Announces Intent to Vote AGAINST the Proposed Merger, Given This
Value-Destructive Transaction Would Benefit OPI and the REITs’
Conflicted External Manager, RMR Group, at the Direct Expense of
DHC’s Shareholders and Other Stakeholders
Highlights Many Superior Alternatives Exist,
Including Targeted Asset Sales to Pay Down Near-Term Debt and
Provide a Runway for Long-Term Value Creation
Sees DHC’s Highly Valuable Senior Housing
Property Assets as a Catalyst for Growth and Believes the Company
Should be Trading Between $9 and $10 Per Share, Based on Peer and
Transaction Multiples for Its Constituent Divisions and Assets
Flat Footed LLC (together with its affiliates, “FFL”) owns
approximately 7.4% of the outstanding common shares of Diversified
Healthcare Trust (Nasdaq: DHC) (“DHC” or the “Company”), making it
one of the Company’s largest shareholders. Today, FFL issued the
below letter sent to the Company’s Board of Trustees regarding
DHC’s recently announced definitive merger agreement with Office
Properties Income Trust (Nasdaq: OPI). In the letter, FFL outlines
why it opposes and intends to vote its DHC shares AGAINST the proposed merger with OPI to
protect the long-term value and interests of all Company
stakeholders.
***
May 23, 2023
Board of Trustees Diversified Healthcare Trust c/o Jennifer B.
Clark, Secretary Two Newton Place 255 Washington Street, Suite 300
Newton, MA 02458-1634
Re: Flat Footed LLC’s Opposition to DHC’s Proposed Merger with
OPI
Dear Board of Trustees:
Flat Footed LLC (collectively with its affiliates, “FFL” or
“we”) is an investment management firm led by individuals with
decades of experience investing in companies with complex capital
structures across the private and public markets, including the
real estate investment trust and senior housing industries. We are
also a significant stakeholder in Diversified Healthcare Trust
(“DHC” or the “Company”), with an approximately 7.4% equity stake,
and a material creditor, owning approximately $157 million of the
Company’s senior unsecured notes across various maturities.
FFL opposes and intends to vote AGAINST the Company’s proposed merger with Office
Properties Income Trust (“OPI”). We believe the Board of
Trustees (the “Board”) has failed DHC’s stakeholders by pursuing
the proposed merger, which would unnecessarily burden the Company
with OPI’s rapidly declining commercial office properties. We also
believe the deal disproportionally benefits OPI and the conflicted
external manager for both DHC and OPI, The RMR Group LLC (“RMR”),
at the expense of DHC stakeholders.
Before investing in DHC, FFL conducted a rigorous analysis of
the Company, including its balance sheet, capital structure,
management agreements, portfolio, and market opportunities. We
believe DHC has highly valuable assets with long-term growth
potential. This is particularly true of DHC’s Senior Housing
Operating Portfolio (“SHOP”) and its ability to capitalize on a
rapidly rebounding senior housing market.
We believe our investments across DHC’s capital structure
demonstrate strong alignment with fellow stakeholders and confirm
our conviction in the Company’s long-term potential, which is why
we strongly oppose – and intend to vote AGAINST – DHC’s proposed merger with OPI, for
the following reasons:
- The proposed merger dramatically undervalues DHC.
- Saddling DHC with OPI’s failing office portfolio and rapidly
deteriorating balance sheet makes no sense.
- The proposed merger only benefits OPI and RMR – at DHC’s
direct expense.
- There are vastly superior alternatives to the
merger.
Given our sizable investment in DHC, we believe our views merit
substantial weight. It appears the Board has failed shareholders by
prioritizing the external manager’s interests above all else. There
are many superior alternatives available to address DHC’s upcoming
debt maturities, such as curtailing RMR’s fee-driven spending to
preserve cash or a targeted sale of a small percentage of its
assets, that we urge the Company to consider.
