Why Vital Healthcare institutional investors are rebelling

Wednesday 5th December 2018

At the root of the stoush between institutional investors in Vital Healthcare Property Trust and its manager is the fear that the manager may buy property at the top of the market.

A month after former chair Graeme Horsley resigned in April, the owner of the manager, Canada-based NorthWest Healthcare Properties Real Estate Investment Trust, announced it had bought an option to buy up to 10.1 percent of ASX-listed Healthscope at an effective price of A$2.39 per share.

Healthscope shares are currently trading at A$2.28.

At that time, Vital’s investors didn’t know if the trust was in on the deal and NorthWest said it didn’t have to disclose that because it wasn’t a material transaction for Vital.

But investors later learnt from the annual report that Vital was indeed financing the Healthscope play.

Then on Dec. 5, NorthWest announced that Vital had agreed to lend it a further A$40 million, taking Vital’s total exposure to A$81 million, after increasing the derivative contract to over another 40 million shares – Deutsche Bank is providing the option – to take its Healthscope stake to 13.4 percent.

The forward price has been amended to A$2.36 per share.

“The loan is repayable in 12 months unless the parties agree to a shorter timeframe. The loan continues to be on arm’s length terms and interest is payable by NorthWest,” the manager said.

Vital’s gearing was already high at 38.7 percent at June 30 and its bank borrowing rose from $668.7 million then to $695.9 million at Sept. 30.

And Vital’s gearing was already set to rise because it is committed to spending a further $112 million on “brown fields” developments within its existing portfolio.

NorthWest had already upped its effective stake in Healthscope by directly buying another 1 percent on market for $A37.1 million and named Vital in the schedule of companies within the NorthWest group.

“An acquisition of Healthscope’s underlying hospital-related real estate remains of interest to NorthWest and Vital in line with their long-term strategy to invest in healthcare real estate assets in the Australasian market,” NorthWest said in announcing the additional purchases.

“NorthWest and Vital currently intend to pursue any potential Healthscope real estate acquisition jointly, with scope to introduce other capital partners as appropriate.”

Healthscope is one of Australia’s leading private hospital operators and has 43 hospitals concentrated in the major metropolitan cities.

The investors, ANZ Investment Funds, Mint Asset Management and ACC, who together own 10 percent of Vital, are alarmed by all this because it is obviously in NorthWest’s best interests as manager to have Vital buy more property because NorthWest’s fees are based on Vital’s gross assets.

But there’s a more than reasonable chance that won’t be in Vital investors’ best interests, especially with the medical properties market looking toppish.

One only has to look at how the valuations of Vital’s own buildings have grown to chart how hot the medical property market has become, particularly in Australia.

In 2011, the year that NorthWest bought Vital’s management contract, valuers used a 10.6 percent market capitalisation rate to assess the value of the Belmont Private Hospital in Brisbane.

In 2018, Belmont’s valuer used a 5.25 percent market capitalisation rate – the lower the market capitalisation rate, the higher a building’s value becomes, and indeed its value has risen from A$14.5 million to A$72.5 million, although that was after an A$12.6 million redevelopment.

Analysts estimate Vital’s cost of capital is between about 6 and 7 percent – chief executive David Carr said earlier this year it’s lower than that but wouldn’t put a number on it.

On top of that is Australian stamp duty of 5 percent and acquisition costs that would likely be about another 1 percent.

So it’s not hard to see how purchasing more properties now could put such investment under water.

And NorthWest is far from being the only shark circling Healthscope.

On Nov. 19, Healthscope said it was allowing Brookfield Capital Partners to conduct due diligence, although Healthscope’s board warned that “there is no certainty that the Brookfield proposal will result in a takeover bid or scheme of arrangement being proposed.”

Brookfield has proposed either offering A$2.455 per share through an off-market takeover offer or, its preferred option, paying a higher A$2.585 per share if it can take Healthscope over via a scheme of arrangement.

For a scheme of arrangement to succeed, 75 percent of shareholders would need to vote in favour and, if it does, NorthWest and Vital will at least recoup their investment.

Earlier in November, Healthscope had shown the door to a consortium led by AustralianSuper, which owns 14.5 percent of Healthscope, on the grounds that “its proposal is significantly less attractive than the Brookfield proposal.”

Incidentally, the AustralianSuper consortium also has a Canadian connection – The Canadian Pension Plan Investment Board and the Ontario Teachers’ Pension Plan.

When announcing Vital’s latest results in August, Carr said NorthWest and Vital had gone into the Healthscope investment with “eyes wide open” and that the option “positions us better than others in terms of an opportunity.”

Observers are struggling to understand what possible advantage this confers.

Consider that Healthscope’s market capitalisation is nearly A$4 billion, Vital’s is $939.3 million and the Toronto-listed NorthWest’s is C$1.26 billion.

Brookfield has US$330 billion in funds under management. No question who has more financial clout.

One thing is clear, that Vital will have to raise more capital to participate in any purchase of Healthscope assets.

Vital’s gearing at June 30 was 37.5 percent under its trust deed and 38.7 percent under its bank covenant.

Vital’s bank covenant allows it to go as high as 50 percent but that wouldn’t go down well with its investors, especially in comparison with the rest of the listed property sector – Goodman Property Trust, for example, had gearing of just 25.8 percent, after taking into account commitments, at Sept. 30.

(BusinessDesk)

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