On 31st October HCP successfully accomplished a spin off and investors were granted 1 share of QCP for 5 shares of HCP. As I was writing in my last note “(…) this deal seems reasonable, nevertheless I think that dividend cut can be adversely taken by investors.”. The last part really happened and share price dropped a lot (even adding $3.5, which is more or less equal of span off value (1 share of QCP costs around $17, so dividing by 5 gives us around $3.5. This means that current $28 is more or less the same as $31.5 before deal.

Well it seems like a good time to have a look on HCP and its’ future prospects. When looking at businesses keep in mind that only some part was span off, most remains the same (it’s 1/3 of locations, but impact on financial results is far lower).

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The deal is one step of reducing huge debt. The other is RIDEA II transaction and selling 64 communities triple-net leased to Brookdale Senior Living for around S1.1b. Altogether debt should be reduced by around $3.3b. In long term net debt/EBITDA should be kept around 6 times.

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And here comes the key issue. With selling so many assets company will reduce FFO, so dividend will be lower. Dividend should be $1.48, which gives dividend yield of 5.3%, well not bad comparing to other Aristocrats, but I would expect more (historically dividend yield was higher).

Generally I don’t feel one thing. Company was paying 4 * 0.575$ = $2.3 per share. Now company is to pay $1.48, although only $3.5 was subtracted from share value due to spin off. So generally speaking deleveraging was very harmful for dividend yield…

 

What are the lessons from HCP story?

Well for me the main lesson is not to invest in heavily leveraged companies. OK, there are businesses where you must use debt, nevertheless it is unnecessary risk for your dividend income. There are other opportunities.

 

Summing up, whole idea of reducing leverage didn’t make HCP a bad company. It is only perception which is changing. I am reducing my investable level from $28 by $3.5 which is the value of QCP. At $25 dividend yield is around 6% and that is a satisfying level for me.

 

Disclaimer: HCP – to position