HCP’s Quality Care Properties Spinoff Set For The End Of October

HCP ‘s (HCP) board of directors approved the spinoff of Quality Care Properties, a REIT whose portfolio is comprised of skilled nursing and assisted living facilities. At the time of the spin announcement, Quality Care Properties, which was previously known internally as HCR ManorCare, was expected to own over 320 properties with estimated annual rent of about $485 million. The new company will trade on the NYSE under the ticker ‘QCP’ and a When-Issued trading market is already in place. On October 31st, shareholders as of October 24th will receive one share of QCP for every 5 HCP shares owned.

The most recent Form 10 provides some additional color on QCP’s portfolio and revenue base:

QCP’s portfolio will initially be composed of, as of June 30, 2016, 274 post-acute/skilled nursing properties, 62 memory care/assisted living properties and a surgical hospital, collectively comprising approximately 39,700 available beds/units, and an 88,000 square foot medical office building, across 30 states. The portfolio includes 249 post-acute/skilled nursing properties and 61 memory care/assisted living properties that will continue to be operated by the subsidiary of HCRMC under its existing triple-net, single master lease guaranteed by HCRMC.

The consummation of the Spin-Off itself will not result in any changes to the HCRMC master lease. QCP will have the right to receive payment of the $257.5 million deferred rent obligation due from the lessee under the master lease as of June 30, 2016, and will own HCP’s approximately 9% equity interest in HCRMC. QCP’s remaining 28 properties are, and are expected to continue to be, leased, on a triple-net basis, to other national and regional operators and other tenants unaffiliated with HCRMC.

HCP’s Chairman & current CEO Mike McKee said that ‘a stand-alone HCR ManorCare portfolio offers a unique opportunity to invest in one of the nation’s largest actively-managed real estate companies focused on post-acute/skilled nursing and memory care/assisted living properties.  Led by seasoned real estate and healthcare veteran Mark Ordan, Quality Care Properties will have the tools and flexibility to maximize the value of its assets over time.’ That certainly sounds optimistic, but the impetus for the spinoff was that the ManorCare portfolio was a drag on HCP’s operating performance. In fact, the top ‘benefit’ of the transaction listed in the first press release was that it ‘Improves HCP’s Portfolio Quality, Growth Profile and Financial Position’. Net Income, Funds From Operations (FFO) and EBITDA have all been declining over the past few years – not a trend investors like to see.

One of the unpublished benefits of the spin is that HCP will now be less reliant on government payees. Many of Quality Care Properties’ patients use Medicare or Medicaid meaning the government is actually footing the bill. In fact, the company is currently being sued by the Department of Justice (DOJ) for alleged overbilling of the government. A spin is a nice way to try and get rid of that overhang! Additionally, the reimbursement rates are always changing and that can be difficult to manage.

In contrast to QCP, according to Mr. McKee the majority of HCP’s remaining portfolio ‘will be private pay, including more than 850 properties across our three core segments of Senior Housing, Life Science and Medical Office.’ In addition to shedding poor performing assets, the transaction will also help improve its balance sheet. The company will receive the ~$1.75b in proceeds from QCP’s recently raised debt and it will use the money to pay down debt and for ‘general corporate purposes’.

It will be interesting to see how the leadership position at HCP shakes out. Mr. McKee only added the CEO title (he was previously the Executive Chairman) on an interim basis after former CEO Lauralee Martin was terminated back in July. The company feels that its bench is strong, so perhaps an internal candidate will be promoted. As noted above, the new company will be led by Mark Ordan, the former CEO of Simon Property Group (SPG) spinoff Washington Prime Group (WPG). Mr. Ordan also has previous experience in the health care property space as well.

Many are comparing this transaction to Ventas’ (VTR) 2015 spinoff of its skilled nursing and acute care facilities into Care Capital Properties (CCP). Unfortunately, CCP’s performance hasn’t been so strong with shares down over 20% since the spin. On a more positive note, at least Ventas has done OK. As previously noted, HCP will remain in the S&P 500 post-spin and Quality Care Properties will be added to the S&P MidCap 400 Index. Perhaps some ‘forced selling’ as a result of the index change will create an attractive entry point for those interested in the situation.

Disclosure: Author holds no position in any stock mentioned.