Medical Properties Trust, Inc. (MPT) Q3 2017 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Q3 2017 Medical Properties Trust Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Charles Lambert.

Good morning. Welcome to the Medical Properties Trust conference call to discuss our third quarter 2017 financial results. With me today are Edward 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're 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 and/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 the federal security 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 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, and thank all of you for joining us today. As you've seen from our press release this morning, the third quarter was another record quarter for MPT. We all know that things seldom work exactly as you have planned, but it is even rarer that everything at a quarter works out better than you had planned. Steve will go through some of the specifics with you in a few minutes. But first, let me hit some of the highlights. As you already know, we completed a very successful $1.4 billion bond issue at a rate lower than we had projected. We were able to close on the Steward-IASIS transaction soon thereafter, virtually eliminating the dilutive interest carrying costs we have projected in our original guidance. In conjunction with the bond issue, we redeemed $350 million of bond with a 6 3/8% coupon, saving us over $4.8 million per year in interest cost. Moving on to our portfolio coverages. I want to reiterate that our lease coverages are greatly enhanced through our master lease structure and cross default provisions. Additionally, we often have credit enhancements through corporate guarantees and letters of credit. As you will note on our supplement, of the same-store facilities reporting, 91% of them are either master leased, cross-defaulted or have parent guarantees. The remaining 9% have coverages greater than 3x. For same-store EBITDAR coverage, for the portfolio Q2 over Q1, was essentially flat at 2.5x. Numerous health care operators have reported declining volume and financial performance erosion in 2017. Our operators saw a slight mix and positive and negative changes to their operations over the last quarter. As we reported last quarter, we have historically been conservatively reporting EBITDAR coverage as opposed to an EBITDARM coverage, as reported by many of our peers. So just to be sure we have an apples-to-apples comparison, our same-store EBITDARM coverage, quarter 2 over quarter 1, had a very slight decline from 3.4x to 3.2x. By property type, we think it's important to break out the U.S. and European properties. First, on a same-store basis again, for general acute care facilities in the U.S., our EBITDARM coverage was 4x versus 4.1x for the last quarter. For our acute care facilities in Germany, the EBITDARM coverage was almost 2x versus 1.6x for the first quarter. And in the U.K., where we have 1 small hospital, the EBITDARM coverage was 1.2x versus 1.4x for the first quarter. The decline here is primarily a seasonal one for the U.K. Our same-store LTACHs EBITDARM coverage increased slightly quarter-over-quarter from 1.8x to 1.9x. The LTACH coverage appears to have stabilized from the effects of the patient criteria rules. We do not have any LTACHs in Europe. The LTACHs now represent less than 4% of our total portfolio, and no 1 LTACH represents more than 0.4% of the total portfolio. Our IRF portfolio continues to perform well in the U.S. and in Europe. The U.S. IRF portfolio only represents about 5.5% of our total portfolio. The same-store U.S. EBITDARM coverage was a strong 2.6x. Our German rehab facilities continue to perform well, but have suffered from the German nursing shortage. This has resulted in higher labor costs, offsetting the rise in revenue. Our operator believes this situation will improve in 2018. The same-store IRF EBITDARM coverage in Germany is 1.6x. In early October, Adeptus emerged from bankruptcy resulting in no loss to MPT. Importantly, throughout the bankruptcy process, all of our rent was paid on time and in full. The Adeptus scenario is a testament to the strength of our underwriting and deal structure. Last October, when Adeptus announced their collection issues, we explained to the markets that our investment in the Adeptus facilities was strong and secured, and at the end of the day, there would be no loss to MPT resulting from their issues. In other operator news, one of our tenants, Surgery Partners, along with Bain Capital, completed the acquisition of National Surgical Healthcare, which created an enterprise with 125 surgical facilities across 32 states. We currently have 2 hospitals operated by Surgery Partners, which continue to perform exceptionally well. 8 of Prime's hospitals, 5 of which MPT owns, were named to the U.S. News & World Report 2017-2018 High-Performing Hospital List. 6 of MEDIAN Kliniken's facilities placed in the top 10 best facilities for quality rankings in Germany. One of their facilities ranked #1 in cardiology rehabilitation facilities in Germany according to the German Pension Insurance Association. We continue to be very bullish on the U.S. health care market. Hospitals remained a critical component of the health care system in every community in America and throughout the world. Clearly, these past 2 quarters, we have seen some disruption caused primarily by the debates over the ACA and potential replacements. We believe these to be temporary interruptions and continue to seek out high-quality acute care hospitals for additional investments. Likewise, we remain very positive on our European markets and look to expand our investments there to bring our total European exposure to 30 plus or minus percent of our portfolio. We have recently increased our staffing in the Acquisitions Department and Asset Management Underwriting Department. We are well poised for continued growth in 2018. Now I'll ask Steve to go over the detailed financial results. Steve?

