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Q3 2014 Earnings Call Transcript

Published: 4 Nov 2014

[Operator:]

Good morning. My name is Stephaney, and I will be your conference operator today. At this time, I would like to welcome everyone to the Newcastle’s Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I would now like to turn the conference over to Ivy Hernandez. Please go ahead.

[Ivy Hernandez:]

Hi good morning, everyone. I would like to welcome you today November 4, 2014, to Newcastle’s Third Quarter Earnings Conference Call. Joining me today are Wes Edens, the Chairman of our Board of Directors; Ken Riis, our CEO; Justine Cheng, our CFO, Julien Hontang, our CAO and Susan Givens, the CEO of New Senior. Before I turn the call over to Wes, I would like to point out that certain statements made today will be forward-looking statements. Forward-looking statements describe management's current beliefs and are subject to a variety of assumptions that could prove to be incorrect. So I remind you not to place undue reliance on any forward-looking statements. I encourage you to review the disclaimers in our earnings release and investor supplement regarding forward-looking statements and to review the risk factors contained in our annual and quarterly reports filed with the SEC. And now I would like to turn the call over to Wes.

[Wes Edens:]

Great. Thanks, Ivy. Thanks to everyone. Let me just spend a couple of minutes on an overview and then I'll turn it over to -- to both Susan and Ken to talk about it. The earnings for the quarter adjusted funds from operation $41 million, $0.66 per basic share. Core earnings $29 million, or $0.47. Obviously the big earnings drag for the quarter was just the cash that we have on hand. So $223 million in total, $0.13 per share had it been fully deployed. Largely a timing issue from our perspective, we have very, very substantial pipelines on really both sides of the equation here. So we think that that cash drag will go away in the very near term, but that is the -- that's the basic highlight for the quarter. Page four; I am [popping] (ph) through the supplement that we posted last night. The big highlight for the quarter obviously the spinoff of New Senior that's scheduled for November 6; it will be separately traded on November 7. We talked about that when we formally announced the spin here a few days ago. Invested $30 million in equity in the quarter. The real news is we have a very, very substantial pipeline that we think will be actionable between now and the end of the year. So that's a big part of Susan's presentation. She will talk about that. On the old Newcastle side that remainder company; we've got really two components of that business that exist right now. The debt business, which started the year just to put it in perspective with a forecast of recovering $650 million from the total business. Thus far for the year, we recovered about $300 million and our current forecast is for the eventual disposal of that assets to yield $350 million to $400 million. So performing slightly ahead of our expectations at the beginning of the year and kind of halfway through, but about what we expected to be frankly. The golf assets we have $82 million in capital there and actually the performance since we switched over, the Senior Management of that group has been quite strong. Again Ken will go through that in just a few minutes here, but we feel good about that part of the business. And then also there is now a developing pipeline of a handful of things which we are focused on in that sector as well that we feel good about. So Page five, the Newcastle spend and this is the -- some of the parts page -- if you look at the business of New Senior that the win issued for that stock traded for just a shade under $19 this morning. I think our view and again Susan will talk about this more specifically is that if you guide that portfolio to 6.5% yield, which we think is consistent with where it is and we fully invest the capital that's a fair premium to where things are right now as opposed to $21.5 or $22 share price, but again she will go through that. The post spin Newcastle, two components real estate debt golf and then of course cash, we use the real estate debt estimates of our $350 million to $400 million, use the golf estimates that we think our equity is worth $150-ish million. So kind of a 2X from where we are right now, plus the cash that's close to $7 share price right now. We're trading just a shade under $5, so just to give you some sense of our view of the metrics of those businesses. Page six, our advertisement of why we do these things and how we think we created value. Since we began to invest capital and raise capital at Newcastle about three years ago, it's been a very good return for us thus far. I understand fully what have you done for me lately. So that will be about how we performed with these companies as we spin them out, but we had a lot of good experience with it. A 51% comp under return, 3.3 times people's money over the last couple of years and I feel very, very good about these two companies and their prospects from here on. So with that, let me turn it over to Susan.