Based on unsolicited feedback received from other stakeholders
and the market’s reaction to the proposed merger (DHC’s common
shares have traded down more than 19% since the proposed merger was
announced), we can state with confidence that our views are
widely held.1
The proposed merger dramatically
undervalues DHC
Under the terms of the proposed merger, DHC shareholders are set
to receive consideration worth only $0.97, which is 43%
below the headline $1.70 offer and 22%
below the trading price the day before
the announcement – clearly not a takeover premium, but a remarkable
take-under.2 We value DHC’s portfolio of high-quality assets at
approximately $5 billion and believe the Company’s stock should be
trading between approximately $9 and $10 per share.3 Therefore, the
proposed merger’s contemplated $0.97 per share takeover price
represents a 90% discount to DHC’s intrinsic value. Notably,
just one year ago, the Board deemed a $4.00 per share cash offer
for DHC to be inadequate.4 Yet, now, the Board is recommending a
transaction in which DHC shareholders are forced to accept $0.97
per share of OPI stock – which continues to decline.
If the proposed merger is approved, DHC shareholders will
receive 0.147 OPI shares per DHC share, which the Company touts,
incredibly, as a 20% premium. Not so. RMR utilized a grossly
overvalued OPI share price when orchestrating the proposed merger’s
terms, as evidenced by the following:
- OPI’s delayed announcement of its dividend cut from $2.20 to
$1.00 per share until after the proposed merger terms were
set.
- OPI’s rapidly deteriorating operating metrics – reported during
OPI’s first quarter earnings call after the proposed merger
announcement.
- OPI’s share price collapsing 43% as a result.5
In contrast, DHC’s value continues to improve. The Company
confirmed during its recent first quarter earnings call that DHC’s
financial condition continues to rebound, largely driven by the
recovery in senior housing – furthering the disparity between OPI’s
declining operating performance and DHC’s increasing earnings
power.
In fact, senior housing properties, such as DHC’s, are widely
expected to continue their post-pandemic rebound, driven by a
once-in-a-lifetime favorable supply and demand dynamic. Aging baby
boomers will fuel senior housing demand, as the growth rate of 80+
year old Americans inflects to a 4.2% CAGR for the next 13 years
vs. the 1.9% CAGR seen over the last 12 years – in short, the
addressable market is set to grow at 2.2x its historical rate.6 At
the same time, new supply is constrained by high construction costs
(up 50% since 2017), materially higher interest rates, and a
lending market largely closed to new development. Accordingly, DHC
expects its valuable SHOP assets to operate at an EBITDA run rate
of $210 million by mid-2024, up from a 2022 run rate of $9 million,
but still only flat with 2019 levels, suggesting significant
incremental upside.7 Indeed, DHC’s external manager, RMR, clearly
shares our optimism for the DHC SHOP portfolio – as evidenced
by:
- Adam Portnoy’s recent $44 million acquisition of AlerisLife,
the manager of 119 DHC SHOP properties, which represents 86% of all
properties managed by AlerisLife.8
- OPI’s plans to raise over $1 billion in new, post-merger
Government Sponsored Enterprise debt, which could only be utilized
by using profitable DHC SHOP assets as collateral.9
Besides undervaluing DHC, there are also no strategic,
cost-saving merits or synergies to the proposed merger. Estimated
fees resulting from the transaction are $75 million, on a combined
market capitalization of $552 million – 14% of the combined company
market capitalization – which is an incredibly high fee burden for
a merger of this size. In 2022, expenses (excluding D&A) were
$1.138 billion for DHC and $242 million for OPI. Estimated
synergies from the merger are a mere $3 million, or 0.22% of the
combined company expenses, which are some of the lowest we have
seen in a contemplated merger in our entire careers and further
cement the complete lack of financial rationale for the
transaction.
Under current leadership, DHC investors have lost 92% in total
shareholder value over the last five years. The proposed merger
consideration is actually less than the current trading price of
DHC. It makes no sense for DHC shareholders to accept such
inadequate merger consideration when the earnings power of the
Company’s assets – in RMR’s own words – is set to improve
dramatically.
Saddling DHC with OPI’s failing office
portfolio and rapidly deteriorating balance sheet makes no
sense
Equally troubling is the proposed merger’s attempt to saddle
Company stakeholders with OPI’s rapidly declining commercial office
portfolio and problematic balance sheet. DHC shareholders are being
asked to believe that DHC, a company with $5 billion in valuable,
unencumbered healthcare assets, needs to merge with OPI – whose
operations appear to be in a death spiral and whose balance sheet
is set to explode – to solve for DHC’s $250 million refinancing.
This is pure nonsense.
In stark contrast to the senior housing market, the prospects
for commercial office properties are bleak and will continue to
darken as the market shifts towards work-from-home employment.
