Highlights Many Superior Alternatives Exist, Including Targeted Asset Sales to Pay Down Near-Term Debt and Provide a Runway for Long-Term Value Creation<\/i><\/p>\n
Sees DHC\u2019s 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<\/i><\/p>\n
WILSON, Wyo.–(BUSINESS WIRE<\/a>)– \n***<\/p>\n \nMay 23, 2023<\/p>\n \nBoard of Trustees \nRe: Flat Footed LLC\u2019s Opposition to DHC\u2019s Proposed Merger with OPI<\/p>\n \nDear Board of Trustees:<\/p>\n \nFlat Footed LLC (collectively with its affiliates, \u201cFFL\u201d or \u201cwe\u201d) 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 (\u201cDHC\u201d or the \u201cCompany\u201d), with an approximately 7.4% equity stake, and a material creditor, owning approximately $157 million of the Company\u2019s senior unsecured notes across various maturities.<\/p>\n FFL opposes and intends to vote AGAINST<\/span> the Company\u2019s proposed merger with Office Properties Income Trust (\u201cOPI\u201d).<\/b> We believe the Board of Trustees (the \u201cBoard\u201d) has failed DHC\u2019s stakeholders by pursuing the proposed merger, which would unnecessarily burden the Company with OPI\u2019s 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 (\u201cRMR\u201d), at the expense of DHC stakeholders.<\/p>\n \nBefore 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\u2019s Senior Housing Operating Portfolio (\u201cSHOP\u201d) and its ability to capitalize on a rapidly rebounding senior housing market.<\/p>\n \nWe believe our investments across DHC\u2019s capital structure demonstrate strong alignment with fellow stakeholders and confirm our conviction in the Company\u2019s long-term potential, which is why we strongly oppose \u2013 and intend to vote AGAINST<\/span><\/b> \u2013 DHC\u2019s proposed merger with OPI, for the following reasons:<\/p>\n <\/b><\/li>\n <\/b><\/li>\n <\/b><\/li>\n \nGiven our sizable investment in DHC, we believe our views merit substantial weight. It appears the Board has failed shareholders by prioritizing the external manager\u2019s interests above all else. There are many superior alternatives available to address DHC\u2019s upcoming debt maturities, such as curtailing RMR\u2019s fee-driven spending to preserve cash or a targeted sale of a small percentage of its assets, that we urge the Company to consider.<\/p>\n \nBased on unsolicited feedback received from other stakeholders and the market\u2019s reaction to the proposed merger (DHC\u2019s common shares have traded down more than 19% since the proposed merger was announced<\/b>), we can state with confidence that our views are widely held.1<\/sup><\/p>\n The proposed merger dramatically undervalues DHC<\/span><\/b><\/p>\n \nUnder the terms of the proposed merger, DHC shareholders are set to receive consideration worth only $0.97, which is 43% below<\/span> the headline $1.70 offer and 22% below<\/span> the trading price the day before the announcement \u2013 clearly not a takeover premium, but a remarkable take-under.2<\/sup> We value DHC\u2019s portfolio of high-quality assets at approximately $5 billion and believe the Company\u2019s stock should be trading between approximately $9 and $10 per share.3<\/sup> Therefore, the proposed merger\u2019s contemplated $0.97 per share takeover price represents a 90% discount to DHC\u2019s intrinsic value. Notably, just one year ago, the Board deemed a $4.00 per share cash offer for DHC to be inadequate.<\/i>4<\/sup><\/i> Yet, now, the Board is recommending a transaction in which DHC shareholders are forced to accept $0.97 per share of OPI stock \u2013 which continues to decline<\/i><\/b>.<\/p>\n \nIf 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\u2019s terms, as evidenced by the following<\/i><\/b>:<\/p>\n \nIn contrast, DHC\u2019s value continues to improve. The Company confirmed during its recent first quarter earnings call that DHC\u2019s financial condition continues to rebound, largely driven by the recovery in senior housing \u2013 furthering the disparity between OPI\u2019s declining operating performance and DHC\u2019s increasing earnings power.<\/p>\n \nIn fact, senior housing properties, such as DHC\u2019s, 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 \u2013 in short, the addressable market is set to grow at 2.2x its historical rate.6<\/sup> 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<\/sup> Indeed, DHC\u2019s external manager, RMR, clearly shares our optimism for the DHC SHOP portfolio \u2013 as evidenced by:<\/p>\n <\/sup><\/li>\n \nBesides 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 \u2013 14% of the combined company market capitalization \u2013 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.<\/p>\n \nUnder 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\u2019s assets \u2013 in RMR\u2019s own words \u2013 is set to improve dramatically.<\/p>\n Saddling DHC with OPI\u2019s failing office portfolio and rapidly deteriorating balance sheet makes no sense<\/span><\/b><\/p>\n \nEqually troubling is the proposed merger\u2019s attempt to saddle Company stakeholders with OPI\u2019s 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 \u2013 whose operations appear to be in a death spiral and whose balance sheet is set to explode \u2013 to solve for DHC\u2019s $250 million refinancing. This is pure nonsense.<\/p>\n \nIn 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<\/sup><\/p>\n \nAs companies continue to downsize their office space en masse<\/i>, OPI renewal rates are expected to worsen while it faces lease expirations equaling at least 33% of OPI\u2019s annual rental income ($178 million) in the next three years.11<\/sup> 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<\/sup> 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.