All told, ManorCare’s turmoil has resulted in falling profits that have served as a major drag on HCP’s overall profitability, and returns on shareholder capital.
| REIT | Operating Margin | Net Margin | Return On Assets | Return On Equity | Return On Invested Capital |
| HCP | -4.3% | -2.6% | -0.3% | -0.7% | 0.8% |
| Welltower | 18.2 | 16.0% | 2.3% | 4.9% | 4.19% |
| Ventas | 14.5% | 13.1% | 1.9% | 4.3% | 3.72% |
| Industry Average | 28.8% | 14.2% | 2.1% | 4.6% | NA |
Source: Morningstar
Potentially even more troubling is that the ManorCare acquisition resulted in HCP taking on a lot of debt, resulting in a far more leveraged balance sheet than its major rivals Welltower (HCN) and Ventas (VTR).
In fact, as you can see below, HCP’s current balance sheet is among the ugliest in its industry, with a low interest coverage ratio, and a current ratio that is far below the industry average.
| REIT | Debt / EBITDA | EBITDA / Interest | Debt / Capital | Current Ratio | S&P Credit Rating |
| HCP | 10.18 | 2.17 | 52% | 0.23 | BBB |
| Welltower | 6.16 | 4.07 | 44% | 2.28 | BBB |
| Ventas | 6.27 | 4.26 | 52% | 1.78 | BBB+ |
| Industry Average | 6.73 | NA | 52% | 0.80 | NA |
Sources: Morningstar, Fastgraphs
HCP’s Turnaround Plan: The Good News
HCP management has announced (3) that it plans to spin off its ManorCare assets into a separate REIT called Quality Care Properties (QCP) by the end of the year.
This REIT will own: 274 SNFs and post-acute properties, 62 memory care/assisted living properties, a surgical hospital, and HCP’s 9.4% stake in ManorCare.
Source: HCP Investor Presentation
There are three main reasons for the spin off. First, it should help HCP to pay down a lot of its debt. Specifically, this is because QCP will pay HCP for the assets it gets from the parent company. And when combined with ongoing asset sales and divestitures of the RIDEA II assets, (a joint venture with Brookdale Senior Living), HCP management expects to raise a total of $3.8 billion; $3.3 billion of which will go to paying down debt.
If management can in fact raise these funds, then it could decrease HCP’s debt from $10.8 billion to $7.5 billion. However, in the short-term while HCP’s debt load may decrease in absolute terms, its leverage ratio will actually increase due to the estimated $500 million in decreased cash flow that is currently coming from the REIT’s ManorCare assets.
In fact, HCP’s leverage ratio is likely to rise, potentially as high as 14.8. This has led both Fitch, and Moody’s (MCO) to recently downgrade HCP’s credit rating. And with HCP’s CEO, Lauralee Martin, resigning on July 11th, and the company having yet to name a permanent replacement, it’s clear that this spin off is just the start of HCP’s turnaround effort. The turnaround will likely take several years and require a continued strong emphasis on paying down debt; potentially at the expense of dividend growth.
The second reason for the spinoff is that it will help to decrease HCP’s reliance on Medicare and Medicaid funding, by increasing the percentage of its cash flow coming from private payers from 80% to 95%.
In addition, the smaller HCP will own younger, more in demand properties focused on the senior housing, life sciences, and medical office buildings, or MOBs.
Thanks to America’s rapidly aging population these are all industries that are expected to be in high demand, and help the new HCP achieve faster growth going forward.
Specifically, HCP, Inc. (NYSE:HCP) expects its leaner, post spin off form to achieve 0.8% faster net interest income growth. This should help the company eventually achieve faster dividend growth in the future, once the balance sheet is returned to a safer level; one more in line with industry standards.
Source: HCP Earnings Release
The final reason for the spinoff is a bit more nebulous. According to Mark Ordan, who HCP has chosen to be the new CEO of Quality Care Properties, “With a singular focus on SNF and assisted living assets and a flexible capital structure, we believe SpinCo (former name of QCP) will have the tools and flexibility to unlock value in the HCR ManorCare portfolio, as we own, manage, sell or transition assets as desired over time.”
Now personally this claim is one that I am skeptical of, as it’s a classic example of non-specific corporate speak that usually follows poor execution, and a pledge to turn things around.
Which brings me to the most troubling aspect of this corporate restructuring; the impact it will potentially have on HCP’s dividend.
