Healthcare Realty: Proposed Deal With Healthcare Trust Locks Value (NYSE:HR)

Healthcare Realty Trust Incorporated (NYSE:HR) is a United States-based small-cap healthcare real estate investment trust (“REIT”) with a market capitalization of a little less than $4.65 billion. The company owns, manages, finances and develops real estate properties associated primarily with the delivery of outpatient healthcare services. The Company operates in the Medical Office Building (MOB) segment and has a nationwide gross leasable area (GSA) of 11.9 million square feet.

Healthcare Realty Trust has a current yield of 4.34% and four-year average yield of about 4%. It has been paying regular quarterly dividends since 1994. However, the dollar value of quarterly dividend has come down from $0.66 in 2006 to $0.31 in 2022. As a result, this high yield generating REIT became an average yield payor due to macro factors beyond its control.

The historical price growth of Healthcare Realty Trust has been disappointing. In over 28 years of its existence, this REIT recorded a price growth of 49 percent, i.e., CAGR of only 1.43%. The company however, had a considerably better price growth of 37.7% during the past 10 years. The stock was on a bull run in the aftermath of the global financial crisis, when it grew from $13.4 on 16th March 2009 to reach a level of $35.83 on 8th August 2016. In almost 88 months, HR’s market price grew by almost 167 percent.

Since then, the stock has failed to record any significant price growth. And the past five years have been very poor for this healthcare REIT in terms of price growth. Healthcare Realty Trust recorded a negative price growth of 8.3 percent, 7.3 percent and 11 percent over the period of 1 year, 3 years and 5 years respectively. Prices dropped by 5.8 percent and 11.3 percent over the past 3 months and 6 months respectively.

The only positive news is the positive price growth of 4.08 percent in the last one month. However, this growth was not due to its fundamentals, but resulted from the announcement of an $18 billion merger deal with Healthcare Trust of America, Inc. (HTA), the largest dedicated owner and operator in the MOB segment. The deal was proposed on February 27th, 2022, and the price has started moving upwards since then.

Ten of the largest asset management firms – BlackRock Inc., Vanguard Group Inc., Principal Financial Group Inc., State Street Corporation, Canada Pension Plan Investment Board, Bank of New York Mellon Corp., Geode Capital Management, LLC, Charles Schwab Investment Management Inc., FMR Inc., and Legal & General Group PLC – together own around 52 percent of the common equity shares of Healthcare Realty Trust.

These 10 firms also own almost 40 percent of Healthcare Trust of America Inc. As a result, I assume a smooth approval of this merger deal by the shareholders. There was unanimous approval to this merger deal by the Board of Directors of both HR and HTA. “The deal is structured as a reverse merger. Healthcare Trust of America will become the corporate successor, while the company’s name will be Healthcare Realty Trust Inc.”

Besides these 10 asset managers, T. Rowe Price Associates, Inc., Mariner Value Strategies, LLC, and Goldman Sachs Group Inc. have a stake of almost 9 percent in Healthcare Realty Trust. The merger deal was agreed upon on the basis of an unaffected price of $30.26 per share of Healthcare Realty Trust. The merger deal is expected to be materialized by the middle or end of the third quarter of 2022. Under such a scenario, I expect the market price of HR’s common equity shares to revolve around the value of $30.26.

The shareholders of HTA are expected to receive an implied value of $35.08 per share, including a special cash dividend of $4.82 per share and a 1:1 exchange ratio based on HR’s unaffected price:

“The special cash dividend of approximately $1.1 billion will be financed through joint venture transactions and asset sales. JPMorgan Chase Bank, N.A. has provided a commitment letter to Healthcare Trust of America for a $1.7 billion debt financing for the transaction upon the terms and conditions set forth in the letter.”

Post-merger, the combined company will have an equity value of $11.6 billion. “After the transaction closes, which is expected in the third quarter, Healthcare Realty shareholders will own 39% stake in the combined entity, while the remaining will be held by Healthcare Trust shareholders.”

“The combined company will have unmatched market scale in concentrated clusters, meaningful corporate and operational synergies, an expanded development pipeline, greater access to capital and enhanced balance sheet strength.” This merger is expected to generate operating synergies, estimated to be $33-$36 million in savings of total administrative cost. The combined entity is expected to achieve 100% of G&A savings within 12 months. “The combined real estate investment trust will have 727 properties in its portfolio and a pro-forma total enterprise value of $17.6 billion as of Thursday’s (24th February) close.”

With enhanced scale, growth and financial benefits, the combined entity will become the fifth large-cap healthcare REIT. The existing four large-cap healthcare REITs – Welltower Inc. (WELL), Medical Properties Trust, Inc. (MPW), Ventas, Inc. (VTR), and Healthpeak Properties, Inc. (PEAK) – will now face a much stiffer challenge in the MOB segment due to the sheer scale and capacity of this merged entity.

Quite expectedly, this merger deal has created a ruckus within the large-cap healthcare REITs. WELL, the largest diversified healthcare REIT, made a $4.8 billion all-cash bid for Healthcare Realty Trust Inc. on 3rd May 2022. WELL offered $31.75 a share for Healthcare Realty, expected to be financed with WELL’s cash and a fully committed bridge loan. This price was 5 percent higher than HR’s 24th February price of $30.26. However, HR’s shareholders had to surrender their ownership under such a situation.

“Welltower also offered to pay the $163 million termination fee Healthcare Realty would owe for walking away from Healthcare Trust.” So, the overall bid value was almost $5 billion, which still is not substantially higher than Healthcare Realty’s current market value. Thus, HR’s valuation by WELL wasn’t something to be excited about. However, the offer was rejected by the Healthcare Realty’s board, and I doubt this approach from WELL has much of a future given the board’s rejection on what seem to be valid grounds.

Despite potential growth benefits and possible operational synergies from the proposed reverse merger deal, there is no substantial basis for investing in the equity shares of Healthcare Realty Trust. In my opinion, the proposed deal has somehow locked its market price at $30.26. Thus, the price may not move beyond it till the deal materializes by the middle or end of third quarter.

Another important thing to note is that WELL’s bid, though valued its shares a bit higher than this merger deal, was not significantly higher than the current market capitalization of HR. This bid emphasizes WELL’s perceived value of Healthcare Realty Trust. Moreover, the combined entity has to sell its existing assets and enter into joint venture agreements in order to finance the special cash dividend of approximately $1.1 billion. This surely will impact the balance sheet of the merged entity.

In my opinion, the share swap deal benefits HTA shareholders more than HR equity holders. Historically, the market price of HTA was slightly lower than that of HR. In addition, HTA shareholders will get additional cash dividends of $4.82 per share. Thus, even if I am interested in taking advantage of this reverse merger deal, I’d prefer to buy common equity shares of Healthcare Trust of America, Inc., instead of investing in the equity share of Healthcare Realty Trust.