Relative to other office REITs, OPI is even more negatively
exposed, given its focus on single-tenant buildings, which leads to
an inability to counter tenant downsizing and to tremendous tenant
leverage in negotiating lease terms, tenant improvements and
owner-funded capital expenditures. In its first quarter 2023
earnings release and call, OPI management acknowledged two
troubling items. First, OPI failed to renew at least half of its
leases due for renewal during the year to date and expects this
trend to continue beyond 2023. Second, the rates for the mere 50%
of leases that actually did renew declined by 19.7%.10
As companies continue to downsize their office space en masse,
OPI renewal rates are expected to worsen while it faces lease
expirations equaling at least 33% of OPI’s annual rental income
($178 million) in the next three years.11 At the same time, OPI has
bonds at coupon rates of 2% to 4% maturing in 2024-2027, with $1
billion of these bonds coming due in the next 19 months.12 This
debt will need to be refinanced, and current trading levels
indicate that this would have to be done at double digit interest
rates, if the debt can be refinanced at all.
It therefore came as no surprise that OPI was forced to cut its
annual dividend from $2.20 to $1.00. However, with the twin looming
problems of OPI’s tenant vacancies increasing at an alarming rate
and the interest rate OPI will have to pay on its debt set to rise
significantly, even the reduced $1.00 dividend appears
unsustainable, meaning that OPI’s stock price will likely fall
further as the dividend decreases, or ceases altogether.
The proposed merger only benefits OPI
and RMR – at DHC’s direct expense
The sole beneficiaries of this misguided merger are OPI and the
external manager, RMR. OPI gains access to DHC’s valuable,
unencumbered assets from which it will seek to raise $1 billion of
new debt, offset its declining cash flows, and stave off an
otherwise likely bankruptcy filing.13 If this is allowed to occur,
RMR will continue to collect massive fees as the external manager
for the post-merger entity, without incurring any capital risk and
regardless of the economic performance of the combined company.
RMR’s compensation is primarily driven by the enterprise value
of OPI and DHC, as opposed to the equity performance of either
company, in addition to fees derived from rent collected and
construction costs incurred. In 2022, RMR collected approximately
$42 million from OPI and approximately $28 million from DHC in
combined business, property, and construction management fees.
These fees are pure profit, as RMR is separately reimbursed for
pass-through expenses of the REITs ($37 million in total expenses
reimbursed to RMR from both companies in 2022). In fact, over
the past four years alone, RMR has collected over $300 million in
management fees from OPI and DHC combined – despite the woeful
performance of both companies.
Since a substantial part of these fees are calculated on
enterprise value and construction costs – not profitability or
equity value – RMR is perversely incentivized to maximize debt
and spending: the primary reasons why DHC faces near-term
challenges today. RMR’s own investor presentation highlights
the importance of debt and construction fees collected from
managing capital programs at its various REIT clients.14
There are vastly superior alternatives
to the merger
Management claims that the merger is necessary to address the
Company’s near-term debt obligations15 and has touted OPI as a
financial savior. Nothing could be further from the truth. As
outlined, despite short-term challenges, DHC is well-positioned for
growth in the coming years, while OPI is a distressed REIT composed
of rapidly declining single-tenant commercial office
properties.
It is worth noting that DHC’s recent “going concern” assertions
are suspect and appear to be an improper attempt to goad
shareholders into approving the value-destructive merger. On May 8,
2023, the Company suddenly announced for the first time that “there
is substantial doubt about [DHC’s] ability to continue as a going
concern” due to its “reduced cash balances” and $700 million in
2024 debt maturities.16 If the Company’s ability to function as a
“going concern” was truly an issue, it should have been disclosed
in its Form 10-K filed on March 1, 2023. Tellingly, no such
disclosure was made until after the proposed merger was announced
and after the Company became “aware that several law firms have
indicated that they are investigating the [proposed] Merger and
related matters…” 17 This hardly seems to be a coincidence and
suggests a troubling lack of candor between the Board and the
Company’s shareholders, calling into question the Board’s true
motivations.
