Sales Raise Over $1 Billion, Giving the Trust the Means to Retire the 9.75% Senior Notes due 2025 When They Become Callable in June 2022.
DHC announced on January 31 that it has entered into a joint venture with two institutional investors on 10 of its Office properties. The joint venture is valued at $703 million and will have $456.3 million of secured debt. The JV investors will pay $196.5 million for an 80% equity stake. DHC will receive cash proceeds of $653 million and retain a 20% equity interest. The 10 properties are valued at $657 per sq. ft. The $703 million estimated value equates to a capitalization rate of 4.98%, based upon full year 2021 actual cash net operating income (NOI).
This follows DHC’s announcement in December of the sale of an additional 35% equity interest in the Vertex Pharmaceuticals headquarters complex in Boston. In that transaction, DHC will receive $378 million for the stake and likewise retain a 20% joint venture interest.
Together, the sale of the joint venture interests will provide proceeds $1.03 billion, giving the Trust the means to retire the $1 billion 9.75% Senior Notes due 2025 in June 2022, when they first become callable. That could eliminate the $97.5 million annual interest payment on the Notes at an estimated cost of $16.0 million in interest expense (on the Office JV secured debt), plus the estimated annual allocation of $26.5 million in FFO from the two joint ventures to the new JV partners. The estimated annual net savings of $55.0 million is worth $0.23 per share.
The JV transactions plus the savings in interest on the 9.75s would increase the Trust’s pro forma coverage of its debt service obligations to 1.8 times, above the 1.5 times minimum on its revolving credit agreement. That should allow DHC to pay down its outstanding revolving credit borrowings over time with the cash now on its balance sheet. Yet, the 9.75s have slipped two points in recent weeks and now yield to 5.58% to the June 2022 call, suggesting greater uncertainty about whether the issue will be called entirely. The Trust could choose instead to use some of the JV proceeds to fund capital expenditures or support the senior living business.
Based upon pro forma rolling 12 month NOI adjusted for the joint venture transactions, I estimate that DHC’s stock is worth $5.67 at a 7% cap rate. I believe that there is upside to that valuation with improvement in senior living profitability. Yet, DHC’s stock was up only 5.5% today to $3.05. Along with the slippage in DHC’s bond prices, the modest response may suggest ongoing market concerns. Nevertheless, I am maintaining my price target of $6.50.
This is a brief summary of my recent update report on Diversified Healthcare Trust dated January 31, 2022. Reach out to me to receive a copy of the full report.
February 2, 2022
Stephen P. Percoco
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