Service Properties Trust (SVC) — Form 10-Q Summary
Business context and period. This unaudited filing covers the three and nine months ended September 30, 2019. SVC is a REIT with hotel investments and net-lease properties. On September 20, it completed its acquisition of 767 service-oriented retail properties from Spirit MTA REIT (SMTA) for an aggregate transaction value of approximately $2.48 billion. At quarter-end, SVC owned 328 hotels and 946 net-lease properties.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $599.8 million | $603.2 million | $1,735.2 million | $1,743.7 million |
| Net income | $40.1 million | $117.1 million | $274.6 million | $294.6 million |
| Net income per share, diluted | $0.24 | $0.71 | $1.67 | $1.79 |
| FFO per share | $0.90 | $1.06 | $2.80 | $3.08 |
| Normalized FFO per share | $0.95 | $1.06 | $2.85 | $3.08 |
| Cash from operating activities | — | $432.5 million | $403.4 million |
Quarterly revenue was nearly flat year over year; net income fell 65.8%. Nine-month revenue declined modestly and net income declined 6.8%. Q3 results included a $3.95 million unrealized loss on equity securities and an $8.45 million debt-commitment write-off. Nine-month results included a $159.5 million gain on the sale of 20 travel centers and $43.8 million of unrealized equity-security losses. These items materially affect comparisons; FFO and Normalized FFO are non-GAAP measures.
Hotel operating indicators: For all hotels, Q3 ADR declined 2.2% to $127.82, occupancy was unchanged at 77.0%, and RevPAR declined 2.2% to $98.42. For the first nine months, ADR declined 0.9%, occupancy declined 1.2 percentage points to 73.9%, and RevPAR declined 2.5% to $96.00. Management cited renovation disruption, added room supply in some markets, and lower business activity in certain locations.
Cash flow and liquidity: Nine-month investing cash outflow was $2.46 billion, principally reflecting acquisitions; financing provided $2.02 billion, including new note issuance and revolver borrowing. At September 30, cash and cash equivalents were $17.0 million, restricted cash was $53.5 million, and $210 million remained available on the $1 billion revolver. By November 7, revolver borrowings had fallen to $700 million, leaving $300 million available. Management said it expects operating sources and financing access to cover obligations and distributions for the next 12 months, but cautioned that tenant or manager payment shortfalls could weaken cash flows.
Debt: At September 30, principal debt comprised $790 million outstanding on the revolver, a $400 million term loan, and $5.35 billion of senior notes. In September, SVC issued $1.70 billion principal amount of notes due 2024, 2026, and 2029 to help finance the SMTA acquisition. A rating-agency downgrade effective October 1 increased the revolver and term-loan interest-rate premiums and the revolver facility fee. SVC reported covenant compliance at quarter-end.
Material changes and outlook
- Net-lease rental income was lower year over year, chiefly reflecting the January sale of 20 travel centers to TA and related lease amendments; revenue from the newly acquired SMTA properties partly offset the decline.
- The acquired SMTA portfolio broadened SVC’s tenant, industry, and geographic exposure, but also increased debt and introduced integration and execution risks. 148 acquired properties, with $43.1 million of annual minimum rent, were classified as held for sale at quarter-end.
- SVC agreed to sell 126 SMTA properties for $438 million and expected to close before year-end; it also reported two subsequent property sales. The company was pursuing asset sales to reduce leverage and had separately commenced marketing hotels as part of a previously announced approximately $300 million hotel-sale plan. Completion and proceeds are not assured.
- Management stated that it expects the SMTA transaction to increase annualized Normalized FFO per share in 2020 after expected asset sales, while warning that performance or sale proceeds below expectations could prevent an increase.
- The current annualized distribution rate was $2.16 per share; the October 2019 quarterly distribution was declared at $0.54 per share. The board retains discretion to reduce or suspend distributions.
- SVC expected approximately $127.5 million of hotel renovations and capital improvements in the final three months of 2019 and $28 million in 2020. It said improvements raise contractual minimum returns in some agreements, but operating performance may not rise accordingly.
Risks, contingencies, and unusual items
- Tenant and hotel-manager concentration remains important: TA represented approximately 24.1% of consolidated annual minimum rents and returns; its leases covered 179 travel centers. SVC also reported that hotel coverage was below 1.0x for five of eight agreements, representing 40% of annual minimum hotel returns and rents. Some shortfalls are not secured by guarantees or deposits.
- Hotel performance weakened on a comparable basis. Certain hotel agreements had low reported coverage, and some managers’ guarantees or security deposits were limited or depleted. The Wyndham guarantee was depleted; SVC planned to exit that relationship and rebrand or sell the 22 hotels.
- Marriott had notified SVC that it would not renew the Kauai hotel lease expiring December 31, 2019; negotiations were ongoing. SVC could not assure a new agreement or the hotel’s future operator or proceeds.
- Leverage, increased floating-rate exposure, credit-rating pressure, refinancing access, and the success of planned asset sales are key financial risks. SVC disclosed sensitivity to interest-rate increases and the anticipated LIBOR phaseout.
- Related-party relationships—including with manager RMR, TA, and hotel manager Sonesta—create potential conflicts of interest. SVC also disclosed that it had no employees and relies on RMR for management services.
- SVC sold its RMR Inc. shares in July for net proceeds of $93.6 million. Its jointly owned insurance affiliate AIC was dissolving; a fourth-quarter capital distribution was expected, but its timing and amount were uncertain.
Important facts for investors to verify
- Whether planned property and hotel sales close on schedule and at proceeds sufficient to reduce debt and improve credit metrics.
- Post-acquisition SMTA property performance, integration costs, occupancy, rent collection, and the effect of properties held for sale on recurring cash flow.
- Hotel-manager coverage and the availability, remaining balances, and expiration terms of guarantees and security deposits, particularly for IHG, Sonesta, Wyndham, and Marriott agreements.
- TA’s ability to meet rent and deferred-rent obligations, given its importance to SVC’s rental income and the disclosed related-party relationships.
- Whether operating cash flow and financing capacity support the $2.16 annualized distribution rate amid higher debt and floating-rate costs.
- Whether the stated 2020 Normalized FFO-per-share expectation is achieved; it is an expectation, not a guarantee.