you did not receive a copy, it is available on our website at www.medicalpropertiestrust.com in the Investor Relations section. Additionally, we are hosting a live webcast of today’s call, which you can access in that same section. During the course of this call, we will make projections and certain other statements that may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause our financial results and future events to differ materially from those expressed in or underlying such forward-looking statements. We refer you to the company’s reports filed with the Securities and Exchange Commission for a discussion of the factors that could cause the company’s actual results or future events to differ materially from those expressed in this call. The information being provided today is as of this date only and except as required by Federal Securities laws, the company does not undertake a duty to update any such information. In addition, during the course of the conference call we will describe certain non-GAAP financial measures, which should be considered in addition to, and not in lieu of, comparable GAAP financial measures. Please note that in our press release, Medical Properties Trust has reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. You can also refer to our website, again at www.medicalpropertiestrust.com for the most directly comparable financial measures and related reconciliations. I will now turn the call over to our Chief Executive Officer, Ed Aldag.

Thank you, Charles. Good morning everyone and thank you for listening in on today’s earnings call. This summer has been a very successful summer for MPT. Since the last earnings call, we've announced almost $1.1 billion in acquisitions, bringing our total investments year-to-date to $1.5 billion. This already exceeds the record-setting total we acquired in 2014. We expect the second half of 2015 to continue to add significantly to this number. With the results announced this quarter, we continue to provide double digit growth in our normalized FFO per share. Our total assets today are approaching $6 billion and our diversification is better than ever. Let me start this morning with the announcement we made concerning Capella Healthcare. We first used the structure when we along with management purchased Ernest Health in 2012. This has proved to be a truly successful partnership. We're delighted to be able to use essentially the same structure to purchase Capella Healthcare with the existing management team. We've signed definitive agreements and expect the transaction to close in the second half of 2015. As the genesis of our company over 12 years ago, our business model has always been to use our hospital operating knowledge to obtain not just real estate returns, but in certain circumstances operating returns as well. We accomplished that with our very first investment with Vibra Healthcare even before RIDEA was available and our investments in Ernest Health and our investments in numerous other smaller transactions. With this release, we announced at MPT has executed definitive documents to acquire $600 million of acute-care real estate interest and invest approximately an additional $300 million in support of a management led refinancing of Capella's operations. Even with this transaction our RIDEA type investments represent only 7% of our assets. Just like with Ernest…

Thank you Ed. This morning, we recorded normalized FFO for the second quarter of $0.30 per diluted share, that’s a 15% year-over-year increase. Our year-to-date results of $0.58 per share, represents a 12% increase over last year's first six months. The primary adjustment to arrive at normalized FFO for the second quarter is approximately $26 million of acquisition cost, the majority of which about $22 million is comprised of real estate transfer taxes that we are incurring as expected, as the MEDIAN assets are acquired. Legal cost, that’s another $2.1 million and other cost directly attributable to successful acquisitions about $1.6 million. I will give you an update on the MEDIAN transaction before we turn to Capella. Early in the quarter, we signed purchase agreements for 32 of the 35 properties. As of today, 30 of those have closed for an aggregate purchase price of about €627,000 million, with a €20 million 31st expected to close in the third quarter. The final four properties aggregating about €58 million are expected to close by year-end, completing the €705 million acquisition that we announced almost a year ago. Turning to Capella, as we have previously disclosed and as Ed mentioned a minute ago, we have agreed to acquire along with Capella management, Capella Holdings Inc. for a total enterprise value of approximately $900 million. And again reiterating Ed’s comment that that reflects about a 7.8 times multiple on recent historical EBITDAR. Subsequent to the transactions, MPT will fully own real estate interest of about $600 million. The $600 million will be represented by $390 million in acquired properties that will be leased back to Capella and $200 million in mortgage loans. The blended GAAP yield to us will approximate 9.1%, that’s based on an escalator floor of 2% annually; it will also…

[Operator Instructions] Our first question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Please proceed.

Thank you and good morning. On Capella, if you could – could you maybe breakout how you valued the operator versus the real estate, I think I heard the 7.8 times EBITDA, I think was that an overall entity value on the $900 million?

Yes, the 7.8 was the total enterprise value that contemplates all of the assets and operations of Capella, and we further bifurcated that down to $600 million of that $900 million with allocated to real estate interest and I even took it further than that on this call disclosing that $390 million of the real estate interest would be purchased and leaseback and the remaining $210 million would be structured as mortgage loans. And just to reiterate the reason we sometimes use the mortgage loan structure is to avoid in-site taxes that would otherwise require additional investment that we can avoid by structuring a portion of the real estate value as loans.

