Buy or sell? Analysts skeptical of ProMedica-Welltower deal

April 29--Executives at ProMedica and Welltower Inc. were all smiles this week after they put together a $3.3 billion deal to buy Toledo-based HCR ManorCare, rescuing the nation's second-largest nursing home chain from bankruptcy and the threat of dismantlement in the future.

But Wall Street analysts expressed reservations whether the acquisition of ManorCare was in the best interest of Toledo-based Welltower, one of the nation's largest real estate investment trusts.

And they raised questions about how a regional health-care provider like ProMedica, which operates 13 hospitals and more than 300 other medical-related facilities -- but all of them in just Ohio and Michigan -- will take advantage of ManorCare's 25-state footprint that includes hundreds of post-acute/skilled-nursing properties, memory-care/assisted-living properties, and other facilities.

The acquisition will make ProMedica a $7 billion health-care entity and the nation's 15th largest not-for-profit health system by revenue.

In discussing the deal with analysts Thursday, Welltower CEO Tom DeRosa asked them to see the bigger picture.

"He tried to spin it as they're not buying skilled nursing properties, they're investing in the company -- ProMedica," said John Roberts, an analyst with Hilliard-Lyons.

"Having said that, they're still buying skilled nursing homes. They might have a 10-year triple net lease or whatever, but in the end, they own the properties," he said. And "they're paying a pretty steep price for an 8 percent [rate of return] for skilled nursing homes."

Dana Hambly, an analyst with Stephens Inc., noted that Welltower's stock was volatile Thursday after the deal was announced near midnight Wednesday.

Mr. Hambly attributed that to the Toledo REIT's part in the deal -- a $1.95 billion purchase of all property of Quality Care Properties, a Bethesda, Md.-based real estate investment trust known as QCP that has owned since 2016 the properties in which ManorCare operated. It was QCP that put ManorCare into default after the nursing home operation could not meet its monthly rent obligations.

"From Welltower's perspective, I think the initial negative reaction in their stock price and where it closed is, this is a lot of money that they're allocating toward a skilled nursing home deal and this increases their exposure to skilled nursing. Investors view [the skilled nursing home sector] as more risky, so it carries more expectations with it.

"If you're going to spend $2 billion, spend it on something other than skilled nursing," Mr. Hambly said.

RBC Capital Markets analyst Michael Carroll agreed.

"I would say that the deal is interesting. And HCR has always been viewed as a high quality operator. But I would say that with the deal, the public markets look pretty hard at skilled nursing deals just because there's been some headwinds in that [sector]," Mr. Carroll said.

Skilled nursing home property investment doesn't provide the high returns that it once did due to lower federal reimbursements and shorter stays in nursing homes, he added.

However, Welltower and ProMedica built in some nice cushions for the risks associated with skilled nursing properties, Mr. Carroll said.

The rents will add 20 cents per share to Welltower's earnings, and it will provide a return that will equal 1.8 times earnings, before interest, taxes, depreciation, amortization, and rent payments.

"... For Welltower's side, they appear to have done a good a job for positioning themselves and for [ManorCare and ProMedica] to succeed," Mr. Carroll said.

"If you're in providing health care and can dictate where [patients] go and discharge patients to your skilled nursing facilities, that should give you a leg up," he said.

Mr. Hambly said the properties used by ManorCare are very good assets and they will benefit further by a $400 million investment ProMedica has agreed to provide for upgrades and new development.

"Skilled nursing has been starved for capital for some time. ManorCare used to be the gold standard, so hopefully they can get back to that level," he said.

While Mr. DeRosa noted that ProMedica was a strong company with $2 billion in cash on its balance sheet and a AAA+ bond rating, Mr. Roberts, of Hilliard-Lyons, said ProMedica financial profile will suffer a bit by assuming ManorCare's $1.1 billion worth of debt.

"I think after that they won't have an AAA+ rating anymore. They could drop three notches with that amount of debt," Mr. Roberts said. "So in essence, ProMedica may not look like the company Welltower is investing in after the deal closes. It's a little bit of a bait-and-switch."

However, Welltower management has earned its credibility over time, the analyst said.

"They've always been a pretty smart group. They've always made smart moves," Mr. Roberts said.

"I won't upgrade to a buy or sell [recommendation]. There's too much uncertainty," he said. "But there is a lot of opportunity too."

Contact Blade Business Writer Jon Chavez at [email protected] or 419-724-6128.

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