Company Overview: Healthcare Realty Trust (HR)
Business Model:
Healthcare Realty Trust is a self-managed and self-administered real estate investment trust (REIT) that specializes in owning and operating medical outpatient buildings. These properties are primarily situated near hospital campuses. The company strategically expands its portfolio through selective acquisitions and property development.
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Currently, its portfolio boasts nearly 700 properties, encompassing over 40 million square feet, with a strong presence in 15 high-growth markets. The properties cater to a diverse tenant base, including more than 30 physician specialties.
Market Value and Activist Involvement:
Market Capitalization: $6.38 billion ($17.99 per share)
Activist Investor: Starboard Value (Ownership: 5.90%, Average Cost: $17.14)
Starboard Value is a highly regarded activist investor with a track record of enhancing operational efficiency and driving margin improvements in companies. Over its history of 155 activist campaigns, Starboard has delivered an average return of 23.37%, significantly outperforming the Russell 2000's 14.29% return during the same period.
Recent Developments:
On November 26, Starboard disclosed a 5.90% stake in Healthcare Realty Trust via a 13D filing with the U.S. Securities and Exchange Commission.
Background and Challenges:
Healthcare Realty Trust merged with Healthcare Trust of America (HTA) on February 28, 2022, in an $18 billion deal. Although the merger received strong shareholder support (92% approval), it proved dilutive for HR shareholders due to the sub-5% cap rate implied in the deal, compared to HR's higher trading cap rate at the time.
The merger presented an opportunity for HR to demonstrate its value by integrating the two businesses, achieving cost efficiencies, and lowering the cap rate below the 4.85% blended rate implied by the merger. However, the company struggled to realize these benefits. Over two years:
Property operating expenses rose from 31% to 37%, exceeding peer averages.
Funds from operations (FFO) yield increased to 9%, far above the 5%-6% range of its peers.
The cap rate climbed to 7%, while the stock price fell over 15%, contrasting with the Russell 2000's 33% gain during the same period.
Additionally, long-serving CEO Todd Meredith stepped down after 23 years with the company, including eight as president and CEO.
Starboard's Strategic Influence:
Healthcare Realty now faces a pivotal moment, with two primary paths to unlock shareholder value:
Remain a Standalone Entity:
This route requires appointing a new CEO, a crucial task for the board. However, given past management decisions and the underperformance post-merger, shareholders may question the board's capability to oversee this process. A board refresh would likely be necessary, with Starboard expected to play a key role. Starboard could help streamline the company’s operations, reduce costs, and align its metrics with industry peers. Though potentially longer and uncertain, this path is achievable with a competent board and management team.Explore a Sale:
The alternative is a sale of Healthcare Realty, a more direct and potentially lucrative option. With an activist investor like Starboard involved and the recent CEO departure, the company is already positioned as a potential acquisition target. Larger REITs such as Welltower, Healthpeak, or Ventas, which operate with lower costs of capital and cap rates of 5%-5.5%, could be strategic acquirers.
Past interest from Welltower reinforces this possibility. Following HR's merger with HTA, Welltower made a $5 billion all-cash bid for HR at $31.75 per share—significantly higher than HR's current trading price of $17.99 per share.
Starboard’s Approach:
Starboard’s history suggests it could guide Healthcare Realty effectively, whether through operational improvements or exploring a sale. For instance, in 2018, Starboard navigated a similar situation with Forest City Realty Trust.
Initially focusing on long-term value creation through board refreshment and cost optimization, Starboard ultimately accepted an attractive acquisition offer from Brookfield Asset Management, exiting the campaign with a 47.27% gain.
Looking Ahead:
The board must act decisively, whether by pursuing a CEO search or exploring strategic alternatives like a sale. Starboard's expertise in operational efficiency and governance can help Healthcare Realty navigate this critical juncture.
While Starboard has not yet nominated directors, it has until December 10 to do so, leaving a narrow window for settlement discussions. If necessary, Starboard may nominate a slate to preserve its options.
Whether Healthcare Realty opts for a turnaround or a sale, Starboard’s involvement could unlock significant value for shareholders.
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