Steve Monroe: We’re here today with Rob Mains, Managing Director of Ryan Beck & Company. He’s been an equity analyst following the healthcare and healthcare REIT market for a long time. Good morning, Rob.

Rob Mains: Good morning, Steve.

Steve Monroe: We’ve had about 17 interest rate increases over the past few years, and despite this, healthcare REIT’s have still performed fairly well in the market, with most at or near their 52-week highs with double-digit returns this year for all but one or two. What’s going on? I thought they were more interest-rate sensitive?

Rob Mains: They are interest-rate sensitive, but stock prices reflect future expectations as well as the past, and right now we’re in a stable rate environment with stable rate expectations, so that helps the healthcare REIT’s. There are two other things that I think are going on, both related to the slowing economy. One is that in a slowing economy, healthcare is viewed as being a defensive industry: people get sick, go to hospitals, go to nursing homes in good times and bad, so it’s a more defensive place to invest. Second, within the REIT sector in a slow economy, triple-net REIT’s become more attractive on a relative basis to operating REIT’s, because you have apartments and office buildings that, when the economy is hot, rents are going up, they’re filling up rapidly. When things start to slow down, the opposite can occur, and in a triple-net environment you’re going to get stable rate increases, and consequently I think there’s been some funds flow out of the operating REIT’s and into the triple-nets, so that’s benefited the healthcare REIT’s; they’re predominately triple-net.

Steve Monroe: You did a pretty interesting – what I call a first-blush – I think you might have called it a first-blush analysis on the Healthcare Property Investors’ $5 billion acquisition of C&L Retirement Properties a few months ago. Has anything changed on that, especially now that they’ve announced at least one of their financing parts of that, a billion-dollar debt package?

Rob Mains: What I said at the time was that the deal looked to be FFO-accretive and FAB-dilutive, at least on a pro forma basis, and I’m sticking by those guns. I think that’s how it will end up. The enormous caveat, though, is that how it’s ultimately going to play out is going to be dependent on the types of financing that the company ultimately does, and there’s a near certainty that there’s going to be not just further financings, I think, but also asset sales; there will be joint ventures; there will be more security issuances. And that’s going to muddy the pro forma type of projections one could make. That being said, I think that ultimately it will prove to be, at least in the near term, FFO-accretive, but FAB-dilutive.

Steve Monroe: So nothing has changed. Do you hear anything about the deal going on right now? It’s supposed to close I think in a week or two.

Rob Mains: Yes; the C&L holders have approved it, so just waiting on the final closing. I figure that luck being what it will, they’ll probably announce it the same day as the Ventas reset, and all us analysts will be up all night writing about them.

Steve Monroe: Did you have any thoughts on the billion-dollar debt financing that HCP did? I think there were three different parts, and different interest rates and all that. Did that look pretty competitive, pretty solid to you, or could they have done better?

Rob Mains: My initial reaction was that they got pretty good pricing. They got $300 million, five years, just below 6%; $400 million at ten years, just a little above 6.3%. That’s pretty strong pricing. As we suggested, though, we’re not done with the financing here.

Steve Monroe: Right. There’s a few billion more to go. Then, just a few weeks ago, Healthcare REIT announced buying – it hasn’t closed – but they’re buying Windrose Medical Properties, a publicly traded medical office building REIT. A good move for the REIT?

Rob Mains: I think it’s going to work in their favor. I was a little surprised by it, but ultimately I think it helps Healthcare REIT in two ways: First of all, they just get the benefit of diversification into a new asset class, and one that’s at least perceived as being fairly resistant to reimbursement risk. But more importantly for Healthcare REIT, it furthers their strategic goal of investing in a diverse suite of services for us aging baby boomers. MOB’s, and I think particularly hospital-affiliated MOB’s that aren’t necessarily on the hospital campus but are instead hospital-associated but in affluent communities, they can be kind of the cornerstone of those types of services. So I think that the MOB piece is probably a necessary part of completing that kind of market continuum of services.

Steve Monroe: That’s a nice comment, because you have these seniors housing REIT’s, and it’s obviously a diversification play. There’s MOB’s out there. Is there something else that should be on the seniors’ housing REIT’s radar screens right now besides MOB’s?

Rob Mains: There are, I guess you’d call them kind of non-healthcare type buildings that could potentially fit in. If you look at CCRC’s, a lot of them include health clubs, they include golf courses – I’m not suggesting that healthcare REIT’s are going to be big invested in golf courses – but if you’re going to provide that sort of suite of services for the more active senior community, you’re probably going to have some of those types of services. That being said, they’ll largely be I think contained within the traditional structure. The golf course might be on the grounds of the CCRC; the health club might be on the first floor of an MOB.

Steve Monroe: We’ve seen dividend yields for healthcare REIT’s in the last several months range from a low of 3.9% to a high of 7.3%, and that’s for specific REIT’s. Is there really that much of a difference in risk among the various healthcare REIT’s, and how much does the difference in yields for these healthcare REIT’s have to do with liquidity for those particular stocks?

Rob Mains: I think investors pay up or don’t pay up based on three factors, and you hit on two of them. One is liquidity, one is risk, and the third one is growth. If you look at the healthcare REIT’s as of last night’s close, Ventas had the lowest yield; it was 4.1%. But Ventas has, number one, the highest FFO growth of its peer group, and number two, the virtual certainty of an eight-figure rent increase from its largest tenant coming when the reset right with Kindred is – however it’s going to wind up playing out – gets finalized.