Thank you, Ed. This morning, we reported normalized FFO of $0.33 per diluted share for the third quarter of 2017. Included in normalized FFO are acquisition costs of about $7.2 million, the majority of which are German real estate transfer taxes and costs related to the closing of the $1.5 billion Steward acquisition, and $4.4 million of financing costs related to that same acquisition. Looking ahead into the fourth quarter, we expect another approximately $14 million in early redemption fees related to the $350 million 2022 unsecured notes issue that we redeemed with proceeds from our September notes offering. Even with this redemption cost, the financing is highly accretive because we replaced 6 3/8% borrowings with 5% borrowings. We closed on about $1.5 billion in hospital real estate during the quarter, bringing the year-to-date total to more than $2 billion, an increase since year-end 2016 of 31%, continuing our 30% plus compound annual growth rate over recent years. And of course, every acquisition we have made during this period has been strongly and immediately accretive to our normalized FFO. With this morning's announcement, we modestly adjusted our 2017 guidance estimate and affirmed our 2018 estimate. We are increasing the range of our 2017 expectations by $0.01 as a result of closer alignment between the September issuance of $1.4 billion in unsecured notes and closing of the $1.5 billion Steward acquisition. Accordingly, we now expect that our full year 2017 normalized FFO per share will fall in a range between $1.30 and $1.32. We continue to expect normalized FFO in 2018 of between $1.42 and 1.46 per share. As we described last quarter when we initiated our 2018 estimate, those estimate do not include any possible acquisitions or asset sales, including possible JV type dispositions, so let me briefly update you. We have previously described the process that is well underway to sell joint venture interest in certain assets to long-term institutional investors. These assets include some of the hospitals that we lease to Steward Health, our largest operator, and there are other portfolios and single assets that we are also considering selling. To remind you, the goals of these sales are as follows, first, to use proceeds to reduce our borrowings and drive leverage to our normalized operating range of less than 5.5x EBITDA. As of today, we are already at less than 5.8x, comparing very attractively to our health care REIT peers; next, to develop access to lower cost long-term capital. We believe this will also serve to independently demonstrate the value of our assets to sophisticated long-term institutional investors; and finally, to reduce our concentration of exposure to any particular operator. Negotiations are progressing with certain parties, and we continue to be optimistic that we will have something to report during this year. Our estimates of future normalized FFO do not include the impact that will result from any of these possible transactions, which may, of course, include reduction of rental income and changes to interest expense and other capital cost, along with the possible additional investment income from reinvestment of sale proceeds. Late in the quarter, the bankruptcy court confirmed the Adeptus reorganization plan that provides for the assumption of 100% of its master lease obligations with MPT. I will not go through the details yet again, other than to just simply remind you that we have agreed to [indiscernible] set for certain facilities and sell or re-lease them in the future. We continue to believe that such transactions will not have any material impact on us. Finally, and this is a monetarily small item but very important. During the quarter, we prepaid the only secured debt on our portfolio, so our balance sheet is now 100% unencumbered, which provides even greater financial flexibility in the future. And with that, we'll be happy to take questions. Operator?

[Operator Instructions]. Your first question comes from Drew Babin with Robert W. Baird.

