The close ties between Vencor's operating company and its soon-to-be launched real estate investment trust might make investors squirm.
Wall Street typically doesn't want the leaders of the companies it invests in doing double duty running more than one organization.
At first glance that would appear to be the case with Vencor, a Louisville, Ky.-based long-term-care company. Bruce Lunsford, Vencor's chairman, president and chief executive officer, also will be president and CEO of VenTrust, the REIT that will hold the company's assets (Feb. 9, p. 22).
But this appears to be a different animal.
In its early stages VenTrust will be a "captive REIT," which means it will rely entirely on Vencor for its lease revenues, rather than have a diverse portfolio of tenants. Thus, VenTrust will need the attention of an executive familiar with Vencor's properties, especially during VenTrust's fledgling years, analysts say. In its later stages, VenTrust plans to diversify and acquire facilities that aren't run by Vencor.
"Public markets always want you to devote your attention to your primary business, but a captive REIT is a bit different in the early stages," says Sydney Scarborough, executive vice president at Lilli-bridge Health Trust, a privately held REIT in Chicago. "(Lunsford) obviously knows the facilities better than anybody."
As a captive REIT, VenTrust will work closely with Vencor while leasing 49 of the operating company's 60 long-term-care hospitals and 205 of its 310 nursing homes in 46 states. The remaining facilities that won't be leased by VenTrust are already leased from other organizations.
By spinning off the REIT, Vencor is attempting to boost its stock price and eliminate assets from the operating company's balance sheet. The company then won't be burdened with costs associated with managing facilities and real estate. Vencor plans to focus on expanding its ancillary businesses to help it become more competitive in managed-care contracting.
REITs offer tax advantages unavailable to other corporations. They don't pay federal taxes on income distributed to shareholders. VenTrust will distribute 95% of its taxable income to shareholders.
VenTrust's size will make it quite a bit different from other captive REITs. When the split occurs in this year's second quarter, VenTrust will have a market capitalization of about $2.5 billion, a mammoth size, particularly for a captive REIT. It will be the nation's second-largest healthcare REIT (See chart).
Most recently launched healthcare REITS have started with initial stock offerings of less than $200 million, Scarborough says.
For example, Kennett Square, Pa.-based ElderTrust raised $96 million last month in its initial public offering. ElderTrust is sponsored by Genesis Health Ventures.
VenTrust also is different because it's a spinoff that's not being formed through an IPO.
"Typically, a captive REIT will go out and raise money in the public market and then use the proceeds to buy the operating company's facilities," says Frank Morgan, an analyst at J.C. Bradford & Co. in Nashville.
Like Vencor, VenTrust will be publicly traded on the New York Stock Exchange. Terms of the transaction call for Vencor shareholders to receive one share of Vencor stock and one share of VenTrust stock for each of their current shares.
"We are basically recapitalizing the entire company," says Richard Lechleiter, Vencor's corporate controller and vice president of finance.
VenTrust will raise money for future capital acquisitions in the first year through existing revenues from Vencor lease payments and through the issuance of debt.
"We do not anticipate an equity offering in 1998," Lechleiter says.
VenTrust, which will earn $225 million a year in lease payments from the Vencor facilities, has set aside more than $150 million for acquisitions through 1999. Executives say their future primary targets will be hospitals, nursing homes, assisted-living facilities and healthcare-related office buildings.
But the REIT's strategic plan also includes going into nonhealthcare real estate ventures. However, executives have been quiet about specific deals.
"The key for the REIT is to diversify," Lechleiter says.
If it goes beyond healthcare, as Needham Heights, Mass.-based Meditrust has, VenTrust will soon reduce the Vencor percentage of its portfolio. Meditrust, which has a diverse healthcare portfolio, is expanding its holdings even further. For example, it's acquiring La Quinta Inns and several golf courses (Feb. 2, p. 55).
But Meditrust is unique because of its "paired-share" structure, which allows it to lease property as well as operate businesses. VenTrust can acquire other facilities outside the healthcare arena but will only be able to lease them. Its structure doesn't allow it to operate businesses.
A core group of a half-dozen executives are setting up the company, including Vencor veterans.
"It's not necessarily a bad thing to have the same executives running the operating company and the REIT," says David Whelan, a principal and national director of finance at Hamilton HMC, an Atlanta-based consulting firm. "If all or most of those facilities in the REIT are operated by the same company, then (the top executives) are joined at the hip. You'll want the same people accountable."
Whelan speaks from experience. He ran a hospital company and a REIT simultaneously in the late 1980s and early 1990s. Whelan was president of Healthcare International, which operated psychiatric hospitals and created a captive REIT, HealthVest, in 1989. However, that REIT was highly leveraged and eventually filed for federal bankruptcy protection in 1991.
HealthVest's failure came during a troubled period for the psychiatric hospital business. And it depended on Healthcare International for more than 90% of its revenues.
Analysts don't see similar dangers in the Vencor transformation because it's in a different market and it plans to diversify. It also won't be highly leveraged, Lechleiter says, expecting a debt-to-capitalization ratio of 40% to 50%.
Although not highly leveraged for other healthcare sectors, VenTrust's debt to capitalization will be slightly above the average for healthcare REITs. "They average around 30%," says Jerry Doctrow, an analyst with Legg Mason Wood Walker, a Baltimore-based investment bank.
Whelan has some advice for potential investors and operators of captive REITs: "Make sure everybody understands what they are buying and that there is clearly a risk still associated with the success of the business of the operating company."