[Susan Givens:]

Great. Thanks Wes and good morning, everyone. I'll briefly touch on the portfolio today before spending a little time talking about the senior housing results for the quarter. As most of you know, we had an update call a little over two weeks ago, to announce the timing of the spin-off of New Senior and to discuss the overall business plans at the company. As Wes mentioned, everything continues to be on schedule with the distribution date set for this Thursday and New Senior will begin treating on a standalone basis on Friday. So this is really an exciting time with a lot going on in this week. Since we just recently went through a lengthy presentation on the business, I'll try to move through these pages pretty quickly and focus on actual results for Q3. Turning to Page eight, you'll see a snapshot of what our portfolio looks like today. We have a little under $2 billion of assets and about $830 million of equity. On the senior housing side, we had very strong quarter and continue to be very happy with the level of deal activity and progress that we're making on the existing portfolio. During the quarter, we closed on three new deals with a total of four properties. The combined purchase price for the acquisitions was $77 million, which responded with a little under $50 million of debt and $30 million of equity. A lot of these properties are part of our managed portfolio and are being managed by our operating partner, Blue Harbor. With these recent acquisitions, our portfolio is exactly where we had hoped it would be at the time of the spinoff. So we feel very good about our position going into the next phase of our lives as a standalone company. Today we're one of the largest owners of senior housing properties with 99 high quality assets and over 12,000 beds across 27 states. As we discussed, we think our portfolio compares really favorably to other healthcare REITs in the market. Our strategy has been and continues to be to focus on private pay, independent and assisted living assets and today over 90% of our portfolio is comprised of these assets. Turning to Page nine, we've laid out the numbers for the New Senior business a little differently this quarter as we prepare to be in reporting on a standalone basis. As we transition to a reporting methodology that's more standard across the healthcare REIT industry. In the materials we discussed a couple of weeks ago, we provided some details around how to bridge from property FFO to normalized FFO and AFFO, which will be the metrics we'll use going forward. For Q3, the senior housing business is still reported as a part of NCT that were just showing property level information on Page nine. All in all, the senior housing portfolio continues to perform very well and we had a very strong quarter. Total NOI for the quarter was $38 million, up 15% versus last quarter. Property funds from operations was $24 million up approximately 30% versus Q2. The bulk of the NOI and property FFO increases came from the first full quarter of contribution from the triple-net acquisition we closed on June 30 when we acquired six properties for $186 million. In addition, we continue to see really strong growth across our managed portfolio where our acquisition strategy has really been focused on off-market transactions where we think the assets are undervalued or underperforming. Same store cash NOI was up 15% year-over-year and total NOI from our managed assets increased 9% in Q3 versus Q2. The numbers shown here obviously don't include earnings that we expect to generate from this $210 million of investible cash. As we discussed a few weeks ago, we think our illustrative full year normalized FFO, which is really property FFO, net of G&A will be around $1.40 per share once the cash is fully invested and we expect meaningful growth beyond that as we grow our existing managed portfolio, realize interest savings that we expect from future financings and fund future acquisition. As Wes mentioned out of 6.5% NFFO yield, our stock should trade around $22 per share based on the $1.40 per share of NFFO. Turning to Page 10, as we've discussed in the past, the supply demand dynamics in the industry are extremely favorable. This continues to be a market dominated by smaller players, which we believe creates an opportunity to build value through consolidation. We think we have a model that's unique and differentiated from others. Our assets are very high quality with the vast majority being independent and assisted living and we believe, we will be the only pure play senior housing REIT out there. So if you want exposure to the aging demographic and you want exposure to the potentially higher returns that come with senior housing, but you don't want exposure to government pay risk, our business is one of the few places where you can find that. Now turning to Page 11, the deal pipeline continues to be very strong. We currently have about $160 million of assets in contract and then another 3 billion to 5 billion pipeline of active deals that we're working on. When we spinoff later this week, we'll have $210 million of invested cash at New Senior, which we think gives us sufficient liquidity to fund our near-term pipeline. The pipeline includes a mix of smaller deals along with a few larger transactions and it includes a mix of triple net deals and managed deals. As everyone knows, the acquisition market is fairly dynamic, so we can't predict exactly what will happen with all these deals, but we certainly expect to successfully execute on a big chunk of this pipeline and importantly we're very confident there continue to be sufficient opportunities that fit our business model. So in conclusion, another great quarter for Senior Housing. We have a lot of exciting things happening in the business and we look forward to updating you on our progress post spinoff. And with that, I'll turn it over to Ken.

