Become A Contrarian REIT Investor
- Contrarian investing is related to value investing in that the contrarian is also looking for mispriced investments.
- New Senior represents a compelling opportunity for investors to take advantage of an attractive 10.1% dividend yield, while bidders begin to surface.
- New Senior is suffering from high leverage and external management – clearly keys that are held by the dominant Ventas.
- The contrarian investor can see through the noise and recognize the true value that can be unlocked.
A contrarian investor is generally characterized by buying or selling based on a contrast to prevailing sentiment. In other words, a contrarian thinks that the “following the herd” mentality can lead to exploitable mispricing opportunities.
Contrarian investing is related to value investing in that the contrarian is also looking for mispriced investments and buying those that appear to be undervalued by the market. In “The Art of Contrary Thinking” (1954) by Humphrey B. Neill, he notes it’s easy to find something to go contrary to, but difficult to discover when everybody believes it. He concludes:
when everybody thinks alike, everybody is likely to be wrong.
Today, I’m going to discuss the concept of contrarian investing, and I’ll also provide a value investing idea. The two are somewhat related because investments may drop during periods of negative news (i.e. due to incorrect assumptions by other investors) regarding the long-term prospects for the company.
Brookdale or New Senior?
Last week, CNBC writer Lauren Thomas wrote:
Shares of Brookdale Senior Living fell Friday after The Wall Street Journal reported, citing sources, that private equity firm Blackstone is no longer going to make a move.
Thomas (my daughter) explained that “healthcare facility owner Ventas, Inc. (NYSE:VTR) is now in talks to acquire either part or all of Brookdale, the newspaper said Thursday afternoon, citing people familiar with the matter.”
Thomas reports that Brookdale’s losses are mounting – she said that the senior living operator “reported a net loss of $268.6 million for the fourth quarter, up more than 50 percent from the same quarter the prior year.”
According to Alana Stramowski with Senior Housing News:
it’s just the latest round of bad results for the senior living giant, which attained its current massive scale of about 1,100 communities following the acquisition of rival Emeritus Corp. in 2014.
Integration troubles and, more recently, challenges related to new supply, labor costs, and other factors have had the company’s share price in a tailspin since 2015.”
Citing more new supply expected to hit the market in 2017, VTR management said during some year-end earnings call that the company is anticipating a significant hit in occupancy and a dip in net operating income within nearly one-third of its senior housing operating portfolio.
VTR’s Senior Housing Operating (or SHOP) portfolio represents 37% of the company’s investments of which Brookdale represents 5% of overall revenue.
As of Q4-16, VTR owns 1,270 properties that consist of 42% triple net, 30% SHOP (based on revenue), 25% office, and 3% in loans.
VTR considers itself the “premier provider of capital to leading healthcare and senior living companies and university-based research institutions,” and as the chart below illustrates, the company has a diversified platform of best-in-class operators:
As viewed (above), VTR has exposure to Brookdale and Holiday; collectively these operators account for around 11% of investments.
In a Forbes article last week, I wrote:
Ventas already has a relationship with Holiday (26 properties) and it seems logical that the large cap REIT with the low-cost of capital advantage would find the latest SoftBank (OTCPK:SFTBF) deal opportunistic. New Senior (NYSE:SNR) is trading at a large discount with a portfolio well-suited for an ownership team armed with cash and credentials.
Although M&A is not necessarily a catalyst for any investment selection, I believe that New Senior represents a compelling opportunity for investors to take advantage of an attractive 10.1% dividend yield, while bidders begin to surface. I wrote that:
we suspect that SoftBank owners will view New Senior through a different lens in which internalization and share price performance are highly correlated.
Although VTR has said publicly that it was only deploying capital within its life science and acute care hospital sectors, I believe that buying New Senior offers a contrarian opportunity for the dominant healthcare REIT to capitalize on a high-quality operator.
BKD owns 1,100 communities, and the dominant senior housing operator has been strengthening its balance sheet through disposing of non-core and underperforming assets, reducing CapEx and lowering leverage. In 2016, BKD sold 51 communities generating $305 million of gross proceeds (and terminated leases on seven communities).
Activist REIT investor Jon Litt’s firm believes that BKD is worth $25 per share, but according to Bloomberg, “analysts have valued the sum of Brookdale’s parts at closer to $21, on average.” Citing Bloomberg:
A $25 bid equates to an equity value of about $4.7 billion. That’s not small, particularly when you add on Brookdale’s $6.2 billion in debt and lease obligations, but it’s certainly a lot more digestible than what might have been. Alternatively, Litt’s firm says Brookdale’s real estate alone is worth about $21 a share.
In November, BKD agreed to acquire a portfolio of 64 U.S. senior-living communities leased from HCP Inc. (NYSE:HCP) at $1.1 billion.
VTR is certainly a logical REIT buyer for BKD’s real estate holdings, but in my opinion, SNR is a better fit.
As viewed in a chart (above), VTR owns 26 buildings leased to privately-owned Holiday that generate $62 million in revenue (3%). By rolling up SNR’s 118 Holiday properties and remaining buildings, VTR could increase exposure in Holiday to just under 150 properties.
Back in January, I wrote on New Senior and provided my NAV (net asset valuation), in which “I suggested a value of $15.67 per share. As noted, since that time, it has sold off a few assets and cap rates have nudged upward around 50 bps. We see consensus estimates at $13-14 per share.”
