HCP, Inc. (HCP), HCR ManorCare Extend Master Lease Agreement; FY15 Outlook Updated

HCP, Inc. (NYSE: HCP) and HCR ManorCare, Inc. (“HCRMC”) have agreed to amend their Master Lease (the “Amended Master Lease”) encompassing a portfolio of 333 post-acute, skilled nursing and assisted living facilities owned by HCP.

Amended Master Lease Highlights

Commencing April 1, 2015, HCP will provide an annual net rent reduction of $68 million, which equates to initial lease year rent of $473 million, compared to $541 million that would have commenced April 1, 2015 prior to the amendment. The contractual rent will increase by 3.0% annually during the initial term. In exchange, HCP will receive the following consideration:

• Fee ownership in nine new post-acute facilities valued at $275 million with a median age of four years, currently owned and operated by HCRMC. The ownership transfer to HCP is expected to be completed within the next 12 months, subject to customary licensing and regulatory approvals. Commencing April 1, 2015, HCP will begin to receive the allocated annual rent on the nine facilities totaling $19 million (included in the amended initial lease year rent of $473 million above). In the event ownership does not transfer for any of the nine facilities, HCP will retain a lease receivable of equal value, earning an equivalent initial cash lease yield of 6.9%, increased annually by 3.0% under the Amended Master Lease;
• A second lease receivable with an initial amount of $250 million, payable by HCRMC upon the earlier of: (i) end of the initial term of the first renewal pool under the Amended Master Lease, or (ii) certain capital or liquidity events of HCRMC, including an IPO or sale. The $250 million lease receivable amount will increase each year as follows: 3% in April 2016 through 2018, 4% in 2019, 5% in 2020 and 6% in 2021 until the end of the initial lease term; and
• Extension of the initial lease term by five years, to an average of 16 years.

Other than as described above, the Amended Master Lease possesses substantially the same terms and conditions as those prior to the amendment. HCP has posted supplemental information relating to the Amended Master Lease on the Investor Relations section of its website at www.hcpi.com.

Update on Sale of 50 Non-Strategic Assets

HCP and HCRMC continue to advance their efforts on the previously disclosed marketing of up to 50 non-strategic facilities. The asset sales are expected to be completed in late 2015 to early 2016, and generate net proceeds between $250 and $350 million. Based on the previously announced 7.75% yield on sale proceeds to HCP, this will result in an annual rent reduction under the Amended Master Lease between $19 and $27 million after completion.

Combined, the lease amendment and asset sale transactions are expected to result in the following benefits for HCP:

• HCRMC corporate fixed charge coverage is projected to increase to 1.28x – 1.30x, and facility-level rent coverage is projected to improve to 0.98x – 1.00x, each on a pro forma, full-year run rate basis, thus strengthening HCP’s future growing rental stream;
• Reduced tenant concentration in HCRMC from 29% to projected 25% of our annualized portfolio income on a pro forma, full-year run rate basis; and
• HCRMC’s cash flows must be retained or reinvested to advance its growth plans until HCP’s lease receivable is fully repaid. And HCP participates, via its 9.4% equity interest, in the projected increase in cash flows and value of HCRMC OpCo over time.

“We appreciate our strong relationship with and continued support from HCP. This pivotal transaction will immediately improve our financial flexibility and allow us to continue to grow the HCR ManorCare franchise,” said Paul Ormond, Chairman, President and CEO of HCRMC. “HCP is an experienced capital partner that understands the challenges faced by our industry in the current environment.”

“The lease amendment directly addresses concerns regarding low coverage ratios on our HCR ManorCare lease, and we believe that the benefits HCP receives represent a fair trade for our shareholders,” said Lauralee Martin, President and CEO of HCP. “This amendment not only results in improved lease coverage, but positions HCR for growth by ensuring that adequate capital is available to advance their strategic business initiatives including continued investment in our real estate portfolio.”

Non-Cash Impairment Charge

HCP will record a non-cash impairment charge estimated to be approximately $481 million, or $1.03 per diluted share, related to our direct financing lease (“DFL”) investments with HCRMC. HCP acquired the HCRMC real estate portfolio in April 2011 for a purchase price of $6.1 billion. The non-cash charge will reduce the current carrying value of the HCRMC DFL investments from $6.6 billion to $6.1 billion, based on the present value of the future lease payments under the Amended Master Lease.

Updated Full Year 2015 Guidance

HCP is updating its full year 2015 guidance solely to reflect the impact from the Amended Master Lease described herein and the non-cash impairment charge above. The guidance does not reflect the previously announced acquisition of 35 private pay senior housing communities from Chartwell Retirement Residences for $849 million or other unannounced investments or dispositions, and is as follows: HCP expects Funds From Operations (“FFO”) applicable to common shares to range between $2.02 and $2.08 per diluted share; FFO as adjusted applicable to common shares to range between $3.06 and $3.12 per diluted share; Funds Available for Distribution (“FAD”) applicable to common shares to range between $2.63 and $2.69 per diluted share; and net income applicable to common shares to range between $0.87 and $0.93 per diluted share. Full year 2015 FFO and net income per share amounts reflect the estimated non-cash impairment charge of $1.03 per diluted share above.

*** The Street sees FY15 FFO at $3.19 per share.

FFO, FFO as adjusted and FAD are supplemental non-GAAP financial measures that HCP believes are useful in evaluating the operating performance of real estate investment trusts. A reconciliation of these non-GAAP financial measures to GAAP earnings per diluted share is included below.

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