[Ken Riis:]

Thanks Susan. So I'll highlight our real estate debt and golf segments of Newcastle on the call today. So I am starting on Page 13 of the presentation. So starting out with the real estate debt portfolio, we continue to actively manage the portfolio. As Wes mentioned, at the beginning of the year, we projected to recover, $650 million of principle if we held all the assets to maturity and in this year we've done a great job harvesting some of that capital. Year-to-date we've realized over $300 million of principle recovery including $38 million in the third quarter. So this leaves us with about $350 million to $400 million of recovery to come over the next one to two years. Looking to Page 14, the portfolio continues to generate solid net investment income and the value has improved every quarter this year. In the third quarter, the value of the portfolio increased one point in price to 77% at par and for the year, the valuation has increased four points or $30 million. The overall credit of the portfolio is showing steady improvement and I am optimistic that the overall valuation will continue to improve. Going on to the Golf segment Page 16, we are very focused on our golf investment and we are working hard to improve performance. As a highlight we own and manage 90 golf courses in 15 states with the concentration on the West Coast. Revenue and adjusted EBITDA are marginally higher versus same period last year, I am on Slide 17, and our goal is to get our annual run rate adjusted EBITDA to $30 million over the near term. We think this will be achieved by reducing operating expenses and corporate overhead and restructuring some leases to lower rent on our leased properties to generate negative cash flow for the company, so upside from here as we continue to restructure the portfolio. So if we achieve our goal of about $30 million of adjusted EBITDA for a full year and we look at industry comparable, which trade about a 10 times multiples to EBITDA, we think we are going to achieve a goal of about $300 million of value for the golf portfolio and net of our third party debt a $150 million of net equity values to Newcastle. With that, I’ll hand it over to Justin to go over the financial results.

[Justine Cheng:]

Thanks Ken. I’ll now talk about our third quarter financial activity on Page 20. To note, all my basic share amounts are weighted average and they are adjusted for the three-for-one and the two-for-one reverse stock split that took place in August and in October, so just a quick recap on our balance sheet position. As Susan mentioned this quarter we acquired four senior housing properties for $77 million gross purchase price. As of 9/30, this brought our total owned portfolio to 99 properties. When New Senior is spun-out later this week, it will have $619 million of invested equity, $210 million of investible cash and $1.3 billion of debt. What remains at Newcastle is our legacy debt and golf portfolio with a total estimated recovery value of $435 million to $520 million or $6.54 to $7.80 per share, the components of which can be broken down into the following. $350 million to $400 million of expected recovery value from our CDOs, a $140 million to $175 million of expected equity value from our $82 million gulf investment, $58 million of cash in corporate liabilities of $113 million. From an earnings prospective, we had a solid third quarter. Our adjusted AFFO, which is net income adding back depreciation and amortization for the quarter was $41 million or $0.66 per share. This includes gains realized from our resi whole loan sale of $7 million or $0.11 per share. Our core earnings were $29 million or $0.47 per share. Pro forma for investing our balance sheet cash had a mid-teens return. As Wes mentioned, our core earnings would have increased another $0.13 per share, bringing it to $0.60. Breaking our core earnings down, our three segments generated $42 million of net investment income, which is before Newcastle's corporate expenses. Senior Housing represented roughly 60% of that with the $24 million contribution and this is up approximately 30% from the prior quarter. This reflects a strong organic and acquisition growth that business is up. Our legacy debt business was a third of our net investment income with $14 million of earnings and year-to-date the portfolio generated mid teen returns. Lastly the golf business added $4 million to our net investment income and marked the end of our high period given the businesses seasonality. As Ken highlighted our golf business had solid organic growth and from a pro forma adjusted EBITDA perspective year-to-date our same-store was up 4% which reflects the operating expense restructuring and the new revenue programs we initiated at the end of the summer. Turning to our GAAP earnings, this quarter we generated $4 million or $0.06 per share and physical real estate assets become a larger part of Newcastle's investment portfolio our GAAP income is increasingly affected by D&A. This quarter D&A was $37 million or $0.59 per share. Lastly, this quarter we paid a dividend of $40 million or $0.60 per share and year-to-date our distribution to stock holders has been $7.74 per share. With the New Senior spend that will add another 18.90 based on yesterday's closing when issued price. That wraps up our third quarter activity and I'll now hand the call back over to Wes or Mandy.