I was hoping to ask, in your conversations with your hospital operators going into next year, obviously, there's been some negative sentiment issues in hospital business, but I was hoping you could maybe isolate a few key items, whether it's cost controls or anything that's happening on the positive side that gives your operators hope that there might be a turning point at some point next year.

Certainly. If you look at our operators across the portfolio, very interesting, most of their revenues were actually up over the last couple of quarters. So they had some additional expense exposure from the nursing shortages and labor shortages that the entire industry has had. There obviously have been some softening of the volumes in our portfolio, but as I mentioned in the prepared remarks, that was fairly mixed across the portfolio. We report a quarter behind so that we get as much information as we possibly can. If you actually look at where our operators are going into the month of November, most of them have seen an increased utilization in November. Now maybe we have a more harsh flu season being prepared than we did maybe last year. But I think for the most part, all of our operators are optimistic about where they see 2018 being.

And among those operators and among the assets in your portfolio, have you noticed any trends in terms of rural versus urban and are geographic as you look across the portfolio?

No. It's been pretty equally mixed across the portfolio, with no specific things you can tie to versus those 2 categories.

Okay. And then just one last question. The Adeptus transition portfolio. Obviously, it's not that large relative to the overall pie at MPW. But any update there in terms of whether it's more likely that those assets might be released? Is there any operator that's aggressively trying to expand in that space or some kind of alternate use that may capture those?

Yes. So most of them will be released. There are a handful that truly can be characterized as kind of orphan, in that they're not in the market that necessarily will attract a home-based operator, and those will likely be sold. But the great majority will - we expect to be released, and in fact, have potential partners already identified with negotiations underway for those.

Your next question comes from Michael Carroll with RBC Capital Markets.

Ed or Steve, can you guys provide us an update on the collection issues that Prime reported last quarter? Are those trends starting to stabilize now?

They have stabilized. We haven't seen them increase greatly yet, but the best news there is that they have certainly stabilized. They seem to have a good handle on what their issues were and are in the process, as we reported last quarter, of fixing those, and we saw no further deterioration of those.

Okay. Can you update us on what the coverage ratio is, similar to the ratio you gave us last quarter?

Sure. And as you know, Mike, we don't generally give out the different coverages for the different operators unless there are special circumstances like this. But Prime's cash EBITDARM basis, if you look just on pure cash collections, is about 2.8x.

Okay, great. And then with regard to Ernest and its impact that it's seeing from the LTACH space, how is that going on right now, and what's the ultimate plan for those assets?

So they actually improved greatly if you look over the last couple of quarters. If you look at just their LTACH portfolio alone, they only have the 1 LTACH that we've discussed in previous quarters that continues to generate negative numbers. We believe that we have a solution to that. And hopefully, in the next quarter, we'll be able to announce what that solution is. But overall, their LTACH portfolio has improved. Their IRF portfolio continues to operate exceptionally well. Their total - just again, purely based on cash, which is not - which is an overly conservative method, if you look at it over a time or period, their current cash collections on an EBITDARM basis is 2x on a total portfolio basis.

Okay. And then with regard to those LTACHs, is it going to be - are you going to be able to keep those LTACHs, or will Ernest have to transition those to a different property type?

Yes. I think it's just the one that we've discussed over the last 2 quarters that will be repositioned.

Okay, great. And then Steve, maybe you can give us some comments on - or remind us why your field elected not to keep the rest of that Adeptus portfolio?

The facilities that we've agreed to sever?

Correct.

Yes. So virtually, all of those are either in 2 markets, those being San Antonio and Austin, or, I used the term a few minutes ago, orphans, that they are kind of outliers in the Houston and Dallas markets that really don't fit with the market structure that Adeptus felt was best. So we agreed, again, as part early on to take those back because we felt like we had alternatives, as I mentioned earlier, for most of those, and for those few that I've termed orphans, we expect to sell.

Mike, you'll remember that when we did our second tranche and third tranche with Adeptus, they and we had changed the model somewhat from the original formations of the industry, which was to make their freestanding emergency rooms have affiliations of some type with their - with other acute care hospitals, and to ask them to go back to the first tranche as a part of their original plan and to re - to position most of those as best they could. So again, it's just - as Steve pointed out, it's getting the model to where they want to be today, which is that they have joint venture operators with their other facilities. The ones that we have agreed to take back, essentially, we have a home for those that they didn't.