<\/p>\n \nIt 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\u2019s 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\u2019s stock price will likely fall further as the dividend decreases, or ceases altogether.<\/p>\n The proposed merger only benefits OPI and RMR \u2013 at DHC\u2019s direct expense<\/span><\/b><\/p>\n \nThe sole beneficiaries of this misguided merger are OPI and the external manager, RMR. OPI gains access to DHC\u2019s 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<\/sup> If this is allowed to occur, RMR will continue to collect massive fees<\/i> as the external manager for the post-merger entity, without incurring any capital risk and regardless of the economic performance of the combined company.<\/p>\n \nRMR\u2019s 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<\/b> \u2013 despite the woeful performance of both companies.<\/p>\n \nSince a substantial part of these fees are calculated on enterprise value and construction costs \u2013 not profitability or equity value \u2013 RMR is perversely incentivized to maximize debt and spending: the primary reasons why DHC faces near-term challenges today. <\/b>RMR\u2019s own investor presentation highlights the importance of debt and construction fees collected from managing capital programs at its various REIT clients.14<\/sup><\/p>\n There are vastly superior alternatives to the merger<\/span><\/b><\/p>\n \nManagement claims that the merger is necessary to address the Company\u2019s near-term debt obligations15<\/sup> 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.<\/p>\n \nIt is worth noting that DHC\u2019s recent \u201cgoing concern\u201d 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<\/i> that \u201cthere is substantial doubt about [DHC\u2019s] ability to continue as a going concern\u201d due to its \u201creduced cash balances\u201d and $700 million in 2024 debt maturities.16<\/sup> If the Company\u2019s ability to function as a \u201cgoing concern\u201d 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<\/i> the proposed merger was announced and after<\/i> the Company became \u201caware that several law firms have indicated that they are investigating the [proposed] Merger and related matters\u2026\u201d 17<\/sup> This hardly seems to be a coincidence and suggests a troubling lack of candor between the Board and the Company\u2019s shareholders, calling into question the Board\u2019s true motivations.<\/p>\n \nAdditionally, RMR\u2019s own investor presentations similarly undermine DHC\u2019s 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\u2019s management fees, claiming \u201climited fee downside to RMR\u201d at \u201ccurrent REIT share price levels.\u201d18<\/sup> In doing so, RMR highlighted that a substantial part of its compensation derives from DHC\u2019s debt.19<\/sup> If DHC\u2019s ability to satisfy its debt were truly a concern, the dependability of RMR\u2019s management fees would be as well \u2013 in this case, the two opposing outcomes are mutually exclusive. Any warning to this effect is glaringly absent from RMR\u2019s investor presentation, an inconsistency which undermines the reliability of DHC\u2019s going concern statement \u2013 implying that the going concern crisis and alleged need to merge with OPI has been fabricated by RMR to further its own interests.<\/p>\n \nAny purported going concern issues faced by the Company can be readily addressed. Simply curtailing RMR\u2019s self-interested, fee-driven spending would go a long way toward preserving the Company\u2019s cash and addressing its near-term liquidity challenges. The current pace of DHC\u2019s capital spending is wholly inconsistent with a company facing going concern problems and one that needs to preserve cash and liquidity.<\/p>\n \nAnd because DHC\u2019s $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 \u2013 just as it has been on several previous occasions. Thus, in our view, the Company needs an additional $250 million \u2013 not $700 million \u2013 in liquidity to get past its 2024 maturities.<\/b><\/p>\n \nThat liquidity should be readily obtainable from a variety of sources or transactions. Given DHC\u2019s expected performance and based on DHC\u2019s\/RMR\u2019s 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 \u2013 and would need to monetize just a fraction of DHC\u2019s numerous and valuable unencumbered assets to pay off a portion, or all, of its maturing debt. These assets\/options include:<\/p>\n \n***<\/p>\n \nIn 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\u2019s prospects by burdening it with OPI\u2019s 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<\/i> DHC stakeholders. FFL, accordingly,<\/b>intends to vote its DHC shares AGAINST<\/span> the proposed merger with OPI to protect the long-term value and interests of the Company\u2019s stakeholders.<\/b><\/p>\n \nSincerely,<\/p>\n \nMarc Andersen Appendix<\/span><\/b><\/p>\n
\nFlat Footed LLC (together with its affiliates, \u201cFFL\u201d) owns approximately 7.4% of the outstanding common shares of Diversified Healthcare Trust (Nasdaq: DHC) (\u201cDHC\u201d or the \u201cCompany\u201d), making it one of the Company\u2019s largest shareholders. Today, FFL issued the below letter sent to the Company\u2019s Board of Trustees regarding DHC\u2019s 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<\/span><\/b> the proposed merger with OPI to protect the long-term value and interests of all Company stakeholders.<\/p>\n
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Diversified Healthcare Trust
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c\/o Jennifer B. Clark, Secretary
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Two Newton Place
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255 Washington Street, Suite 300
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Newton, MA 02458-1634<\/p>\n\n
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Flat Footed LLC<\/p>\n