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ANALYSIS: Vital investors foot the bill for ditching a dud idea

Monday 2nd September 2019

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Investors were mightily relieved when Vital Healthcare Property Trust’s manager announced in May that Vital wouldn’t be party to buying Healthscope properties for A$1.25 billion.

Trading in Vital speaks volumes: the unit price jumped from $2.12 on May 9, the day before Canada-based NorthWest Healthcare Properties Real Estate Investment Trust’s announcement, to as high at $2.65 in July.

But the relief is rather like the deliverance you feel when you stop banging your head against a brick wall.

In the May announcement, NorthWest promised Vital wouldn’t be charged fees and third-party due diligence costs relating to that deal.

But it would still pay the fees associated with taking a stake in Healthscope ahead of its successful takeover by fellow Canadian company, Brookfields.

NorthWest has said the stake gave it and Vital a seat at the table when Healthscope’s assets were carved up.

In Vital’s annual results in early August, NorthWest said of the prospective Healthscope investment that “declining to participate in this opportunity was exceptionally difficult.”

However, the facts show it was an easy decision if it was about acting in the best interests of Vital's unitholders.

First wind of the Healthscope opportunity landed in May last year. The market was told NorthWest had bought a 10 percent stake in the ASX-listed Healthscope via a derivatives arrangement, but not that Vital was already financially committed.

Even so, Vital’s institutional investors immediately did their sums on what Vital would have to pay for any Healthscope properties.

It was clear, even that early in the piece, that the price of Healthscope assets would be at yields below Vital’s cost of capital.

Despite refusing to say whether Vital had any involvement in the purchase, NorthWest did say that “an acquisition of Healthscope's underlying hospital related real estate is of interest” to both it and Vital.

NorthWest and Vital "currently intend to pursue any potential Healthscope real estate acquisition jointly, with scope to introduce other capital partners as appropriate."

It wasn’t until August last year that Vital’s unitholders learnt they had financed the stake with a $40 million loan that was about to rise to more than $80 million.

The institutions' initial calculations proved correct: NorthWest and the Singapore-government-backed Australian property vehicle it manages bought the Healthscope properties at a 5 percent yield.

The effective yield after costs to Vital would have been south of 5 percent but its cost of capital is about 6 percent.

Rather than being an “exceptionally difficult” decision to keep Vital out of it, it was a no-brainer. The price was too high.

But paving the way for NorthWest’s acquisition was a costly exercise for Vital.

The annual report shows total gross fees NorthWest charged rose 11.2 percent to $31.2 million in the year, but that double-digit increase looks far more reasonable than the 74.5 percent jump in gross fees to $22.1 million reported for the first half of the year.

NorthWest reimbursed Vital $5.9 million of the fees charged at the half year, a victory for the outraged investors at last year’s rowdy annual meeting and probably also for Graham Stuart, an independent director appointed to the manager’s board in December.

Stuart had strongly signalled his intention to act in unitholders’ interests.

The Financial Markets Authority can probably take a bow here too – it had made it very clear that it was breathing down necks at Vital’s trustee, Trustees Executors, to ensure they were doing their job of ensuring the manager acted in the best interests of Vital’s unitholders.

But despite this victory, the Healthscope episode was costly for unitholders.

One direct impact was that net distributable income fell 4.7 percent to almost $44 million for the year – remember that 11.2 percent increase in NorthWest’s fees.

In addition, Vital lent NorthWest a total of A$80.3 million to buy the stake in Healthscope but received only half the benefits.

It received $7.4 million in dividends and made a $6.1 million capital gain when the Brookfields takeover succeeded.

It also received interest at 4 percent from NorthWest of $2.7 million in the year ended June and $283,000 in the previous financial year.

The weighted-average interest rate Vital paid on its own bank borrowings of $735.4 million in the latest year was 4.4 percent – is having Vital borrow at 4.4 percent to lend to its manager at 4 percent in the best interests of unitholders?

In any case, Vital’s costs more than wiped out its gains from the Healthscope deal.

The annual report shows NorthWest charged it a “derivative acquisition fee” of $2.8 million, derivative financing costs of $2.4 million and a derivative “capital charge” of $3.3 million, or $8.5 million in total.

So NorthWest charged Vital $8.5 million in fees for the privilege of lending NorthWest $80.3 million.

Vital also paid third party commission, interest and legal fees of $9.3 million in the latest year as well as $3.3 million the previous year.

The net outcome for Vital was a cost of $1.6 million in the latest year on top of a $3.3 million the previous year.

Acting head of the management company, Miles Wentworth described this as “a cost of doing business.”


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