And just, so ultimately your – what’s the implied valuation of the operator, so there's $290 million or $300 million total investment to the operator for 49% interest?

Yes. Well, the operator has a 100% interest. And 100% interest is shared 51% with the management team and 49% with us. But your question regarding the valuation is again based on the same starting point, which was 7.8 times historical EBITDA and then carving out the real estate, then you end up with the $300 million and that valuation equates to about a 4.2 time to 4.3 times multiple on the operating entity.

On a pro forma basis for the rent and mortgage payments?

That's correct.

Okay. That's helpful thank you. And then as it relates to capital, you said that you will be opportunistic as it relates to the capital markets and you’ve got the bridge loan in place for now. Can you maybe, obviously it’s a little bit of a delicate situation and in terms of what you guys expect to do, but can you talk about how you would envision funding relative to closing from a timing perspective?

Well again, I guess and most accurate we can say is we are going to be opportunistic, we’re going to keep our eyes on the markets, and at the right time in our view we will access that capital. Now it’s important that we point out that just because we’re not doing something immediately, that shouldn't imply that we’re trying to time the market, there are a lot of conditions that have to come together and we believe we will be ready to access the capital markets when all of those conditions converge and that could be sooner than later in fact.

What’s the debt equity split assumed in the $0.04 accretion roughly?

45% leverage, based on the Capella transaction.

Okay, and then lastly maybe just as it relates to AXA, can you speak to the structure of the venture with them? Is there a size of the joint venture, are there fees that you guys will receive, anything you could sort of share there, I know its early days?

It is early days Jordan and we have signed some agreements, but certainly not all of them, and so we’re a little bit constrained on giving the financial details. The important thing for us and why we wanted it to become known sooner than later is, is the strategic import and value to us of having what truly is the 800 pound gorilla in Western Europe. Sourcing deals for us, leading interference in ways in certain governments where we’re not used to that and don't know people, and so just structurally the first two deals are separate JVs, they do not include further commitments beyond the initial transaction, and we’ll be eager when we get a little bit further down the road to describe some more of those details. But the main point again is, this is really a strategically valuable transactions for us.

My last one on that is, I just noticed, you know obviously that the ventures are planned to be managed obviously locally by AXA, given that, that’s sort of their domain if you will. Can you just maybe speak to what the opportunity is as you guys see it in terms of investing in Spain in northern Italy as seemingly more passive investor in this JV?

Well I’m not sure we're going to be any more passive than we normally would be, they will manage locally. But again these are to a great extend net leases, which do not require a lot of facility management, there is regulatory management and reporting and so forth. But the real value, one of the real values that AXA brings is their footprint, is their market and their resources across almost all jurisdictions. And the value we bring that they were looking for is expertise in hospitals operations and real estate. So that’s the synergy that you know in the cliché, we hope the value is greater than the sum of this parts and we've taken a modest step to begin developing that relationship and truly expect that gets larger as we get closer to finalizing these first deals.

But Jordan, I think it’s very important to point out that we maintain our very active role in the underwriting of the healthcare operations and in the asset management of the healthcare operations.

Okay. We look forward to hearing more details. I will yield the floor. Thank you.

Your next question comes from the line of Mike Carroll with RBC Capital Markets. Please proceed.

[0:26:09] [Audio Gap] Italy and Spain investments, I know you’ve been looking at these markets for some time now, but it seems like these deals are quicker than originally expected, what changed there?

Well nothing changed Mike, and I didn’t hear the first part of your question, you came into the middle of sinus, let me know if I don’t answer the full question. This did not happen any quicker than we expected it to happen, we’ve been looking at these markets for a long time, we’ve been working on these particular portfolios with AXA for a long time.

Okay. Then what are the near-term goals in this market, how big do you want to grow these portfolios and will these existing – or will you just grow with this existing relationship?

Our goals for these markets are the same as they are in every market. It’s not to be any particular size in any given market, but to take advantage of opportunities within those markets. We typically wouldn't go into a market if we thought that it was going to be limited, Spain as an example, with a €21 million investment here. Obviously we expected there will be more opportunities there than just the $21 million the opportunity. In Italy, we already have other opportunities that we’re looking at, so it certainly doesn’t mean that we’ll do any more, but both of them are places that we would welcome additional investments.

