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HCR ManorCare was 'doomed' by high leverage, Welltower CEO says

Top executives at the two largest healthcare real estate investment trusts laid out contrasting views of the skilled nursing industry in back-to-back conference presentations, with Welltower Inc.'s CEO arguing that the industry's problems are largely the result of private equity firms' moves to buy out operators using high leverage.

Welltower agreed in April to acquire Quality Care Properties Inc., a REIT that was formed when HCP Inc. spun off its troubled portfolio of skilled nursing assets. In tandem with the transaction, ProMedica Health System Inc., which will own 20% stake in the properties in a joint venture with Welltower, acquired the properties' operator HCR ManorCare Inc.

In a presentation at U.S.-based real estate investment trust trade organization NAREIT's REITWeek 2018 conference, Welltower executives emphasized the high credit quality of ProMedica, which will be the REIT's tenant under a new lease, as well as the health system's plans to spend $400 million over the first five years of the deal on property improvements.

Some observers remain skeptical of skilled nursing, an industry in which many operators — including HCR ManorCare, which filed for bankruptcy in March — have struggled with changing government reimbursement rules.

In the presentation's question-and-answer period, one audience member told Welltower CEO Tom DeRosa, "Congratulations on getting that steaming bag of real estate back." The comment harkened back to an earlier remark of DeRosa's, from REITWeek 2016, in which he characterized skilled nursing spinoffs, including the Quality Care deal and a similar transaction by Ventas Inc., as tantamount to handing investors a "leaking, steaming bag of real estate."

The audience member asked why Welltower plans to keep HCR ManorCare's management team operating the portfolio, which "appears to people like me as a failed enterprise."

"Don't confuse over-levered skilled nursing deals that were done by private equity groups with the operating viability of this post-acute care business platform," DeRosa said, alluding to HCR ManorCare's majority owner, Carlyle Group LP, which acquired the operator in 2007 for $6.3 billion.

In an interview following the presentation, DeRosa said Carlyle paid too much for ManorCare, creating a problem that was compounded by reimbursement cuts.

"It was doomed," he said. "It doesn't mean it's a bad business. It meant that it was over-levered, and it couldn't work under the capital structure that had been crafted. We believe we've addressed those issues."

He said that viewing the transaction as a skilled-nursing acquisition, rather than a transaction with a health system, is "missing the point."

DeRosa contended that ManorCare operates high-quality properties, as rated by the federal Centers for Medicare & Medicaid Services, and said the operator's management team had "one hand tied behind its back" as a result of its capital structure.

In a presentation immediately afterward, Ventas executives took a contrasting view, characterizing their decision to dispose of the company's skilled nursing portfolio as an example of sound capital management.

"We don't fancy ourselves to be visionaries in any way, shape or form, but we do work very hard to be students of the market," Chairman and CEO Debra Cafaro said. CFO Bob Probst said the 2015 spinoff of Care Capital Properties was a reaction to high property valuations in contrast with weakening operating fundamentals.

Asked what would have to happen for Ventas to reinvest in skilled nursing, Cafaro and Probst paused for a long moment before answering.

"We would have to believe that it would be one of our best capital allocations uses," Cafaro said, "and right now we think we have far better risk-adjusted returns in other areas."