Thursday, August 25, 2016

iStar: Non-Dividend Paying REIT with Significant Development Assets

iStar (STAR), f/k/a iStar Financial, is an internally managed former commercial mortgage REIT that ended up foreclosing on a variety of land, development projects, and operating assets (office, hotel, condo projects) across the country following the financial crisis.  Over the last several years iStar has poured money into these foreclosed assets to reposition them for an eventual exit, much of that investment should start showing up in asset sales over the next 1-3 years.  Cash from the sales could then be recycled into their core commercial mortgage and net lease business making the company easier to understand and value.

iStar is an odd REIT that doesn't pay a dividend, REITs are generally under-invested in by institutional investors (although that may change now that REITs have recently been carved out of financials into their own S&P sector) but are generally favored by retail investors because of their high dividends.  iStar misses both investor bases.  iStar is a unique pass-through entity that has NOLs from the financial crisis (similar to ACAS in the BDC industry) and are using their tax asset to shield taxable income (bypassing the 90% distribution rule) in order to reinvest in their business and repurchase shares.  They're not getting credit for this strategy as it doesn't immediately result in higher dividends or in a clearly articulated higher NAV value.  Instead, iStar uses a gross book value metric in their press releases which adds back depreciation on their real estate but does not give any credit to the increase in real estate values since they acquired the development assets via foreclosure or the additional value created above cost as they've deployed capital into those properties.

iStar breaks out their business into four main buckets: 1) Real Estate Finance, 2) Net Lease, 3) Operating Properties, and 4) Land and Development.  Real Estate Finance and Net Lease are complementary businesses as a triple net lease property is essentially a financing transaction.  The Operating Properties and Land and Development segments are the assets iStar acquired through foreclosure, over time these segments should shrink from 36% of assets to become a smaller part of the pie.
2015 10-K
Their asset base is pretty well diversified across geography and real estate subsectors, although the public market likes clean pure-play REITs, diversification still reduces risk, especially in the land and development asset class.  If one area of the country is seeing a slowdown, they can pull back their development plans and focus on other opportunities (seeing this with HHC shifting capital away from their Houston assets).
Q2 16 10-Q
There's a lot of noise in their Operating Properties and Land and Development businesses as earnings are lumpy based on when assets are sold.  iStar breaks out their commercial Operating Properties between stabilized, those that are leased up at prevailing market rents, and transitional, those that have low occupancy and need to be re-positioned.  I think it makes the most sense to value iStar's core Real Estate Finance, Net Lease business lines and the stabilized Operating Properties as if it were a typical straightforward REIT that pays a dividend.  The below is a bit of a crude back of the envelope valuation, but it shows that the market is giving little credit to the value in iStar's transitional operating properties and in their land and development holdings.

On an FFO basis:
iStar has quite a bit of leverage, so a pure FFO multiple probably isn't appropriate but still shows the value embedded in iStar's complicated structure as the shares currently trade for $11.00, less than 14x FFO of just the core Real Estate Finance and Net Lease portfolios.

On an NAV basis:
The above analysis assumes a 6.5% cap rate for the net lease and stabilized operating property assets and values the rest of iStar's assets at book value despite many of the land and development assets being valued at 2010-2012 cost basis on the balance sheet.  One way to look at iStar's valuation, the market is hair-cutting the foreclosed assets by 70% despite significant progress made in recent years to entitle and further develop these assets.  It's likely that these assets could be worth 1.5-2.0x what they're carried at as value is realized over the next 1-3 years.

Land and Development Assets
iStar's Land and Development assets are quite extensive but there's not a lot of disclosure around the specifics of each asset in the 10-K, maybe something for the new CFO to implement?  In total they control land that will eventually contain over 30,000 residential units, not an insignificant number.  Management expects the back half of 2016 and into 2017 to be big realization years, with $500MM in exits targeted from the Land and Development and Operating Properties segments.  Below are a few projects that are currently in production or under development:
  • 1000 South Clark: 29 story, 469 unit luxury apartment complex located in Chicago's South Loop.  iStar partnered with a local builder in a JV, its both an equity investor and a lender in the deal, it will likely be sold after stabilization early next year.
  • Asbury Park Waterfront: iStar recently opened an "adult playground" hotel, The Asbury, in Asbury Park, NJ (Jersey Shore), the hotel/entertainment venue is meant to spur additional development in the surrounding 35 acres of land iStar owns that will eventually support over 2,700 residential units.  iStar is currently finishing up a small condo project, called Monroe, which is 40% sold and has plans to revive an uncompleted high rise construction project called Esperanza that was abandoned after the financial crisis.
  • Ford Amphitheater at Coney Island: iStar just recently completed construction on a 5,000 seat amphitheater along the boardwalk in Coney Island, the amphitheater was built to spur additional development around it, which iStar has 5.5 acres and plans for 565 residential units.
  • Grand Vista: 5,500 acres of mostly raw land on the outskirts of Phoenix that has plans for 15,000 residential units, this was a large failed project before the financial crisis and it may take a while before Phoenix builds out to this site.
  • Highpark: Formerly known as Ponte Vista, Highpark is a 62 acre former naval shipyard in San Pedro, California which will house 700 new residences.
  • Magnolia Green: A classic master planned communities outside of Richmond, VA with a golf course and room for 3,500 residential units.  It has an estimated sellout date of 2026 and another 2.400 units remaining to be sold.  Richmond is becoming a hot market, the city itself is pretty vibrant and it's in a good geographic weather location, it should attract both millenials and retiring baby boomers.
  • Marina Palms:  Two luxury towers along with a marina in North Miami Beach, the second tower is currently under construction and slated to be finished in December 2016.  The company partnered with a local builder and contributed the land for a 47.5% interest in the JV.
  • Spring Mountain Ranch Place: 785-acre master planned community located in the Inland Empire.  For the first phase of the development, iStar partnered with KB Homes and retained a 75.6% interest in the JV, the first phase calls for 435 homes, 200 of which had been sold as of 12/31/15.  Additional phases of the MPC will bring a total of 1,400 home sites.
NOLs
iStar has $856MM of net operating loss carry-forwards at the REIT level that can be used to offset taxable income and don't expire until 2034.  The NOL allows iStar to utilize retained earnings to grow rather than tap the capital markets constantly like traditional REITs.  This is a plus for iStar as they trade for a significant discount to my estimate of NAV, if forced to pay out market rate dividends they might not be able to access enough capital to fully realize the value of their development assets.  Additionally, they have more available free cash flow to buyback shares which should ultimately be a better use of cash at these prices than paying out a dividend.