Okay. And then with regard to the Capella investment, how should we think about the annual capital expenditures and will you start providing that for us once that deal closes?

Well the capital expenditures, we obviously in doing our underwriting we had figures that we expect and we work through with the management company at each individual hospital. The expenditures are being funded, they are out of operations and is taken into account in our analysis. If there are any extraordinary capital expenditures then we’ll look at those on a case-by-case basis. Generally speaking, the capital expenditures we expect for this seven hospital portfolio is somewhere between $25 million and $35 million a year.

Great. And then my last question is on the Adeptus development. I think in the press release this morning you indicated that the cash yield will be double digits. But I thought that you previously announced that those developments will be about 9% cash yield, is there anything different that I’m missing between I guess that reporting there?

No, there is no difference. Keep in mind that during construction which can take depending on local conditions can take upwards of 9 plus months. During construction they're not paying rent on our construction advances that accrues and so accounting conventions prohibit us from recognizing that, what is truly income. So it accrues and becomes part of the lease base. And so then when you start recognizing the repayment of that portion, it pushes, in the case of Adeptus it pushes us up over that 10% mark on a cash receipt basis.

Great. Thank you.

Thanks. Your next question comes from the line of Tayo Okusanya with Jefferies. Please proceed.

Yes, good morning. I think I have to send you guys Rosetta Stone books with all these different countries and languages you have to be in. Just getting away from the deal pipeline a little bit, could you just talk a little bit about you know some of your larger tenants ISIS, Ernest, Prime, kind of what how those guys are doing generally what market conditions are like for them?

Sure. Everyone in the existing portfolio is doing very well Tayo. No one has strong growth, but everyone has good solid growth. The ISIS hospitals that we won are performing exceptionally well, continuing to be leaders in their markets; Prime Healthcare markets have been very stable for the last year, they continue to perform very well all across the board. Ernest Health has done very well in the last 18 months or so, they had the downturn with their LTACs about two or three years ago as did everybody else, but their entire portfolio is performing exceptionally well. When you look at same store analysis, and I think I gave those exact numbers on the last earnings call, it show just how well the existing original 16 hospitals are performing, and then as I mentioned on today's call we’ve got 10 additional hospitals with them, so their overall EBITDA is doing exceptionally well.

Okay. Then second question, this kind of news this – an interesting news this morning from Community Health, of them kind of spinning out some of their rural hospitals into a different entity. Just kind of curious what you think about that and whether you think that would be a good strategy from any of your operators that may also have decent exposure to rural hospitals?

Yeah, Tayo, I know a little bit about some of the community hospitals, I only saw that list late last night. It’s interesting – it will be interesting when we all get looking at it in a little more detail because they will continue to own a large number of rural hospitals in any definition. So I can’t address specifically what they're trying to do in separating what they call rural hospitals from their total overall portfolio. And other than that I just don’t think I can address it at this point.

Not sure. Thank you very much.

Thanks Tayo.

Your next question comes from the line of Juan Sanabria with Bank of America Merrill Lynch. Please proceed.

Hi, just hoping you could speak a little bit more on Capella in terms of the OpCo, sort of the capital in place there or equity to fund growth and how that works, and was the $25 million to $30 million in CapEx for the entire real estate value?

The $25 million to $35 million in CapEx is for the seven existing portfolio of hospital.

But it’s not just real estate; I mean that’s the whole company CapEx. It may include expensive equipment and machinery and other non-real estate capital volumes.

But how is the rest of the OpCo structured other than the $290 million of debt, and could you provide what the cash return on that $290 million of the 15 year loan is?

So what we’ve said and trying to be as descriptive as the agreement allow us to be, what we said is the coupon on that $290 million loan is equivalent to the initial going in cash rate on the leases and the mortgage loans. And I think if you would do the back in the envelope type math, we've given you that the GAAP coupon, you know you’re going to get to something in the low 8s as the going in cash coupon. So that’s the fixed return that we did pay along with the lease and the mortgage income, and then basically after all of that is paid, we split with our joint venture partner who is Capella management, we get 65% of the remaining earnings or distributions or whatever the measure is and they get 35%. For the first year, which by the way takes into account this $25 million plus CapEx run. For the first year, we expect that that will result in an extra $0.02 a share for us over and above the $0.04 that we’ve included in run rate guidance.