[Ivy Hernandez:]

We can open up the floor for questions. Operator?

[Operator:]

(Operator Instructions) Your first question comes from the line of Douglas Harter with Credit Suisse.

[Douglas Harter:]

Thanks. I was just hoping you could give a little more color on when that cash in particular the New Senior cash can be deployed and kind of timing for being able to achieve that targeted level of returns you laid out in the last call?

[Susan Givens:]

Sure. You know, obviously we have a very, very large pipeline and as I mentioned, you know we can never predict exactly when the cap will be deployed. But given where we are in our pipeline and given the level of deal activity our expectation is that cap gets deployed very soon here. So our hope is that a lot of that can make a pretty decent dent in the cash balance through the balance of Q4 and you know right now everything is looking like it is on track to hit that.

[Douglas Harter:]

Got it. So it wouldn’t look like first quarter would most likely be the quarter where you have a full deployment and full run rate of earnings?

[Susan Givens:]

That's correct.

[Douglas Harter:]

Got it. And then Wes you had mentioned that you see some more developing options for the golf business. Is that likely to use the cash as the CDO business deploys or you guys still exploring other options for what to do with that cash?

[Wes Edens:]

Yeah our expectation is that we will deploy that capital sooner rather than later as well. The pipeline for the Senior Housing is a very clear and definable one. The golfs that we're looking at is less clear, it's a lot less cash as well obviously, but it's less clear. But there's two things in particular that I think are quite interesting and as Susan said it is hard to predict kind of the timing and eventual resolution of that. But I'm feeling pretty encouraged by it, so we'll see.

[Douglas Harter:]

Great, thanks.

[Operator:]

(Operator Instructions) Your next question comes from the line of Matthew Howlett with UBS.

[Matt Howlett:]

Thanks for taking my question. Ken and Wes, I mean can you just give us a little more clarity on the breakdown of the sort of core EPS from the New Senior versus the legacy, I mean you have a pretty good idea where the net FFO is going to be on New Senior initially, but I don’t have a clear picture on this is that the income on the debt and I know starting off some nice capital and it's appreciating. But do you also see some income being generating from golf and that give you a success and you know I think there is still positive net interest rate from CDO 8, 9, and I'll see some yield also will be purchased. And so, is there an indication I guess, I'm getting to is where that dividend you can add of legacy while you continue to write up the paper and liquidate it?

[Justine Cheng:]

So Matt, as I had mentioned 60% of our net investment income came from New Senior this quarter. Our core portfolio in terms of the legacy business and golf generated the remainder which is a little over a third or 40% of that. Our portfolio at least in the legacy side and Ken can dive into this a little more has been generating a kind of mid teens return and so I think going forward we expect that to continue with the remaining balance.