Clearly, the supply issues and operator pressures in senior housing has impacted shares in SNR; however, the new ownership group (SoftBank) could create an opportunity for VTR to capitalize on this “contrarian” play. SNR is also suffering from high leverage and external management – clearly keys that are held by the dominant Ventas!
Ventas Has Cash And Cash Flow
VTR has made great strides in enhancing its balance sheet and financial strength. In 2016, the company issued around $1.3 billion in equity over the course of the year at an average gross price of approximately $70 per share.
The company also raised $850 million of new senior notes, including the most attractive 10-year bond in the company’s history with an all-in rate below 3.25%. VTR retired or refinanced approximately $1 billion of in-place debt, yielding approximately 2.3% on a GAAP basis.
By merging into VTR, SNR investors (of which I’m one) could benefit from a highly accretive transaction in which VTR could use its currency to accelerate earnings and dividend growth. SNR does have elevated debt (just over $2 billion at Q3-16), but VTR could easily replace that with its strong liquidity.
VTR’s cumulative capital activity during the year further bolstered its balance sheet. At year-end, VTR’s net debt to adjusted EBITDA improved to 5.7x, a 0.4x reduction from year-end 2015 leverage of 6.1x.
VTR’s fixed charge coverage grew to 4.8x; net debt to gross asset value improved by 4% to 38%; and secured debt to total indebtedness reached 6%.
VTR plans to drive an even stronger financial profile and liquidity in 2017, including refinancing approximately $1 billion of low-cost short-duration debt with longer-dated notes.
In terms of cash flow, VTR’s same-store cash NOI increased 2.7% for the full-year 2016, in line with its 2.5% to 3% total same-store guidance range. VTR’s fourth quarter same-store NOI growth of 2.9% was in line with expectations.
During the year, VTR grew normalized FFO per share by 5%, at the high end of the guidance range presented at the beginning of 2016. Here’s a snapshot of VTR’s quarterly FFO/share growth:
VTR’s management team has a history of thinking outside the box. In 2016, the company made or committed to investments of nearly $2 billion, including the accretive $1.5 billion acquisition of a high-quality life sciences and innovation center portfolio. Also, VTR successfully spun off most of its skilled nursing properties by forming Care Capital Properties (NYSE:CCP).
By capitalizing on perceived “mis-pricing,” VTR has been able to not only maintain a healthy dividend, but also grow it. Here’s a snapshot of VTR’s dividend history:
VTR grew its dividend by 6% in 2016, and the company expects 2017 normalized FFO per share to range from $4.12 to $4.18. Also, the company expects the total same-store portfolio to grow cash NOI by 1.5% to 2.5%, with all segments contributing to growth. Here’s a snapshot of VTR’s FFO/share compared with the peers:
Here is a snapshot of the same FFO/share data in %:
As you can see, the company is forecasting modest FFO growth in 2017 and 2018. However, VTR is well-positioned to boost profits by utilizing its low cost of capital advantage. VTR could easily power up earnings by acquiring deals above a 5.7% cap rate – and while the company continues to acquire hospitals, life science buildings, and related properties, it seems likely (to me) that the company could take advantage of the “contrarian” senior living opportunities, namely New Senior.
Also, on the earnings call last week, VTR said it plans to sell around $900 million of assets, and this should fortify the balance sheet, as the company drives accretive investments. VTR does not need to issue equity short term, but it’s likely to do so if it acquires a larger portfolio acquisition.
It’s no secret, VTR’s CEO, Debra Cafaro, is one of my favorite REIT CEOs. She is the essence of an “Intelligent REIT Investor” and her risk management skills are second to none. I have been a shareholder in VTR for a number of years, and I have been pleased with the results:
Over the last 6 months, most healthcare REITs (except MOB REITs) have underperformed, creating an opportunity for contrarian investors:
VTR shares are cheap, based on P/FFO metrics, but take a look at SNR:
Here’s a snapshot of VTR’s dividend yield compared with the peer group:
In closing, there’s little argument that BKD should look to monetize its real estate holdings, and a REIT deal seems obvious. However, I consider SNR a more logical deal for VTR due to the simpler structure (SNR already has leases in place with Holiday) and the recently announced SoftBank deal (with Fortress).
While “everyone is thinking alike” (that VTR will acquire BKD), I’ll offer an even more contrarian forecast – that Ventas pursues New Senior. As an investor in SNR, being acquired by VTR seems to be a logical move for the company to internalize and benefit from VTR’s balance sheet and low cost of capital advantage.
A contrarian investor believes that investments may drop “too low” during periods of negative news, due to incorrect assumptions by other investors, regarding the long-term prospects for the company. New Senior has been trading on negative news for quite some time, and although the senior housing news may be the talk of the town, the contrarian investor can see through the noise and recognize the true value that can be unlocked.
Disclosure: My brother works for Blue Harbor, a company affiliated with New Senior and Fortress.
Check out The REIT Beat if you’d like to get more of my ideas, including early access to my highest-conviction REIT plays, access to Q&As with management teams, weekend REIT reports, and more. We’d love to have you on board, so have a look.
Source: F.A.S.T. Graphs and VTR and SNR Filings.
Author Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
Disclosure:I am/we are long APT, ARI, BXMT, CONE, CORR, CCP, CCI, CHCT, CLDT, CUBE, DLR, DOC, EXR, FPI, GPT, HTA, HASI, KIM, LADR, LTC, LXP, O, OHI, QTS, ROIC, STWD, SNR, STAG, SKT, SPG, STOR, TCO, UBA, VTR, WPC, PEI, EQR, DEA, MVEN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.