|Shares Out. (in M):||94||P/E||0||0|
|Market Cap (in $M):||1,430||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
QCP currently trades at $14/share versus a downside valuation of $13/share and upside to $24/share. I estimate fair value to be ~$19/share,. Thus, the stock has positive, asymmetric risk reward with acceptable downside and total return potential to $19/share is +45% (+35% to $19/share plus +10% FCF Yield/cash accumulation over a 1YR horizon). I employ a variety of valuation approaches, including DCF, relative asset value, and downside stress cases. Upcoming newsflow will be volatile, and the stock may get cheaper, but ultimately long-term value is higher than current trading levels with potential catalysts over the next 2 weeks.
QCP is a special situation REIT with a single tenant in financial distress (HCR ManorCare). HCR is unable to make lease payments to QCP and is poised to file bankruptcy (indeed, QCP has recently asked for a Receiver for HCR). Consequently, QCP is in the position to take over HCR's operations and assets, and the proper valuation of QCP is a valuation of QCP/HCR on a consolidated basis. Thus, a proper valuation of QCP requires valuing (I) HCR's assets/liabilities and (ii) QCP assets/liabilities.
QCP was spun-out in Fall 2016 to address a lease restructuring scenario of a major skilled nursing tenant, HCR ManorCare. HCR had fallen behind on rent owed to QCP as soon as Q4 2016, and entered into forbearance in 1H 2017, with QCP filing for receivership after non-payment in mid-August 2017.
QCP has no analyst coverage, having been spun out in Fall 2016 as a non-dividend paying REIT that needs to restructure the lease of its single tenant. Further, I have zeroe'd out LTM revenue and EPS as these metrics are not relevant. On HCR's stated lease payments to QCP, QCP trades over a 20% FCF Yield. However, HCR cannot afford those lease payments, and thus historical financial performance is not relevant.
TENANT (HCR) IS FINANCIALLY DISTRESSED:
Using rough numbers, HCR's EBITDAR is roughly $450MM (LTM). However, rent owed to QCP accrues at nearly the same rate. On top of this, HCR is responsible for significant capex on its assets (say $50MM) and has significant interest expense (~$50MM). Consequently, HCR generates negative FCF and has fallen behind on rent payments owned to QCP.
HCR'S CONSOLIDATED ASSET MIX CAN'T AFFORD LEASE TO QCP:
Only HCR's skilled nursing/assisted living assets are leased from QCP. HCR has in effect been subsidizing its skilled nursing lease payments with cash flows from a Hospice business, which is not an explicit party to the lease.
QCP IS IN POSITION TO TAKE OVER *ALL* OF HCR'S ASSETS:
QCP's lease payment is from HCR's Skilled Nursing Assets. However, the lease is guaranteed by the parent entity of HCR, and thus has a claim to all of HCR's assets for any missed lease payments/lease reduction payments. Said another way, if QCP agreed to reduce HCR's rent in any fashion, QCP will receive a negotiated receivable from HCR in exchange for such a concession. Thus, any rent reduction results in QCP taking a substantial economic stake in HCR.
Such a value exchange took place once before in 2015 (HCR was already stressed back then as well). I estimate that in exchange for a ~$68MM lease reduction, QCP received ~$525MM of value in exchange, or a ~8x economic stake versus the lease reduction. Part of the value was real estate received, and part of it was a Note Payable owed from HCR to QCP.
Further, I have noted that HCR's entire asset pool does not generate enough EBITDAR to pay the lease owed to QCP. Thus, there is no economic value to the equity holders of HCR ManorCare. HCR cannot afford a lease payment to QCP, and QCP will receive major claims against HCR in exchange for a lease reduction. In essence, a lease reduction to QCP just converts a cash payment to QCP to 100% equity ownership.
QCP RECOGNIZES THIS DYNAMIC:
QCP's CEO is Mark Ordan, an ex-Goldman Banker who is considered to be financially sophisticated. He has also been CEO of 4 companies that have restructured operations and sold out entirely (Fresh Fields, The Mills Corp, Sunrise Senior Living, and Harris Teeter). Ordan has received significant warrants in QCP (exercise prices from $15/share - $30/share) which only kick in if QCP maximizes its economic claims against HCR. Given QCP's motion to appoint a receiver to HCR, it is clear that QCP is not seeking to cut HCR's lease in exchange for zero consideration.
QCP/HCR ManorCare are considered to be skilled nursing businesses, but actual TEV asset mix is only ~50% skilled nursing, with the remaining TEV roughly split with assisted living and hospice assets. This mix is relevant as the market views QCP/ManorCare as a challenged skilling nursing operator, but skilled nursing assets do not represent the entirety of the consolidated asset mix.
