Healthcare Realty Trust has a stake in Activist Starboard, and two paths to create value are emerging.

Company: Healthcare Realty Trust (HR)

A self-managed and self-administered real estate investment trust, business owns and operates medical outpatient buildings primarily located around hospital campuses. The company selectively grows its portfolio through property acquisition and development, with nearly 700 properties totaling over 40 million square feet, concentrated in 15 growth markets. Its properties are in high-growth markets with a broad tenant mix that includes over 30 physician specialties.

Stock Market Value: $6.38B ($17.99 per share)

Activist: Starboard Value

Ownership: 5.90%

Average Cost: $17.14

Starboard is a highly successful activist investor with a wealth of experience in helping companies improve their operational efficiency and increase their margins. Over the course of its history, Starboard has launched a total of 155 activist campaigns and has achieved an average return of 23.37%, compared to 14.29% for the industry as a whole over the same period.

What's happening

Healthcare Realty Trust was the subject of a 13D filing by Starboard on Nov. 26, which revealed a 5.90% stake held by the latter.

Behind the scenes

Healthcare Realty Trust (HR) is a real estate investment trust that owns and operates medical outpatient buildings primarily on or around hospital campuses. On Feb. 28, 2022, the company entered into an agreement to merge with Healthcare Trust of America (HTA) in an approximately $18 billion deal. Although HR shareholders approved the merger with 92% of the votes cast, the deal was somewhat dilutive to HR shareholders as it implied a sub-5% cap rate, which was below the HR's trading rate at the time.

Although management had the chance to demonstrate the wisdom of the acquisition by integrating the two businesses, recognizing synergies, and reducing costs, resulting in a blended cap rate below 4.85%, this did not occur. Two years later, property operating expenses have increased from 31% to 37%, significantly higher than peers. Additionally, the FFO yield is 9%, much higher than the 5% to 6% range of its peers. The cap rate is now at 7%, and the stock is down over 15%, in contrast to an increase of 33% for the Russell 2000. Recently, the company's long-time CEO, Todd Meredith, who served as president and CEO for eight years and spent a total of 23 years with Healthcare Realty, stepped down.

Healthcare Realty is currently at a critical juncture, with two paths to unlocking value. The first is to remain a standalone company, which would require the hiring of a new CEO. However, after a questionable acquisition and underperforming management team, stockholders may question the competence of the current board. Therefore, going down this path would require a refreshment of the board. Starboard Value may want to assist in this decision by taking at least one seat on the board. Additionally, Healthcare Realty needs an operational turnaround to address its bloated cost structure and align with peers. This would be a challenging and uncertain path, but achievable with the right board and management team.

The sale of Healthcare Realty is the second, shorter, and more certain path for the company. The arrival of an activist and the departure of a CEO are the two things that put a company in pseudo-play. Several potential strategic acquirers are interested in this company, including larger companies with lower cost of capital and cap rates, such as Welltower, Healthcare Trust of America, and Healthcare Realty. This is not just an academic hypothesis; interest from strategic buyers has already been demonstrated. About a month after Healthcare Realty and Healthcare Trust of America agreed to merge, Welltower offered to acquire Healthcare Realty for $31.75 a share in a nearly $5 billion all-cash bid. It is interesting to note that when the Healthcare Trust of America merger was approved, activist fund Land and Buildings unsuccessfully opposed the transaction in favor of the Welltower offer.

Healthcare Realty is at a crossroads, and the board needs to decide whether to conduct a full search for a new long-term CEO or explore a sale. Starboard, a top operational and corporate governance activist, would be a valuable addition to the board in either case. While Starboard is not a "sell the company" activist, it is a fiduciary and an economic animal that will do what is in the best interest of shareholders. If there is an opportunity to sell the company, Starboard would weigh that against a plan to find a new CEO. The firm has a proven track record of success, having achieved a 47.27% return in a similar dual-path situation at Forest City Realty Trust in 2018.

Although we believe management should welcome Starboard at this critical moment, we have been taken aback by management teams in the past. Starboard has not yet formally appointed directors, and the company has until December 10 to do so. It is not a lot of time to come to an agreement, and we could see Starboard nominating a board if only to maintain their options moving forward.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. The fund owns Healthcare Realty Trust.