The second-lowest yield is Windrose at 5.3%. They’re subject to being bought out, so that explains that. The third-lowest is Healthcare Property Investors, the largest, most diversified, and I think that that does reflect risk.

The highest yield, Medical Properties Trust, is invested in a large number of long-term acute-care hospitals and in-patient rehab facilities, which are really about the only types of assets right now where you’ve got somewhat significant Medicare risk. So I think that their high yield is a reflection of perceived risk. Everybody else is within a fairly narrow band of yields, about 5.9 to 6.9%.

Now, within that 100-basis-point spread, there probably are some inefficiencies in the market, but I don’t think there’s really a lot. By and large what you’re seeing is probably appropriate pricing based on, again, risk, growth and liquidity. But within that 100-basis-point band, I think what the market is saying is there’s not that much difference among the remaining REIT’s.

Steve Monroe: Okay. Do you think we’re going to see, with the remaining publicly-traded healthcare REIT’s, any more merging among them?

Rob Mains: You can make a logical kind of academic case in favor of it, which is that you’ve got a lot of publicly-traded REIT’s chasing a fairly stable pool of assets. There’s not a lot of new assisted living coming online, and the number of nursing homes continues to decline, so the question is if they all want to be able to sustain growth, how do you do that with a stagnant pool of investments out there.

There are two counters to that. The first is that right now if you look at the logical acquirers – that would be the largest publicly-traded REIT’s – most of them have pretty full plates. HCP has CNL; Ventas has Senior Care; Healthcare REIT has the Windrose deal. And then if you look at the nature of mergers in this business, particularly again when you’re talking about triple-net REIT’s, you don’t have a lot of operating synergies. If you add one and one together, maybe you’ll get two and an eighth, but you’re not going to get two and half or three, usually. So the lack of synergies I think is a little bit of a gating factor as well.

Steve Monroe: Changing the subject a little bit, you started coverage on the skilled nursing sector this summer with Genesis Health and Sun Healthcare. Do you like the skilled nursing sector now?

Rob Mains: Steve, you remember that ten years ago when I followed both of those companies as well as some other ones, interestingly, all of us analysts were saying eerily similar things to what we’re saying now, which is that there’s an opportunity for the nursing homes to grow in their provision of medically complex services that are by and large reimbursed by Medicare, and that way they’re going to generate superior per diems and superior margins and therefore sustain bottom-line growth. We know how that ended in BBA 97 and the immediate aftermath.

I think the difference this time is that, number one, the whole investment thesis now is not predicated on a cost-base reimbursement system that is prone to abuse that is about to have its legs cut out from underneath it; but also the providers haven’t levered up like they did in the mid-nineties, buying nursing homes solely for the idea of converting them to being more medically complex and therefore levering up the balance sheets. You’ve got fairly clean balance sheets in the industry. Partly it’s the magic of Chapter 11 –

Steve Monroe: Chapter 11 gets rid of a lot of the debt.

Rob Mains: But the acquisition appetite among the nursing homes has been very, very limited so far, so I don’t see the risk of them getting into an over-levered position where a reimbursement hit would hurt them; and by the same token, I don’t see a big risk of a reimbursement hit, certainly nothing on the scale of what happened with
BBA 97.

Steve Monroe: Right. Last question for you: Are there any publicly-traded skilled nursing companies that you think may be susceptible to a leveraged buyout, similar to the HCA one announced this summer?

Rob Mains: Yes; I follow the hospital sector, and there are two important features of the HCA deal that I think some people missed. The first one is management of HCA – and this I don’t think is a secret – clearly felt they weren’t getting the love from the public markets. The multiple they felt was depressed relative to what they felt the enterprise value was worth. If you compare HCA right now, and this is after it’s had a run because they’re getting bought out, it’s PE multiple is still well below the PE multiples of all the publicly-traded nursing home companies. So the nursing home companies, for whatever it’s worth, are getting more respect in the public markets than are hospitals right now, and there’s a lot of reasons for that, but nonetheless you reach the same conclusion.

The second thing is that HCA is one of only two publicly-traded hospital management companies that was actually free cash-flow positive on a trailing 12-months’ basis. All the other ones were either on an acquisition binge or doing development work, but for a private equity perspective weren’t generating cash, while HCA has continued to generate pretty substantial cash flows. Right now there’s only one skilled nursing company that’s got positive free cash flow on a trailing 12-months’ basis. No surprise, it’s Manor Care, and Manor Care commands the premium multiple of the whole group. So I don’t think that this is an industry where we’re likely to see private equity do the type of thing that they did with HCA. I just don’t think that the dynamics are there, either to motivate the buyers or the sellers.

Steve Monroe: Except Manor Care management was in discussions about doing a similar thing – it was about a year ago – but the stock price has gone up probably too much now in the past year that the economics just won’t work.

Rob Mains: Yes, multiple expansion can put a lot of those ideas on the side of the road.

Steve Monroe: Absolutely. Rob, thank you very much for being with us today.

Rob Mains: Thanks for having me, Steve.

Steve Monroe: Okay.

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