Your next question comes from Jordan Sadler with KeyBanc Capital Markets.

Can you give us a little bit of insight in terms of what you're seeing on the transaction side in terms of the acute care market in the U.S. here today, and what your appetite is? And I'm also just curious in terms of what you're seeing in terms of asset pricing.

So Jordan, it's been the same that we've been reporting most of the summer, which is that all of our acquisitions targets in the U.S. and in Europe continue to be acute care hospital providers. We've got good opportunities in both the U.S. and in Europe. We're a little bit out of whack where we would like to be in our distribution between the 2 continents based on the most recent acquisitions that we've done in the U.S. So most of the focus in the early part of 2018 will probably be some portfolio of properties that we're looking at in Europe, but we continue to have very good opportunities here in the U.S. I think, as Steve pointed out earlier, we don't expect any material acquisitions for the remainder of this year. Oh, and the pricing. The pricing, not a whole lot of difference from what we've seen in the summer, maybe a little bit of better pricing or less pressure on the pricing, I should say, from people that we're talking to.

Okay, that's helpful. And then maybe for Steve. You've had some success in the bond market recently. I'm kind of curious what the thoughts are from the agencies as well as bond investors regarding individual operator or tenant exposure. So what the sensitivities are, the thresholds are that you may want to work some of these exposures down to in terms of a maximum? And then thoughts on where they stand on Europe versus U.S., and if they're more comfortable with the geographic diversification or less.

So I'll take those in reverse order, Jordan. From the beginning, going back to 2013 when we did our first €200 million deal in Germany, both the agencies and our investors had been very supportive of the diversification and what that has meant in Germany. So that's been very positive. With respect to overall concentration issues, clearly, when we announced the Steward transaction earlier in the year, we saw that, that would drive corporate level concentration up to a range where we haven't been in a while and we don't want to be for very long. We continue to focus internally on not being exposed to any particular property or market, and that remains less than 4%. However, with Steward at roughly 37%, and as I mentioned a little bit earlier in my prepared remarks, it's absolutely one of the key goals as we go down this road of selling a piece of Steward to reduce that concentration. And again, just to reiterate, we're hopeful, as we've said over the last couple of quarters, to have something that we can announce during the year 2017, and we still have reason to think that that's something we'll be able to do. So over the course of the next couple of years, our goal is, by virtue of selling exposure and also growing away from Steward, to see that concentration come down from the high 30s and into the low to mid-20s, with a trajectory to keep that coming down as we continue to grow.

Okay. So in terms of any joint venture we may see or sales we may see in the coming weeks or months expect something domestic initially, is that fair?

No. I wouldn't handicap it that way because we're very active both in Europe and with the Steward targets. And there could be kind of a race to the finish line as to which one happens first.

Next question comes from Tayo Okusanya with Jefferies.

I appreciate the color, Ed, you gave about the coverages and the kind of what was impacting them. I guess when you kind of think about all of these factors that impacted coverages in 3Q, how do you see that playing out over the near-term? Do some of those things kind of abate and coverages bounce back? Or do you think it gets worse? I'm just kind of curious how you're kind of thinking about some of those risk factors.

Sure. Well, if you look at the coverages that we presented from a year-over-year basis, clearly, the 2017 was not as strong as 2016. The positive thing for us is that if you look at it over a quarter-over-quarter basis, that it's been relatively flat. And then when we look at where the statistics are today, where they are going into the month of November, we are seeing slightly better volumes. Again, we don't know exactly what the flu season will bring, but we're optimistic that the downturns that we had in the first and second quarter will be somewhat subsided. Now remember that the third quarter will include the month of August, which has the time period that everybody in Europe takes off and an awful lot of positions in the U.S. take off. So it's always been one of the softer quarters. But overall, we feel good about the flatness of the curve right now.

