Was HCP Already Overvalued Into Spin-Off News?

HCP Inc. (NYSE: HCP) has seen a positive news reaction from investors on word that the company will spin off its HCR ManorCare portfolio of skilled nursing and assisted living assets, along with other skilled nursing assets, into a new publicly traded real estate investment trust (REIT). The question of 24/7 Wall St., ahead of getting full spin-off data, is whether this news should be this positive.

What matters here is that when investors hear the term “spin-off” it brings music to their ears. It can unlock massive value from a larger structure. It can create a scenario in which a buyer may emerge as well — for the company itself or for the unit being spun off. This is where special situation and activist investors come into play.

HCP’s message about this move is that it will improve the company’s portfolio quality while increasing its focus on core growth businesses. This is its senior housing, life science and medical office operations.

After the spin-off, HCP’s diversified portfolio is expected to consist of more than 860 properties. This generates annual portfolio income of approximately $1.4 billion. The so-called SpinCo will be a real estate portfolio consisting of over 320 properties with expected annual rent of approximately $485 million.
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The first in-depth research report on this matter comes from Merrill Lynch. The firm does not share the market’s enthusiasm as it has an Underperform rating, and it has a $30 price objective (some $6 or so under the current price). Merrill Lynch’s take is that the value remains unclear and that costs and distributions remain unknown — ditto for the one-time costs associated with the deal.

Brookdale Senior Living Inc. (NYSE: BKD) also has a tie to this valuation of the new SpinCo. Merrill Lynch’s team said that Brookdale is one-third of the pro-forma rents and that coverage is weak. Merrill Lynch’s report said:

HCP also sold half of its 80% stake in RIDEA JV/II with Brookdale (BKD) for $740 million to help reduce leverage and its exposure to Brookdale at a 6.5% cap rate. Post spin and the RIDEA sale, roughly one-third of HCP’s NOI will come from Brookdale. We note Brookdale’s triple-net senior housing EBITDAR coverage is a very modest 1.04-times, which is negative post capex. Given this risk, HCP is looking to sell 25 non-core Brookdale assets. We continue to monitor.

Additional notes were seen in the Merrill Lynch report, including that HCP currently values HCR at $5.1 billion on its balance sheet. Even assuming a large haircut, the firm doesn’t see the SpinCo attracting merger M&A interest from pure-play senior and nursing facility operators. HCR’s size was one reason, but also noted were recent operating track record and an ongoing Department of Justice investigation.

HCP shares were last seen trading up 4.3% at $36.06 on the heels of the news. This $16.8 billion REIT has a 52-week trading range of $25.11 to $40.90, and its consensus analyst price target is $29.85.