Published December 1st, 2016 by Bob Ciura
HCP (HCP), a health care real estate investment trust, recently made a huge decision that affects all of its shareholders. In response to deteriorating performance at HCR ManorCare—one of its biggest tenants—HCP spun off its ManorCare portfolio into a separate company.
The new company is called Quality Care Properties (QCP), or QCP.
Investors expecting QCP to mimic HCP may be in for an unwelcome surprise. QCP has not yet set a dividend rate. Given its fundamental challenges, it is unclear whether QCP will be able to pay as high a dividend as HCP.
And, it is also uncertain if QCP’s fundamentals will improve enough to justify dividend growth moving forward.
QCP is just starting out and has a difficult turnaround ahead, so it has a long way to go before it matches HCP’s dividend track record.
HCP’s troubles began last year, when ManorCare was charged with submitting false Medicare claims. According to the Department of Justice, ManorCare filed claims that were not eligible for reimbursement because they were not covered or were not necessary services.
This situation has weighed on HCP all year. Dealing with ManorCare distracted HCP from managing the rest of the business. Rather than continue to invest valuable time and resources into ManorCare, it chose to separate itself entirely.
HCP completed the spin-off of QCP on October 31. HCP investors who held the stock on Oct. 24 received one share of QCP common stock for every five shares of HCP common stock.
QCP is now an independent, publicly-traded REIT, with its own management team. Its portfolio will be focused on post-acute and skilled nursing facilities, as well as memory care and assisted living properties.
QCP’s portfolio will initially be composed of:
- 257 post-acute/skilled nursing properties
- 62 memory care/assisted living properties
- 1 hospital
- 1 medical office building
Source: QCP Investor Presentation, page 5
QCP’s primary tenant will be ManorCare.
For HCP, the benefits of the spin-off are clear. It gets to completely exit the post-acute space. Going forward, nearly all of its revenue will come from private-pay sources.
Source: Proposed Spin Off Presentation, page 4
Freeing itself from ManorCare will provide HCP with much greater stability. It will retain a diversified health care portfolio, while also focusing on its higher-growth opportunities.
Source: HCP 3.0 Post Spin Outlook Presentation, page 3
The remaining 14% of revenue will come from the company’s Other segment, which primarily includes hospitals, U.K. real estate, and all debt investments.
The key takeaway is that going forward, HCP will have a high-quality tenant portfolio. It will still have 800 properties in its portfolio, many of which are large, established health care giants.
In addition, its cost of capital will likely fall now that it no longer has ManorCare weighing it down. That should improve HCP’s balance sheet.
Source: HCP 3.0 Post Spin Outlook Presentation, page 9
All in all, the deal seems like a great way for HCP to rid itself of the ManorCare headaches it has suffered over the past year.
Therein lies the problem for QCP shareholders.
The company’s financial position is very challenged. Last year, QCP absorbed a $237 million impairment to earnings. This caused net income to decline 61% in 2015.
Furthermore, the reason why HCP is excited about its portfolio—reducing its exposure to post-acute and skilled nursing—is a reason for QCP investors to be concerned. These were among HCP’s poorer-performing properties in recent years.
HCP management insists the spin-off is in the best interest of both companies. According to the company, going forward QCP will be able to focus more on its own set of strategic priorities, first of which is to right the ship at ManorCare.
Next, HCP management believes QCP will have greater capital flexibility. And it will also deploy a number of strategies that it would not be able to, if it were still a part of HCP.
These initiatives may work out, but at the very least will take time to implement. As a result, HCP investors who decide to stick with QCP will need to exercise patience. That patience should extend to the dividend payments as well.
Importantly, QCP decided to retain its REIT status, at least for now. As a result, it will be required to pay a dividend moving forward. Any company classified as a REIT must distribute at least 90% of its taxable income to shareholders.
However, the exact dividend level to be issued remains unclear. In its Form 10-A Registration filing, management appears to be taking a cautious tone towards the dividend policy:
“To help create additional liquidity and flexibility to execute our strategy, and in light of our high tenant concentration in one operator, HCRMC, and the ongoing headwinds facing HCRMC and the broader post-acute/ skilled nursing industry, we anticipate initially instituting a conservative distribution policy.”
Moreover, QCP has reserved the right to make future dividend payments that are made up of both dividends and stock in the company. If the company exercises this option, it could choose to make only 20% of dividend payments in cash, with the remainder in stock.
And, QCP has advised investors that while it intends to retain its REIT status, it may decide to change this should conditions warrant. If QCP abandons the REIT structure, it is likely lower dividends would follow, as the company would no longer have to distribute 90% of its taxable income to shareholders.
Putting it all together, and these seem to be relatively unattractive options for income investors.
HCP made the right choice spinning off QCP, if only to rid itself of the ManorCare issue once and for all. Shareholders now can choose which company they want to remain invested in.
HCP is a stronger company because of the spin-off, while QCP’s challenges remain. The company has put in place a capable management team. There is a firm plan to effectively manage QCP and return it to growth.
Whether investors should stick with QCP during its turnaround is a different question. There are many high-quality REITs with strong dividends to choose from. Investors looking for a more secure dividend payout may want to search elsewhere.