Health care properties riding wave of real estate mergers.

MERGER-and-acquisition activity among real estate investment trusts has reached an estimated $47 billion record so far this year around the globe, with often undervalued REITS selling out to competitors that can better appreciate their value.

That's particularly the case in the health care sector, with Health Care Property Investors Inc.'s recently completed acquisition of CNL Retirement Properties Inc. among several such deals announced so far this year.

The $5.3 billion stock, cash and assumed debt deal, which closed earlier this month, increased the Long Beach-based company's portfolio by 50 percent to 807 properties in 44 states. In the process, it became the nation's largest health care REIT, with $9.2 billion in assets compared to $3.1 billion for its next largest public competitor.

Orlando-based CNL not only expanded Health Care Property--which specializes in independent and assisted living communities, medical office buildings and other facilities--but also diversified its portfolio. More than 80 percent of CNL's properties are profitable private-payer assisted-living facilities, with much of the remaining portfolio comprised of medical office buildings on or near universities. Many of the properties are high-end and relatively new.

The deal is seen as part of a strategy to increase Health Care Property's appeal to a wider array of investors by positioning it as a large-scale asset manager with less exposure to economic cycles than an office or retail REIT. That strategy is based on expectations that Depression-era seniors and aging baby boomers will continue to increase the demand for its properties. In addition to the CNL acquisition, Health Care Property made $187 million in other acquisitions in the second quarter, including 11 senior housing facilities. So far Wall Street is buying the strategy. Both equity and debt analysts are cautiously optimistic about Health Care Property's long-term upside while' in the short term the stock has been surging, even though its CNL transaction leaves the company highly leveraged.

Shares of Health Care Property have steadily risen from under $26 a share when the deal was announced in early May to a 52-week high of $32.99 on Oct. 10, before settling at $32.29 the following day. Indeed, optimism about the deal has helped the company shake off less-than-spectacular earnings news.

Transaction benefits

In August, the company reported that its second-quarter revenue rose 21 percent to $140 million, but its $36.3 million net income was down 4 percent from the same period a year ago. (Third quarter earnings are due Oct. 30.)

Wachovia Capital Market senior analyst Stephen Swett raised his rating on the company's shares in September to "market perform" from "underperform." He cited improved financing costs and property values in recent months that have made the CNL deal less risky, with Health Care Property also benefiting from its greater heft.

"We expect investors to focus more on the benefits of the transaction in terms of size, diversification and potential upside to estimates," Swett wrote in a note to investors. (Shares have been trading above Wachovia's $30 to $32 valuation range.)

In connection with the transaction, Health Care Property obtained new bridge, term and revolving credit facilities providing for aggregate borrowings of up to $3.4 billion with a syndicate of banks.

In September it sold $1 billion in bonds. Bond rating companies are taking a wait-and-see view of Health Care Property's plans to decrease its debt load. Moody's Investor Service is still evaluating whether to decrease its "Baa2" debt rating, but Fitch Rating downgraded most of its ratings to "BBB" from "BBB+" the day after the deal closed.

"Fitch is very concerned by the significant increase in leverage and related erosion of debt service coverage rations resulting from the acquisition," said Fitch analysts Janice Svec and Mark Nolan an Oct. 6 report. "While management is continuing to negotiate asset dispositions and sales to joint ventures, (it) has yet to announce any completed agreements."

Health Care Property Investors Inc. (Nasdaq:HCP)

YEAR (Dec. 31)                    2005       2004

Revenue (millions)              $477.3     $419.6
Total Expenses (millions)        305.2      253.2
Operating Income (millions)      172.1      166.4
Net Income (millions)            151.9      147.9
Earnings Per Share               $1.12      $1.11

SUMMARY

Business: Real estate investment trust
Headquarters: Long Beach
CEO: James F. Flaherty
Market Cap: $4.5 billion
Dividend Yield: 5.21%
Total Liabilities: $2.5 billion
P/E Ratio: 29.73
Long-Term Debt: $1.9 billion