Service Properties Trust — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. Although the request references 2019 Q4, this is an annual filing; fourth-quarter results are noted below where disclosed. Amounts are in U.S. dollars.
Business context
Service Properties Trust (SVC) is a REIT owning hotels and service-oriented net-lease properties. At year-end it held 329 hotels with 51,349 rooms and 816 net-lease properties with approximately 14.9 million square feet. In September 2019, SVC acquired 767 net-lease properties from Spirit MTA REIT (SMTA) for an aggregate transaction value of approximately $2.48 billion; subsequent dispositions reduced the net-lease portfolio to 816 properties. SVC relies on third-party hotel managers and tenants and is externally managed by The RMR Group LLC.
Key financial results
| Metric | 2019 | 2018 |
|---|---|---|
| Total revenue | $2.316 billion | $2.295 billion |
| Net income | $259.8 million | $185.7 million |
| Net income per common share | $1.58 | $1.13 |
| Operating cash flow | $617.7 million | $597.0 million |
| FFO available to common shareholders | $608.4 million; $3.70/share | $605.5 million; $3.69/share |
| Normalized FFO available to common shareholders | $620.7 million; $3.78/share | $605.7 million; $3.69/share |
| Common distributions paid | $353.6 million; $2.15/share | $346.8 million; $2.11/share |
| Interest expense | $225.1 million | $195.2 million |
Revenue increased 0.9% and net income rose 39.9%. The filing attributes the earnings change to multiple factors, including lower general and administrative expense, asset-sale gains, higher interest expense, impairment and investment valuation losses. Net income should therefore be considered alongside FFO and the significant one-time or valuation items below. Distributions exceeded GAAP net income available to common shareholders.
Hotel performance softened: for all 329 hotels, 2019 ADR fell 1.5% to $128.76, occupancy declined 0.9 percentage points to 72.5%, and RevPAR fell 2.7% to $93.35. For 319 comparable hotels, RevPAR decreased 1.5%. Management cited renovation disruption, new hotel supply in some markets and weaker business activity in certain locations.
Year-end cash and cash equivalents were $27.6 million, plus $53.6 million of restricted cash. Debt was approximately $6.13 billion principal amount ($6.06 billion net carrying value); reported debt to gross book value of real estate was 52.0%. SVC had $623 million available on its $1.0 billion revolving credit facility. Net cash used in investing was $2.13 billion, primarily reflecting acquisitions and capital spending, while financing provided $1.52 billion, principally from debt issuance and net borrowings.
Material changes and unusual items
- The SMTA acquisition materially expanded SVC’s net-lease business and increased leverage. SVC issued $1.7 billion of senior notes in September 2019 and used debt and cash to fund the transaction.
- SVC sold 150 net-lease properties during 2019 for aggregate proceeds of $821.2 million, including 20 travel centers sold to TA for $308.2 million. The TA transaction generated a $159.5 million gain.
- SVC recorded $39.3 million of real-estate impairment charges: $10.9 million on 19 net-lease properties held for sale and $28.4 million on two hotels. It also recorded $40.5 million of unrealized losses on equity securities and an $8.5 million loss on early extinguishment of debt.
- Fourth-quarter 2019 revenue was $580.9 million and net loss was $14.9 million, or $0.09 per share, compared with revenue of $550.8 million and net loss of $108.9 million, or $0.66 per share, in fourth-quarter 2018.
- Hotel coverage was below 1.0x for five of six hotel agreements, representing 42.5% of annual minimum hotel returns and rents. Aggregate hotel coverage was 0.86x. SVC reported $69.9 million of unguaranteed minimum-return shortfalls under its Sonesta and Wyndham agreements for 2019.
Outlook, risks and contingencies
Management stated that it expected available operating sources and financing capacity to cover operating and capital expenses, debt service and distributions for the next 12 months, while warning that tenant or manager payment failures could reduce cash flow and require lower or suspended distributions. SVC’s annualized distribution rate at filing was $2.16 per share; the Board retains discretion over distributions.
SVC expected approximately $155 million of capital improvements and renovation spending in 2020, including substantial hotel investment. It also planned to sell approximately $300 million of hotel assets to reduce leverage and was marketing or considering sales, rebranding or repurposing of 20 Wyndham, 33 Marriott and 39 Sonesta hotels. Completion, proceeds and operating benefits were not assured.
After year-end, on February 27, 2020, SVC restructured its Sonesta arrangements: it agreed to sell, rebrand or repurpose 39 extended-stay hotels; reduced minimum returns on 14 continuing full-service hotels from $99.0 million to $69.0 million; and received an approximately 34% interest in Sonesta’s parent. The changes also altered capital-reserve and termination provisions.
Key risks include high leverage and refinancing needs; potential credit-rating deterioration following the SMTA transaction; floating-rate debt and the then-expected LIBOR phaseout; dependence on TA, which represented 24.6% of annual minimum rents and returns; weak hotel agreement coverage and limited or absent guarantees for some operators; renovation costs and disruption; tenant defaults, competition, economic sensitivity, and related-party conflicts involving RMR, TA and Sonesta. The filing reports that S&P assigned a negative outlook and Moody’s downgraded SVC’s ratings after the SMTA transaction. SVC said it was in compliance with debt covenants at year-end. No litigation was identified as expected to have a material adverse effect. The auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether post-year-end hotel sales, rebranding and repurposing plans proceed, at what prices, and whether proceeds reduce debt.
- TA’s ability to meet lease obligations and the effect of its concentration in SVC’s rent base; verify current lease coverage and rent collections.
- Whether hotel operating results improve enough to support minimum returns, particularly under Sonesta and other agreements with coverage below 1.0x or limited security.
- Actual 2020 capital spending, renovation disruption and returns on the planned investments.
- Debt maturities, refinancing access, credit ratings, covenant headroom and sensitivity to interest rates and LIBOR replacement terms.
- The sustainability of distributions relative to cash flow, normalized FFO, capital needs and leverage reduction goals.
- Related-party terms and governance protections, including the Sonesta restructuring and SVC’s externally managed arrangements with RMR.