Additionally, RMR’s own investor presentations similarly
undermine DHC’s recent going concern statement. As recently as
March 2023, only a few weeks before the proposed merger
announcement, RMR assured its investors about the stability of
RMR’s management fees, claiming “limited fee downside to RMR” at
“current REIT share price levels.”18 In doing so, RMR highlighted
that a substantial part of its compensation derives from DHC’s
debt.19 If DHC’s ability to satisfy its debt were truly a concern,
the dependability of RMR’s management fees would be as well – in
this case, the two opposing outcomes are mutually exclusive. Any
warning to this effect is glaringly absent from RMR’s investor
presentation, an inconsistency which undermines the reliability of
DHC’s going concern statement – implying that the going concern
crisis and alleged need to merge with OPI has been fabricated by
RMR to further its own interests.
Any purported going concern issues faced by the Company can be
readily addressed. Simply curtailing RMR’s self-interested,
fee-driven spending would go a long way toward preserving the
Company’s cash and addressing its near-term liquidity challenges.
The current pace of DHC’s capital spending is wholly inconsistent
with a company facing going concern problems and one that needs to
preserve cash and liquidity.
And because DHC’s $450 million revolving credit facility lenders
are, per its financial statements, supported by over $1.0 billion
in collateral, an extension of the revolver past January 2024
should be readily achievable – just as it has been on several
previous occasions. Thus, in our view, the Company needs an
additional $250 million – not $700 million – in liquidity to get
past its 2024 maturities.
That liquidity should be readily obtainable from a variety of
sources or transactions. Given DHC’s expected performance and based
on DHC’s/RMR’s own internal projections that SHOP will reach EBITDA
of $210 million by mid-2024, we believe the Company will be able to
comply with its 1.5x Fixed Charge Coverage requirement restricting
debt issuance by late 2023/early 2024, allowing it to refinance its
4.75% senior notes maturing in May 2024. If this does not prove
possible, the Board has numerous other options – and would need to
monetize just a fraction of DHC’s numerous and valuable
unencumbered assets to pay off a portion, or all, of its maturing
debt. These assets/options include:
- 10 Wellness Centers, six of which are Life Time Fitness
facilities with annual Net Operating Income (“NOI”) of $12 million.
We estimate a value of approximately $160 million for the six Life
Time facilities alone. The other four centers are leased to
regional operators and have an estimated NOI of $5.8 million. Based
on discussions with other public REITs, we believe a deep and ready
market exists for these assets at a 7.5% cap rate.
- 27 Triple Net Lease senior housing facilities with NOI of $23
million annually (estimated value of approximately $267
million).
- The Company’s remaining equity stakes in two joint ventures,
Seaport Innovation LLC and The LSMD Fund REIT LLC, which the
Company carries on its balance sheet at a $153.4 million value as
of March 31, 2023.
***
In sum, DHC is uniquely positioned to capitalize on the rapidly
growing senior housing market, which has yet to be reflected in its
share price. And there is no basis to dampen DHC’s prospects by
burdening it with OPI’s dying commercial office portfolio and
looming debt refinancings. By simply selling a small portion of its
assets, DHC should be well-positioned to pay down its near-term
notes, extend its revolving credit facility, and maximize value for
all DHC stakeholders. FFL, accordingly, intends to vote
its DHC shares AGAINST the proposed
merger with OPI to protect the long-term value and interests of the
Company’s stakeholders.
Sincerely,
Marc Andersen Flat Footed LLC
Appendix
Business Unit Value 2024 EBITDA
Multiple Notes SHOP Portfolio
2,940.0
210.0
14.0x
EBITDA based on 2024 company guidance; Multiple based on current
2024 Brookdale multiple(*)
Annualize1Q23 NOI Est.
CapRate Life Science Buildings
505.0
40.4
8.0%
Gross BV was $703 million at Dec 31, 2022 Medical Office Buildings
1,050.0
84.0
8.0%
Gross BV is $1.33 billion at Dec 31, 2022 Triple Net Senior Housing
267.1
22.7
8.5%
Gross BV was $195 million at Dec 31, 2022 Wellness (Life
Time/Others)
175.9
15.0
8.5%
Gross BV was $180 million at Dec 31, 2022 JV- Seaport
104.8
DHC carrying value at Mar 31, 2023 JV- LSMD Fund REIT
48.7
DHC carrying value at Mar 31, 2023
Total Asset Value
5,091.5
TOTAL Debt
(2,830.0)
Total debt at Mar 31, 2023 Cash
150.0
Estimated excess cash at Mar 31, 2023
Net Debt
(2,680.0)
RMR Mgmt Fees
(222.0)
Capitalized value RMR management fees
Equity Value
2,189.5
Shares Outstanding
239.7
Share balance at May 3, 2023
Value per share
$ 9.13
(*) Company guided to $210mm on its April 11, 2023 conference call.