Skilled Nursing - These are nursing homes. Nursing homes make most of their profit from providing rehab therapy to patients discharged from hospitals, and this is reimbursed by Medicare. The custodial portion of nursing homes (that comes to mind when you think 'nursing home') generates nearly no profit with reimbursement from Medicare. Skilled Nursing is a challenged category with declining occupancy trends, hurt by (I) faster patient recovery times/transition to home care and (II) penetration of Medicare by Medicare Advantage, which offers lower reimbursement levels. At some point, baby boomers will age into Skilled Nursing facilities and inflect occupancy upwards -- but it is unclear when this will happen. Bulls will say 2020, my own model suggests 2025, but no one really knows.
Assisted Living - These beds are worth 2x Skilled Nursing beds. Further, this asset class is poised to be a share winner from skilled nursing and home health services over coming years.
Hospice - This is providing at home services for patients near the end of their life. This business is growing GDP+, with 20% EBITDA margins and no capex.
QCP HoldCo – This represents lease income from some properties held at QCP’s holding company.
2015 2016 2017
HCR: SNF/ASL $486 $457 $335
HCR: Hospice 69 77 85
QCP: HoldCo 4 4 4
EBITDA 559 538 $424
HCR: SNF/ASL ($46) ($45)
HCR: Hospice (4) (4)
QCP: HoldCo - -
Capex ($50) ($49)
LEASE NEGOTIATIONS HAVE HARMED HCR'S FINANCIAL PERFORMANCE:
Many datapoints have skilled nursing operators generating YOY EBITDA of -5%. However, HCR is comping -20% in 2017. HCR's assets are considered above average, and this underperformance on EBITDA has arisen only in recent quarters (at the same time of falling behind rent) without occupancy falling off (occupancy is in-line with peers). Thus, HCR's business has suddenly - and idiosyncratically nose dived - at the same time HCR has been seeking a lease cut from QCP. Furthermore, as occupancy has held steady with peers, this appears to be a one-time cost issue.
To put in perspective, Revenue is perhaps off $30MM in 2017, but EBITDAR may decline $125MM. These decrementals make no sense, and should be reversible (for example, by transitioning operations of the assets away from HCR to someone else, as the QCP Receiver motion asks for).
One should value QCP as if it takes over all of HCR's assets and liabilities.
Be conservative and do not assume a recovery of HCR's financial performance (which is underperforming by arguably $100MM EBITDA in 2017)
I assume QCP can maintain its REIT status by either (I) converting to RIDEA or (II) releasing HCR's assets to new operators.
VALUATION FRAMEWORK: CONSOLIDATED LIABILITIES OF ~$2.4BN
HCR: $300MM Net Debt
QCP: $1,540MM Net Debt
Other: $500MM of Other Cost/Claims (DOJ settlement, deferred compensation, transaction cost, etc.)
VALUATION FRAMEWORK: ASSET VALUATION
There are 4 major buckets of asset value: 1) HCR's skilled nursing assets, 2) HCR's assisted living assets, 3) HCR's hospice business, and 4) QCP's other NOI income
VALUATION FRAMEWORK: ASSET VALUATION - QCP OTHER NOI INCOME
Net of corporate expense, QCP has a conservative ~$4MM NOI. At a 9% caprate = ~$50MM value
VALUATION FRAMEWORK: ASSET VALUATION - HCR HOSPICE BUSINESS
I estimate the Hospice business generates ~$85MM EBITDA. One can reasonably value this business at ~$1.1BN, Such a high valuation is based on a (I) a levered DCF with low capex, (II) access to cheap leverage in the current environment and (III) ability to shield taxes via maintained REIT structure [more on this later]. Public comparable multiples would imply a higher valuation as many Home Health businesses trade at 12-13x 2018 EBITDA, and Home Health businesses should trade at lower multiples than Hospice businesses (Hospice businesses have less reimbursement risk and higher EBITDA margins).
VALUATION FRAMEWORK: ASSET VALUATION - HCR ASSISTED LIVING + SKILLED NURSING
One can value these assets on a $/bed basis (valuing assisted living beds at higher valuation than the skilled nursing) or a consolidated DCF. I do both.
A conservative DCF of the Assisted Living/Skilled Nursing business (11% Equity WACC on very conservative EBITDAR assumptions) implies $2.8BN asset value for these assets.
Looking at public comparable valuations implies a much higher valuation. Firstly, the aforementioned DCF values the skilled nursing business at ~8x EBITDA on depressed 2017 operating results vs. public competitors trading at 9x+.
Another analysis is implying what $/bed we are creating HCR's skilled nursing beds for. HCR has ~4,500 Assisted Living Beds and ~37,140 SNF beds. Market comparable companies create SNF beds for $80K-$100K/bed. The purest comp is Omega Healthcare (OHI), which creates SNF beds for over $100K. If we are punitive to HCR and whack this $100K for a relatively lower EBITDA generation/higher Medicare mix, we would still value OHI's beds at near $70K/bed for a relative value analysis. Said another way, if we value HCR's Assisted Living Beds at $180K/bed (industry average) and its skilled nursing beds at $70K/bed (well below industry average), one can imply $3.2BN of asset value for these segments.