Can I ask why you haven’t included that in run rate guidance, if you feel pretty comfortable that you’ll get it?

We are very comfortable that we will get it, but it’s not contractual. And the other $0.04 is contractual, they have to make the payment just like anything and we'd rather recognize that non-contractual estimated income as we actually realize it.

Okay. And just one more question on the OpCo, what’s the split between or how is the rest of the OpCo capitalized other than the $290 million, is there any equity in there?

Yes. The equity will be split, as same as the ownership, 51% to the management team and 49% to an MPT subsidiary.

But what’s the dollar amount of equity relative to the…

It’s nominal. You should probably assume total not more than $10 million. I mean that’s very, very important to, especially the management team, but – so I don’t mean to despair you by calling it nominal, but it’s not material to the transaction.

Got you. And the non AXA on the JV structure, who is sourcing these deals and is the partner AXA the parent or retail fund investors? Like who ultimately bears the risk from an AXA perspective?

From the risk bearing perspective, they are managed funds either for country AXA insurance providers for example or outside funds for example in one of the transactions we’ve described and we just can’t name, but it’s a highly familiar US state pension fund, and so those are the types of partners that we have. And as far as sourcing the deal, it goes both ways, and in fact that’s how the relationship got initiated is we actually were successful in acquiring an asset that AXA was also attempting to acquire, and that caused them to bring to us the deal and we took to them a deal and that’s the way we expect it to work is both entities will be bringing possibilities to the venture. There is no obligation, I think Ed mentioned it, there is no obligation on the part of either venture to take or even offer for the most part of the transactions.

And just lastly from me. On MEDIAN, can you just give an update on the debt financing there, timing, what you are seeing in terms of cost in the marketplace today and why you haven't moved as of yet to secure that?

The Euro bond market has been virtually shut down until recently, starting in early to mid- June when the Greece circumstances took over the headlines, and truly it’s only been recently that, that market begins to show life. And so just like the other capital markets transactions that we plan in the foreseeable future, we will be, we are prepared to act when market conditions are good for us and the bankers both here and in Europe seems somewhat encouraged that, that market is redeveloping and finding – getting its feet under it again.

Any sensitive pricing that you could arrange?

No, you know, that’s one of the things you know that we keep our eye on is not only pricing, but the depth of the market and really all of components that go into being confident that we can get a good strong execution.

Thank you.

Thanks Juan.

Your next question comes from the line of Mike Mueller with JPMorgan. Please proceed.

Yeah, hi. I guess for the Capella real estate part of the transaction, can you talk a little bit more about the $210 million mortgage loan, what assets is on, is it outside of the seven that you’re buying?

No, it’s not. There is seven assets; five will be subject to leases, got some conventional type leases and there is nothing that would otherwise keep us from putting the other two under leases, except if we did that of course we’d be paying Capella, creating a capital gain that would require immediate discharge of that tax liability. And so we can achieve exactly the same things economically, structurally, credit wise by simply loaning mortgage funds to those operators, which by the way will be guaranteed and will have cross default provisions. So we’re not losing any credit. It’s solely because of the desire not to pay taxes when it's not necessary to pay taxes.

Okay, so I guess legally you’re buying five and putting the mortgage on two though, is that correct?

That’s correct, that’s correct.

Okay. And is the term on the mortgage the same as the lease term, and everything is identical?

Everything is identical including the escalator, but of course perhaps getting into the weeds of this level, but remember the 9.1% GAAP yield, we get to straight line the least, but we don't get to straight line the loan amount, but we nonetheless get a guaranteed 2% escalation every year beginning in year one, even though it’s not reflected in that 9.1% blended rate.

Got it. Okay. So it’s basically a 100% LTV loan then?

On the mortgage?

On the mortgage?

That’s right. Again, it’s meant to mimic the lease structure and of course of purchasing leaseback is done at a 100% of the real estate valuation.

Got it. And just to clarify the run rate guidance of 120 to 132 that has $0.04 in there, but not the $0.02, is that correct?

Correct.

Correct.

Okay. I think that’s it. Thanks.

Thanks Mike.

There are no further questions left in the queue. I will now turn the call over to Mr. Aldag for closing remarks.

Thank you, Britney, and thank all of you for joining us today and as always if you have any questions please don’t hesitate to call myself, Steven Hamner, Charles Lambert, or Tim Berryman. Thank you very much.

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.