Okay, that's very helpful. And then second of all, the potential JV. Again, I appreciate some of the color that Steve gave around that. But just curious, I mean, is there any risk that the JV transaction could actually end up being dilutive to earnings? I'm assuming you're going to do this transaction at a lower cap rate and being able to kind of reinvest the proceeds at higher cap rates and it creates accretion. But is there any risk that, that line of thinking isn't necessarily correct?

Yes. Clearly, it will be initially dilutive, Tayo, because it is - the reinvestment of those proceeds are not going to happen overnight. So obviously, when you're selling that much of the portfolio, there will be some initial dilution of it.

Okay, that's helpful. And then lastly for me. Adeptus, the assets that are going to be removed from the master lease and sold off, I think there's been talk in the market for a while that you were kind of close to doing that. Did Adeptus actually have to come out of bankruptcy first before you could execute that? Or is there anything in execute will be holding that up?

No, that is absolutely correct. We had to get through bankruptcy before we could move forward on that.

Your next question comes from Juan Sanabria with Bank of America.

This is Kevin [indiscernible] on for Juan. I just had a question, you said going back to Prime. I guess, is there any update on the DOJ lawsuit? And then also, is the key issue there, I guess, still around the kind of corporate integrity agreement issue?

I'm certainly not privy to the exact negotiations between the 2 entities, other than they have not reached any settlement agreements. Prime feels very positive about their position and right now is comfortable with pursuing - with moving to a trial date. If a trial happens and both parties continue to go through their discovery, that won't be until sometime probably in late 2018. We certainly are familiar with some of the potential dollar exposure, and it's just not a big issue in our minds.

Okay. And then secondly, regarding tax reform. I guess, has that changed your way of thinking around repatriating capital back to the U.S. or the way you're funding acquisitions in Europe or in the U.S.?

No, it really doesn't. Because as a REIT, our European earnings have always been treated the same as our U.S. earnings, and so we could bring that back, those earnings back today. And along as we're covered by the dividend deduction, which we are, then there would be no impact even under today's tax regime.

[Operator Instructions]. Your next question comes from Vlad Rudnytsky from Deutsche Bank.

I have just two questions on coverage. So since these metrics are reported on a 1 quarter lag basis, do you expect any impact from the hurricanes coming to next quarter? And then doesn't look at the general acute care same-store pool has changed. So maybe can you talk specifically what drove the year-over-year decline in coverage to 3.1?

First, on the hurricanes. We had very minimum effects from the hurricanes. So take the first one, I'm going to make sure that I get the names right. It's Irma; Harvey was the Texas hurricane. While we had one facility in Corpus Christi that actually closed the day of the hurricane, it opened back up the next day. We had no significant floodings at any of the facilities. They seemed to have all learned their lessons from Hurricane Ike 7 or 8 years ago. And so we did very, very well in there. There might be some minimum mixed results from that, but we don't expect any. The next one, the Hurricane Irma down in the Florida, we only had 4 facilities in the path of that one that were affected. They had literally minimum damage to the facilities, some minor roof damage, some disruption, literally, just a matter of 1 or 2 days in the patient care. But again, we don't expect any significant issues there. And I'm sorry, Vlad, what was the second part of the question?

I mean, basically, talk about the specifics of the year-over-year declines in the general acute care coverage. Doesn't look like the pool has changed on a same-store basis?

Sure. The declines that we've seen overall had been more on the expense side and slightly reduction in the volumes. But even with the slight reduction in the volumes, most of our tenants saw an increase in their revenue over that same time period. So the most of the decline is coming from the expense side. But again, as we look at where we are getting some preliminary indications as to what the third quarter results are going to look like and as we're going into the fourth quarter here, we - it looks to be stabilized and maybe even a slightly positive uptick in some of our facilities. So we are hopeful that we've seen the worst of the decline and are quite comfortable with the stable aspects of it.

I'm showing no further questions at this time. I would now like to turn the conference back to Ed Aldag.

Thank you, Operator. Again, we greatly appreciate all of you listening in today. We appreciate your questions. If you have any additional questions, please don't hesitate to call us. And we look forward to seeing many of you at NAREIT in November. So thank you very much.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.