What's Incremental To Our View

We recently hosted a non-deal road show with GPT’s CEO, Gordon DuGan, President, Benjamin Harris, and Head of Investor Relations, Brittany Sanders. As a reminder, we originally covered CSG before the merger with GPT. Frankly, our opinions of GPT’s mgmt team had not yet been solidified through years of coverage, so we found our extended time with mgmt very useful and timely. Overall, our initial positive inclination regarding the mgmt team is confirmed. We consider Gordon (and the GPT team) as a smart steward of shareholder capital, straight forward, and has a mindset focused on the long-term.

Key Takeaways:

Smart steward of shareholder capital: 1) As a reminder, we were very vocal critics of the way CSG was sold to Gramercy, and we surmised that GPT was buying CSG at a discounted valuation (note: We expected a deal, just not this one), but Gordon clearly delivered for GPT shareholders. 2) In addition, GPT has executed on the capital recycling plan ahead of schedule and on budget. GPT has disposed of $1.4bn of assets at a 6.8% cap rate thus far compared to the original guidance of $1.145-$1.225bn at a cap rate range of 6.7%-7.2%. The company has already sold nearly two thirds of the entire CSG portfolio. Remember, GPT acquired the entire CSG portfolio at approximately 7.5% cap, and the company has been able to sell, the arguably, higher cap rate suburban office assets at a 6.8% cap rate. 3) Gordon DuGan has a notable track record of building companies (running WPC and building Gramercy from infancy stage).
Focused on the longer term: The company assumes lease-up risk prior to selling largest office assets to obtain better long term returns and continues to do so with the newly formed TPG JV. In our opinion, many management teams take the ‘rip the band-aid off’ approach to portfolio repositioning, but sometimes that is not always the best choice, due to less optimal asset pricing (though the stock may get a short term benefit). We respect mgmt. for choosing a more balanced approach to asset sales and taking on lease-up risk. According to mgmt, as tenant lease term nears expiration on suburban office assets, market pricing can significantly deteriorate (unlike other asset classes) and pricing can fall as much as 25%-30% due to the risk of the unknown. This is why GPT formed the suburban office JV with TPG, to hold office assets with near term tenant roll, attempt to release assets, and then potentially sell at better prices.
Straight forward: Obviously subjective, but overall, Gordon never shied away from some of our tougher questions and provided us straight forward answers throughout.

Other notes:

Sold 2 Amazon buildings in Phoenix. We think this was a smart move; the large box market in Phoenix is not deep and we see risk that as Amazon’s distribution strategy evolves, there may be reduced demand for the first generation locations that were largely driven by tax reasons.
GPT goal is to become 75%-80% industrial as this is management team’s preferred asset class (ours as well) vs. suburban office, which can have significant leasing challenges and CapEx requirements.
Lifetime Fitness is performing well, 4-wall coverage is appx. 3x.
3Q16 should be a trough quarter for earnings as GPT will become a net acquirer in 2017 (seeking to purchase $1bn of industrial assets (6.5%-7.0% cap rate) and sell another $200-$400m of sub. office assets).
No noticeable impact on industrial demand or asset pricing from Brexit, thus far.

While we have a Hold rating on GPT, we have a favorable view on management and portfolio strategy; we are simply seeking a more relatively attractive entry point. And generally, we have growing concerns about lofty REIT valuation levels, that in large part have been driven by elements such as: Brexit, investors’ search for yield, and easy monetary stimulus (globally) that has grown the fed’s balance sheet from $890bn in 2008 to ~$4.5trillion in Aug-2016.

Ki Bin Kim, CFA
212-303-4124
kibin.kim@suntrust.comAnthony Hau
212-303-4176
anthony.hau@suntrust.com

Ian Gaule, CPA, CFA
212-590-0948
ian.gaule@suntrust.com
Kevin Cheng, CFA
212-303-4149
kevin.cheng@suntrust.com

FULL REPORT

$1.25B Steward Health Acquisition

Upsized Equity Offering Bolsters Unique Position

Rating: Buy

Market Cap (M): $3,537; Price: $14.80 as of 09/27/2016

Price Target new: $18.00; Price Target prior:$18.00

Sector: Healthcare REITs

What's Incremental To Our View

We view MPW's $1.25B Steward Health Care System investment and upsized equity offering positively - adding a new operator relationship and portfolio diversification benefits. MPW is acquiring nine hospital properties from Steward (a Cerberus Capital Management affiliate) for $1.2B along with a $50M equity investment in Steward. Combined with the additional portfolio/capital market activities (~$800M dispositions, $300M MEDIAN investment, 11.9M share ATM), MPW projects ~10% per share accretion. We believe MPW will continue to leverage its unique market position into additional opportunities.

The deal structure with Steward Health is anticipated to be split equally between master lease (five properties) and mortgage loan arrangements (four properties) with cross-default provisions and corporate guarantees, reflecting a 10.1% GAAP cap rate and CPI based escalators. The agreement also includes the right of first refusal for MPW to acquire future Steward hospitals.
MPW will invest $50M in equity in Steward Health that, in addition to providing a 4.9% economic interest, offers certain protective rights regarding Steward credit decisions. Cerberus has also agreed to invest $150M in MPW through a private placement transaction.
The Steward deal should deliver meaningful diversification benefits, with Steward becoming MPW's largest tenant at 17.8% of assets (replacing Prime previously at 20.8%). Prime, MEDIAN, Ernest, Adeptus and RCCH fill the next five spots, representing 16.1%, 14.9%, 8.7%, 7.1% and 6.5% of total gross assets, respectively.
MPW raised ~$700M in equity through its 50M share overnight equity offering (priced at $14.50) and expects an additional $150M private placement from Cerberus. While the company initially projected an incremental ~$700M in debt, with the upsized equity offering, we think the debt offering may be more likely in the $500M range, helping MPW maintain its low leverage.
We view this deal positively, and think it further strengthens MPW as a key financial partner with its hospital tenants. We also believe the deal size and relationship should enhance MPW's recognition and unique position in the hospital sector.
We have updated our model, with our 2016 Normalized FFO estimate moving lower to $1.19 (from $1.30), reflecting the upsized equity offering and assumed incremental $500M in debt, but no Steward revenue (assume deal closes near year end for modeling purposes). Our 2017-2018 Normalized FFO estimates move higher to $1.38, and $1.47 (from $1.34 and $1.43), reflecting the expected incremental benefits of the Steward investment.