Over the past year, one of the biggest risks facing HCP Inc. (NYSE: HCP), a real estate investment trust, or REIT, is the ongoing saga regarding its major tenant HCR ManorCare.
ManorCare is its biggest tenant, and last year revealed that it was being investigated by the Department of Justice. ManorCare was charged with submitting false Medicare claims for services that, according to the DoJ, should not have been reimbursed.
This has cast a shadow over HCP ever since; the stock has underperformed its peer group including Welltower (NYSE: HCN) and Omega HealthCare Investors (NYSE: OHI). In the past year, Welltower stock is up 1%, while Omega is down 7% and HCP has declined 12%.
HCP has worked to reduce its reliance on ManorCare, but this has been a costly and time-consuming process that has weighed down the entire company. In response, the company is announcing a major strategy change. Here’s what investors need to know.
Behind the HCP Spinoff
HCP is a REIT that specializes in health-care properties including senior housing, hospitals and outpatient facilities.
Along with its second-quarter earnings, HCP disclosed plans to that it will spin off HCR ManorCare into a separate, publicly-traded REIT.
ManorCare itself represents more than 20% of HCP’s total revenue. Its portfolio consists primarily of skilled nursing and assisted living assets. As a result it is clear that a negative result of this investigation could have a significant effect on HCP, and the company appears to be expecting a fairly large financial penalty.
In the second quarter 2015, HCP took a $478 million charge relating to impairment of ManorCare direct financing lease investments. In the first quarter 2016, the company took an impairment charge of more than $800 million. This situation has dogged HCP for several quarters.
The good news is that HCP has taken significant steps to reduce its reliance on ManorCare during this difficult period. For example, last year HCP sold 50 HCR ManorCare non-strategic assets with proceeds of $350 million. HCP also acquired $847 million in properties from Brookdale Senior Living (NYSE: BKD), a provider of private-pay senior housing, to further expand beyond ManorCare.
But these steps only insulated HCP so much. The company is still suffering eroding profitability as a result of the ManorCare situation. Last quarter, HCP’s funds from operation, or FFO, declined 12% from the same quarter a year earlier. FFO is a critical metric for REITs, which is essentially a non-GAAP equivalent to earnings per share.
Why HCP Spinoff is the Right Move
It became clear to HCP management that the company would not be able to fully solve the ManorCare issue from internal efforts. Spinning off ManorCare into an independent entity will be beneficial to both sides. No longer having ManorCare holding down HCP will drastically improve its financial situation.
The HCP spinoff will enable HCP to vastly improve its portfolio and focus on its high-growth opportunities such as senior housing, life sciences, and medical offices. HCP will have a much higher-quality portfolio which will allow it to generate better financial terms when it pursues asset acquisitions. And, HCP’s portfolio going forward will be geared toward private-pay assets.
At the same time, HCR ManorCare will be able to fully devote itself to shoring up its financial position and improving its own portfolio. HCP investors will receive shares of the new company and thus be able to decide for themselves whether they want to stick with HCR ManorCare or not.
The news of the spinoff was fairly well received; shares of HCP popped 5% after the announcement, which signals investors are in favor of the transaction. The key takeaway is that shareholders should view the HCP spinoff positively.
DISCLOSURE: Bob Ciura personally owns shares of HCP and Welltower.
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