VALUATION: BASE CASE
I've established ~$4.2BN of consolidated asset value across QCP & HCR. Netting out the $2.4BN of net debt = $1.8BN of equity value to QCP. This implies $19/share.
VALUATION: DOWNSIDE CASE
It is difficult to be punitive on the relative value case with such strong public comparables, but one can stress valuation to $17/share (still higher than current trading levels). Stressing a DCF is possible to drive a $13/share valuation (driven by a 13% Equity WACC on our conservative DCF).
VALUATION: UPSIDE CASE
I think there is $5/share of upside to my base case valuation. Firstly, crediting a $50MM EBITDA recovery off weak 2017 results is worth a conservative share (valuing at 7x EBITDA.. although this should be worth 10x FCF contribution). Transaction costs could be $100MM lower than my conservative assumptions (e.g., DOJ settlement amount or treatment of management deferred compensation), or another ~$1/share. Lastly, my DCF capex assumption may be conservative by $10MM/YR, which is worth another $1/share.
VALUATION: SUMMARY OF CASES
Thus, I see a stock at $14, with downside to $13, fair value to $19 and upside to over $24/share.
VALUATION: JUST ANOTHER APPROACH....FORECLOSE ON THE ASSETS, BUT RELEASE THEM TO NEW OPERATORS
Another way of valuing QCP would be to foreclose on HCR's assets and release them out to new operators. Such a scenario makes the most sense, as operating skilled nursing/assisted living businesses should be done on a local basis (there is limited benefit for operating these businesses at a national level).
In this scenario, we value the Hospice and NOI the same. But we then take our conservative EBITDARM forecast for the skilled nursing assets ($369MM in 2019), apply a 1.5x coverage ratio, and imply a new $250MM lease stream to QCP. At a 9% cap-rate this is $2.7BN of value, which drives a ~$17.50/share price. Note that this $17.50 is conservative as (I) cap-rates for 1.5x coverage in private markets trade at 8%, not 9%, and (II) we are effectively transferring equity value to the new operators - for free - of 0.5x (that is, you are giving operators the assets to run at a 1.5x coverage ratio, which means 1.0x is to QCP and 0.5x is to the operator). Importantly, another national operator, Golden Living, disaggregated its portfolio to regional operators and saw rent pick-ups in certain cases of +10-20%. I am neither giving credit for such a rent pickup OR a recovery of HCR's own depressed 2017 results in this analysis. Thus, the $17.50 is a very conservative interpretation of this analysis.
At current levels, I believe you can own QCP naked long (as I conservatively model operating trends and risk reward is unequivocally favorable). Further, the operating disconnect between HCR's financial performance and public comparables introduces basis into L/S trade expressions. However, a long-term L/S trade (e.g., against OHI) can make sense to hedge against operating trends in the skilled nursing business to isolate the relative value - but one must be wary of operating basis risk over the next 2 quarters.
DISCLOSURE: The author of this posting and related persons or entities ("Author") currently holds a long position in this security. The Author makes no representation that it will continue to hold positions in the securities of the issuer. The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note, nor suitability of the security for any potential investor. The views expressed in this note are the only the opinion of the Author. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the note.
************ SEPTEMBER 25, 2017 UPDATE ******************
QCP stock rallied to ~$16/share (before fading to $15.50/share) on back of press release disclosing (a) HCR ManorCare and QCP have agreed to extend HCR's time to respond to the receivership motion by 30 days to October 18, 2017 & (b) HCR's CEO has resigned. The positive reaction by the stock makes sense. Firstly, resignation of HCR's CEO should be positive for HCR's woefully performing operations and reduce a source of friction between HCR/QCP's negotiations (as the CEO has a claim against HCR and has offered to buy QCP assets, in a gross conflict of interest). Secondly, QCP has no incentive to extend HCR's time to reply, except if it was value maximizing to QCP; I believe this extension suggests a consensual resolution of the QCP/HCR lease dispute is in process. Unfortunately, significant damage has been incured by HCR's operations, and must be turned around (which should be doable).
Positive Catalysts: A consensual resolution of the lease restructuring should be a positive event. Such a consensual restructuring will allow QCP to resume dividends to shareholders, which will cause a re-rating of QCP's stock price in-line with other healthcare facility REITS. In terms of timing, (I) HCR must respond to QCP's receivership motion over the next week, and (II) QCP is sitting on substantial cash to reinstitute a dividend immediately if an appropriate resolution is reached.
Negative Catalysts: As noted, HCR's financial performance has been atrocious in 2017. I conservatively model 2H17, but operating results may worsen in 2H17, leading to a greater disconnect between HCR's asset mix and realized financial performance. Q3 results will not come for a few weeks, however, and we will have newsflow regarding QCP's negotiations with HCR ahead of then.