At $2.9 B, the portfolio is valued at $117K/unit, which is a 38%+
discount to recent industry sales.
At the current equity price
($1.00), the SHOP Portfolio is being valued at $41K/unit.
About Flat Footed
Flat Footed LLC is a special situation, value-oriented
investment management firm focused on leveraged, asset-heavy
companies with complex capital structures. The Flat Footed LLC team
has cumulatively managed $2.8 billion since founding their first
fund together in 1999. For more information, visit
www.flatfootedllc.com.
1 Source: Bloomberg. DHC’s stock closed at $1.24 per share on
April 10, 2023, the day before the proposed merger was announced,
then opened at $1.29 per share and closed at $1.20 per share on
April 11, 2023. It closed at $1.00 per share on May 19, 2023. 2
Using OPI’s May 19, 2023 closing price of $6.59 and the 0.147
exchange ratio. 3 Based on our valuation analysis, which is
detailed in the Appendix on page 9, after accounting for some
degree of capitalized cost of RMR’s fees and the Company’s debt. 4
Preliminary Form S-4 for the proposed merger filed by OPI on May
19, 2023 5 Source: Bloomberg. OPI’s share price closed at $11.55 on
April 10 (the day before the proposed merger announcement) to its
current trading price of $6.59 (as of close on May 19). 6 Olivia
Lueckermeyer, “Senior Housing Industry Mounts A Comeback As Baby
Boomers Age In And New Construction Stalls Out,” Bisnow (April 28,
2023),
https://www.bisnow.com/dallas-ft-worth/news/senior-housing/senior-housing-industry-mounts-a-comeback-as-baby-boomers-age-and-new-construction-stalls-118736.
7 See Office Properties Income Trust to Merge with Diversified
Healthcare Trust (April 11, 2023) (“April 11 Slides”) at page 10. 8
Adam Portnoy is the President and CEO of RMR, and is the chair of
the board of directors, a managing director, and president and CEO
of its parent, RMR, Inc. 9 See Office Properties Income Trust &
Diversified Healthcare Trust Merger Joint Conference Call Script
(April 11, 2023) (“April 11 Script”) at page 6. 10 See April 11
Script at page 7; Form 10-Q for the Quarterly Period Ending March
31, 2023, Office Properties Income Trust at page 17. 11 Mark
Maurer, “Companies Plan Additional Cuts to Office Space Amid
Looming Downturn,” The Wall Street Journal (July 7, 2022),
https://www.wsj.com/articles/companies-plan-additional-cuts-to-office-space-amid-looming-downturn-11657186201;
Form 10-Q for the Quarterly Period Ending March 31, 2023, Office
Properties Income Trust at page 18. 12 See id. at page 27. 13 See
April 11 Slides at page 4. 14 See The RMR Group Inc. Investor
Presentation (March 2023) at page 21. 15 During the Company’s May
9, 2023, investor call, it identified three “short-term challenges”
concerning the Company’s ability to: (i) refinance or extend ~$700
million of near-term debt coming due in 2024, (ii) increase
liquidity and (iii) increase dividends. See First Quarter 2023
Results – Investor Conference Call Script (May 9, 2023) at page 1.
16 Form 10-Q for the quarterly period ended March 31, 2023,
Diversified Healthcare Trust at pages 6-7. 17 See id. at page 45.
18 See The RMR Group Inc. Investor Presentation (March 2023) at
page 19. 19 Id.
View source
version on businesswire.com: https://www.businesswire.com/news/home/20230523005570/en/
For Investors:
Flat Footed LLC ir@flatfootedllc.com
Okapi Partners LLC Mark Harnett (212) 297-0720
mharnett@okapipartners.com
For Media:
Longacre Square Partners Greg Marose / Charlotte Kiaie,
646-386-0091 FFL@longacresquare.com
Diversified Healthcare (NASDAQ:DHC)
Historical Stock Chart
From Mar 2024 to Apr 2024
Diversified Healthcare (NASDAQ:DHC)
Historical Stock Chart
From Apr 2023 to Apr 2024