Ventas Adds Value

Health-care real estate investment trust

Furthermore, Ventas expects to be able to increase its dividend (combined at both the spin-off and Ventas) by 10% or more. After incorporating the Ardent deal in our model, we think its combined dole for 2016 could reach $3.55 per share, up from $3.16 currently. Based on our new 2016 forecast, our projected 2016 dividend would represent less than 80% of our normalized adjusted funds from operations estimate. While this is higher than Ventas’ recent low-70s payout level, it would keep Ventas with the largest payout buffer among health-care real estate investment trusts we cover. We think this favors Ventas, not only for the relative dividend safety it provides but also for the incremental cash flow Ventas can retain to reinvest to grow its asset base, giving it some benefit from relatively fewer shares issued for growth.

In a REIT sector that appears overvalued in general, Ventas stands out as relatively attractive, trading at a 5%-10% discount to what we expect our new fair value estimate to be.

Shedding a Difficult Health-Care Property Type

In spinning off most of its skilled nursing facilities, Ventas is shedding most of its investment in a health-care property type that has faced challenges recently because of a difficult admissions environment and revenue pressure from government reimbursement policies. Although Ventas has avoided the headline risk in this sector that its peer

Seizing a Growth Opportunity In acquiring Ardent, Ventas is positioning itself for potential growth in the fragmented hospital space. By separating Ardent after the acquisition into a property company/operating company structure (in which Ventas will own the real estate leased on a long-term basis to the operating company and own roughly 10% of the operating company), Ventas is positioned to acquire other hospital systems and split the real estate and operations in a similar manner. Although we like the Ardent deal, we expect hospitals to face a difficult operating environment in the future as well, as the health-care environment pushes services to outpatient facilities and government reimbursement levels likely remain under pressure, due to potential payment cuts, treatment quality incentives, and other measures. Furthermore, although we think a number of health-care service areas will benefit from an expanded base of insured people under the Affordable Care Act, we think hospitals will benefit relatively less, as uninsured people were unlikely to defer emergency services provided in acute-care hospitals previously. Nonetheless, the deal's initial yield of 7% (or greater) combined with 2.5% contractual rent escalators provide an attractive 9.5% total return profile for Ventas, which we think is somewhat value-accretive for shareholders. The biggest risk we see to this prospect is future revenue growth at Ardent that fails to keep pace with the 2.5% annual rent escalators in the lease, which could make it difficult down the road to sustain the rent increases. However, the initial lease yield implies a reported 2.9 times EBITDARM coverage level, which--while not huge--does provide some buffer for periods of lagging revenue growth at Ardent, in our opinion.

These transactions further reflect Ventas’s management’s willingness to continue to push the envelope within its sector. These transactions represent the continuation of what has at times been aggressive portfolio repositioning since its IPO. Such moves, which often involved acquisitions as opposed to dispositions, have not only expanded Ventas’ balance sheet, but also created massive value for shareholders and produced the most impressive dividend growth among its largest health-care REIT peers, in our opinion. Since 2001, Ventas has delivered roughly 9% compound annual growth in its dividend, relative to less than 3% at peers HCP and Health Care REIT. Furthermore, the Ardent deal adds another potential growth platform for Ventas, similar to its industry-leading entry into senior housing assets under the RIDEA (operating) leasing structure in 2007-08 and Lillibridge acquisition within the medical office building segment.

Moreover, the Ardent deal highlights the external growth opportunity within the health-care property space. Relative to many other areas of commercial real estate, the vast majority of health-care assets (we think at least 80%) remain in private hands. As Ventas’ experience with Ardent--which it reportedly courted for 15 years--shows, it can take time for these assets to come to market. Although the timing of such deals is difficult to predict, we expect further opportunities to arise from time to time, providing potential incremental avenues for cash-flow growth and value creation at health-care REITs in general than other property sectors that are already more concentrated among REITs’ hands.

Growing and Aging Population, and ACA, Are Tailwinds In general, Ventas' business remains exposed to favorable tailwinds, such as a growing and aging population and additional users of the health-care system because of ACA. With the advent of the Affordable Care Act in the U.S., change is underway in the health-care industry. The reforms bring a renewed focus on constraining growth in health-care costs, while potentially introducing tens of millions of new insureds to the health-care system. Despite the uncertainty with current (and potential) changes to the health-care industry, the bulk of health-care spending is nondiscretionary and often requires physical space--that is, real estate--for its delivery, favorable conditions for health-care landlords. Ventas has long-term leases, well-located senior housing properties, and future opportunities for profitable external growth with partners expanding their operations and by consolidating its industry.

In recent years, Ventas has added senior housing operating assets to its diversified portfolio. Given the direct impact of their operating variances on Ventas' financials, we view its operating assets as potentially introducing more variability to Ventas' results than its legacy (mainly triple-net leased) assets. However, Ventas is also immediately exposed to operating improvements at these properties, which can drive faster growth in strong markets. The firm's strategy in this area is sound, as it attempts to limit downside risk by owning high-quality assets in markets with favorable demographics that it expects to enjoy expanding demand over time. Ventas reports that its operating portfolio is in areas within its markets with higher average household incomes and higher home values, which--along with the ageing of the population--should benefit demand for its senior housing operating assets. Early results of this effort are encouraging, as these assets have been some of Ventas' best performers of late.