[Ken Riis:]

Yeah that's right.

[Matt Howlett:]

Okay. Then sort if you could just give us, we could back into that but I mean in terms of operating expenses at the legacy what will remain there, I mean we could get a better idea of where the dividend would be on the legacy?

[Justine Cheng:]

We can certainly follow up with you with more detail on that Matt and we can take that offline.

[Matt Howlett:]

Okay. Well, let me ask it this way. Is it, are you still, I mean with the goals to pay during that as a legacy as you turn that capital over is this something that will be ongoing?

[Justine Cheng:]

Absolutely, I think we have no plans to change our dividend policy right now.

[Matt Howlett:]

Okay, great, that's helpful and congrats on really recovering some embedded value in each of that. I'm just reaching on the New Senior where are you on the debt refinancing first of all? I think you said you potentially have some room to refinance that?

[Susan Givens:]

Yeah, we I think we talked about Matt that we have $1.3 billion of debt today and as we think about that 1.3 roughly half of that is refinancable with kind of limited or no prepayment penalties. And so, we're working on multiple kind of refinancing options as it relates to that piece of the debts back. So and we talked about the average kind of cost on the debt there is just 4% to 4.5%. Based on what we're seeing and kind of discussions we're having right now we think we can bring the cost of debt on half of the 1.3. So call it 500 to 700 as depending on what we call out we think we can bring the cost of debt down by 50 to 100 basis points.

[Matt Howlett:]

Okay so that will be all incremental tops the net FFO numbers you have in the presentation?

[Susan Givens:]

Yeah, so if you think about it, it is roughly kind of $0.05 to $0.10 of incremental and per FFO earnings.

[Matt Howlett:]

In the same that the managed portfolio continues to grow at the rate it's growing at that would be incremental?

[Susan Givens:]

That's exactly right.

[Matt Howlett:]

Okay, and then you know just a broader question for U.S., I mean this is the third spend I think New Residential has been good and you know top seen a lot of income, but it certainly held up in price. New Media has been a tremendous success. I think a lot of guys wanted to get there, if you look at New Senior just the cost of capital here what's implying on the one issue still well higher than what you've seen peers. Is it just a timing issue? Do you think that over time that it will be competitive with the cost of capital so you can grow with conjunction with your peers? I mean just sort of give me this is the third one how do you feel about it relative to the other two?

[Wes Edens:]

Well, when we look at the permanent capital space we try and identify markets that are large and are addressable. So it's been an actual transact where we think that there are good investment opportunities. The Senior Housing business is one that we've been active in for the last 15 years here in the U.S. and have been very productively active. We made a lot of money by ourselves and investors over that period of time. When we started investing on balance sheet in Newcastle’s Senior Housing business we did show what the, you know, the pieces that we could do a good buy, you know a lot of high quality properties at kind of half market prices and constructed a company that we think has great growth potential and that's all come to pass I feel like the business and where it's positioned right now is really phenomenal. I'm very happy with Susan and the team that we have on the field to take it forward. And I think when you at the size of the marketplace, when you look at the, kind of the evident dislocations between the handful of consolidated operators and owners and the, kind of the majority which is really held by mom and pops, I think that there is a tremendous amount of potential for it. When you look at the reach base in general I mean it's an obvious truism but I'll say it anyhow, it's much easier to grow a small company than it is a very large one, because you have really two tools that are in your toolbox. One the organic growth from the properties and the leases and two is the acquisition growth that you can execute on that and you know we've had a good run of it over the last couple of years, a year and a half since we've been doing this and I feel like the prospects for it are extremely bright. I think that people are rightfully focused on us investing the capital that we have, but when we look at it it's kind of the opposite issue. We think that there is considerably more amounts of opportunities when we have capital right now and so we want to be very thoughtful about how we deploy this cash to generate the best returns fast also. Yeah, we feel very, very good about it.

