ISS supports Vital Healthcare's rebel investors

A key proxy analysis and recommendations firm widely used by New Zealand institutional investors is recommending that investors in Vital Healthcare Property Trust support resolutions put forward by three rebel institutions.

Institutional Shareholder Services’ (ISS) advice directly contradicts the advice to unitholders of Vital’s manager, Canada-based NorthWest Healthcare Properties Management. Vital invests in medical properties.

ISS is supporting the rebels’ view that the management structure of Vital creates “a direct conflict of interest” between NorthWest and Vital’s investors and that NorthWest’s ability to fire at will is “an unambiguous threat” to the supposedly independent directors.

ISS also notes that the manager’s ability to unilaterally increase its management fees is “a direct conflict of interest” between NorthWest and Vital investors.

The three institutions, ACC, ANZ Investment Funds, and Mint Asset Management, which together own 10 percent of Vital’s units, have proposed five resolutions at tomorrow's annual meeting aimed at removing these conflicts of interest and at giving Vital’s investors more say in how their investment is managed.

NorthWest has caused Vital to co-invest in a 13.4 percent stake in ASX-listed Healthscope, with a view to buying some of its medical properties. It has borrowed $81 million from Vital in the process.

Since NorthWest’s management fees are based on Vital’s gross assets, any purchases will increase NorthWest’s fees. “The potential purchase of Healthscope properties by Vital highlights the need for urgent changes to the governance arrangements to manage this fundamental conflict and ensure a fair outcome for unitholders,” ISS says.

The rebels fear NorthWest will have Vital pay too much for any Healthscope properties it buys, given that property prices are at or near the peak of the cycle and because there are rival parties eyeing Healthscope, setting up a bidding war.

Property giant Brookfields Capital Partners is currently conducting due diligence on Healthscope and that company has already repelled another suitor, a consortium led by AustralianSuper.

Another reason contributing to the rebel investors’ concerns is that Vital was already highly geared – its $670.1 million of drawn bank debt at June 30 took its gearing under its bank covenant to 38.7 percent, up from 29.3 percent a year earlier and NorthWest has committed it to more than $120 million of developments on sites Vital already owns.

ISS says NorthWest’s ability to fire the independent directors is “an unambiguous threat which may potentially influence the behaviour of the independent directors, obstruct the exercise of their critical role and act as an impediment to recruit high-quality directors”.

A week after former independent chair Graeme Horsley stepped down from the board on May 1 this year, NorthWest announced the Healthscope investment but kept investors in the dark about Vital’s involvement until Vital’s annual results were released in August.

Previously, the management company’s chief executive, David Carr, had argued that any involvement by Vital wasn’t material and therefore didn’t need to be disclosed.

ISS says the fees NorthWest is charging Vital’s investors are “materially higher than those charged by other listed property vehicles and the lack of a tiered fee structure means that this differential will increase as the asset base growths.”

It cites the fee structures of a number of other listed property vehicles including Goodman Property Trust, in which investors are charged 0.5 percent on the first $500 million of assets and falling to 0.4 percent thereafter. By contrast, Vital’s investors are charged a flat 0.75 percent fee.

That analysis doesn’t include NorthWest’s incentive and other fees which have allowed it to collect about $100 million in gross fees since it bought the management contract for $11.5 million in 2011.

Distributions to Vital’s investors over that period have risen from 8.1 cents per unit to 8.56 cents.

“For listed property vehicles with a tiered structure, the economies of scale that result from a larger portfolio are effectively shared with investors. In Vital’s case, the flat fee structure means all of this benefit accrues to the manager,” ISS says.

ISS is also recommending that Vital’s investors support the director the rebels have proposed, Paul Mead, rather than vote for the director NorthWest has proposed, Graham Stuart.

It notes that Stuart has more than 30 years’ experience in senior executive and governance roles but that NorthWest is only allowing investors to choose one or the other director, despite the rebel investors pleading for the number of directors to be increased from five to six. Such an increase is allowed under Vital’s governance documents.

Two of the current directors are NorthWest representatives, so even if the other directors were truly independent, NorthWest would still have disproportionate representation, controlling 40 percent of the board while owning a little under 25 percent of Vital’s units.

Incidentally, that unitholding effectively gives NorthWest an iron grip on Vital since any vote to oust it as manager would need 75 percent of those voting to succeed and its holding makes that practically impossible.

Mead is also “an experienced and well-regarded director” and also has property, banking and finance experience, ISS says.

“A vote for the election of Paul Mead is warranted, given that investors may only vote for one of the two director nominees and the institutional investor proponents of the non-binding proposals have provided a reasonable case to support those proposals.”

As NorthWest has frequently noted, it won’t be bound legally by the resolutions the rebels have proposed, even if a majority of investors support them.

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