[Matt Howlett:]

Yeah, just on that, you know I mean, there's been off, it relaxes the marketplace you'll make a deal and you've just had these low cap rates and these peers have such you know expensive currency they can raise money and do that. I guess, would you feel confident, I mean you talked about $22 on New Senior and possibly higher than that to get you into a cap rate that would be low enough. I mean, you want to grow to $3 billion to $5 billion in New Senior, do you feel it’s just a timing, the same way it’s sort of shake that with New Media where it just took a while to get going and then you get the following when it goes regular way and you get really the real investors that understand the story and will give you the currency to continue to grow at the rate you’d like to?

[Wes Edens:]

I think so, I think people have confidence in our ability to execute in this sector, just given the track record that we've got and you know, but it’s all about tomorrow, you know people look at kind of how you’ve done and what you have done for them lately. That’s why I kind of joke about it, we’d had a good track record since we started you know this path a couple of years ago. But I do think that we've got, we have a tremendous amount of kind of clear water in front of us in this particular sector. And I think it’s not about the size of the business so much it is the productivity. I want to sit down and talk with Susan, she’s the new CEO of this business while we worked together for many years. I said let’s come with a plan where we think, you know what does it take for us to double the earnings of this company over some reasonable period of time? And those are lofty aspirations, but I think that there’s actionable set of opportunities and steps to kind of get us from here to something that’s a lot better. The wanted a good example. We've spun that company back on valentine’s day, so it’s been less than a year, it’s done terrifically we think as well as it’s done we think the prospects for it are even brighter and do not feel the same way about this, I really do so…

[Matt Howlett:]

Great, well thanks I appreciate it.

[Operator:]

Your next question comes from the line of Jason Stewart with Compass Point

[Jason Stewart:]

Hey, good morning, thanks for taking the questions. If I could start on the commercial loan portfolio for a second, it looks like a lot of the repayment activity is coming from the commercial loan portfolio. How do you feel about other parts of the portfolio starting to accelerate in terms of repayment activity or is it the expectation that that’s going to be the primary driver of cash flow near-term?

[Ken Riis:]

We sort of show that, we sort of into the timing of our expectation as the remaining capital in the debt portfolio will be realized over next one to two years. It’s hard to really project when prepayments are coming in. But, I think we’ve done a pretty good job of doing that here internally and I think that we think will be able to realize this capital over next one to two year, probably closer to the one year. But that range is really some assumptions that prepayment in and the later ranges feeling more to maturity of the assets.

[Jason Stewart:]

Okay, and then Ken can you remind me what you know for 8 and 9 when we get to the auction call day which I think is November next year for 8 what happens if the fair value of the collaterals and excessive the debt?

[Ken Riis:]

Yeah. So the auction call date is sort of a very structured process where you have to be able to sell all of the assets at current value to pay off all of the debt of the CDO. So if you can do that then the trustee will initiate the auction call. We obviously are we know about that and our goal is to optimized the recovery of the assets in the CDO’s to us if we own a large portion of the capital structure. So we are also looking at that as we move along here.

[Jason Stewart:]

That is in all or none it doesn’t it’s not…

[Ken Riis:]

Yes all or none.

[Jason Stewart:]

Okay and then on the golf portfolio could you just give us an idea of how you guys are thinking about any kind of CapEx requirements there?

[Justine Cheng:]

Generally industry average is 2% of revenues.

[Jason Stewart:]

Perfect.

[Justine Cheng:]

And that’s kind of what we are running at.

[Jason Stewart:]

Okay, thanks.

[Operator:]

At this time I would like to turn over the conference back over to Wes Edens for closing remarks.

[Wes Edens:]

Great, well thanks everybody for joining and exciting times for Newcastle and New Senior. We look forward to seeing you next quarter. Thank you.

[Operator:]

Thank you. This concludes today’s conference. You may now disconnect.