Share Repurchases
The company is a large net seller of real estate, they will be selling down their portfolio as time goes on using the proceeds to pay down debt and repurchase more shares.  In the past twelve months iStar has repurchased 19% of their shares outstanding, after the second quarter they approved another $50MM increase to their repurchase program.  The combination of selling their non-core assets above book value and buying back shares below NAV is powerful and could lead to some substantial returns.

Risks
  • Jay Sugarman is the CEO of iStar, he's been in that position since the late 1990s and thus led iStar into the financial crisis, he has a lot of the trappings of a NYC real estate guy (owns a sports team, Philadephia Union of the MLS, and a massive home in the Hamptons).  But like Michael Falcone at MMAC, sometimes you need the guy who led you into the abyss to lead you out because they know each asset intimately and where the bodies are buried.
  • Does iStar go back to the "boring" business of real estate finance and net lease after diving into the glamorous development world?  Their website and headshots don't look like your typical REIT or credit shop, I worry the management team has fallen in love with real estate development and the portfolio won't ever resemble a clean REIT until iStar exhausts its NOLs.
  • Timing of asset sales, a few of iStar's land and development assets have long tails (10+ years), if they intend to do the development themselves versus selling to a local builder it could push out the value realization time frame.
  • Leverage, convertible bonds/preferreds, development assets all make iStar more vulnerable to a recession and a downturn in real estate prices.  They have some near term debt maturities and are generally dependent on the capital markets on an ongoing basis for both debt refinancing and asset sales.
iStar reminds me of a combination of HHC (hard to value development assets, atypical for a public vehicle), MMAC (real estate acquired through foreclosure that's difficult to piece out, cannibal of its own shares), and ACAS (pass through entity that doesn't pay a dividend due to its NOL assets).  Over time I think can generate similar gains as those previous ideas.  Thanks to the reader who pointed it out in a previous comment section.

Disclosure: I own shares of STAR

Monday, August 1, 2016

Verso Corp: Bankruptcy Reorg, Cheap Valuation

Verso Corporation (VRS) is a paper producer, primarily of coated papers used in magazines, catalogs, direct mailings, and other commercial applications.  They operate 8 paper mills, most of which are in the upper midwest.  This is a business in secular decline, shrinking mid-single digits annually the past five years as all media shifts to digital formats.  Verso was created by Apollo Global in a $1.4B 2006 leveraged buyout of International Paper's coated paper business, shortly afterwards the industry began to decline and Verso was sub-scale and had too much debt to compete.

In January 2014, Verso announced they would attempt to fix the scale problem and agreed to purchase competitor NewPage for another $1.4B.  The deal was heavily scrutinized by the Department of Justice fearing a monopoly in the coated paper market, all while both businesses were struggling and needed the combination to cut an estimated $175MM in costs.  Eventually the combined company agreed to sell 2 paper mills to appease regulators for $74MM and the deal was completed, but not in time to save Verso which filed for bankruptcy this past January with $2.8B in debt.  In July, Verso emerged from bankruptcy eliminating $2.4B in debt leaving it with $371MM split between an asset-back line and a term loan.  The former Verso and NewPage creditors became the equity shareholders and the company resumed trading under the symbol VRS.

After a company emerges from bankruptcy, the new equity is often in the hands of disinterested owners, the former debt holders, and similar to a spinoff there's no IPO road show to get investors excited.  The dream scenario is when a good business over-leverages themselves and a temporary setback in their business pushes them into bankruptcy while the underlying business is solid with long term growth prospects.  That's not the case here with Verso, the paper business is a declining commodity industry with high fixed costs and a variable priced end product that also has to compete against foreign producers benefiting from the strong dollar and lower labor costs.  But a cheap price can overcome a lot of flaws and Verso's equity is priced very cheaply.

Verso's management provided financial projections out to 2020 as part of the bankruptcy process, here's a link to the entire docket but I found the disclosure statement filed 5/10/16 to be the most helpful.
Verso expects to earn $145MM in 2017, it's current market cap is $404MM, so it's trading at a forward multiple of under 3 times earnings.  But P/E is probably not the best measure for Verso, they have a significant pension liability at $565MM that needs to be funded.
Verso expects to generate approximately $70MM annually in free cash flow after making pension plan contributions which works out to a 17% free cash flow yield.

PJT Partners, a 2015 Blackrock spinoff, was Verso's financial advisor through the process and provided their own valuation analysis.
A $700MM market cap would equal $20.35 per share (75% higher than today's $11.50) and value Verso at ~5x earnings, 10% free cash flow yield, and about ~4.4x EBITDA before pension contributions.  Sounds like valuations for other declining industries like newspapers and terrestrial radio stations.  Cheap and very reasonable even for a terrible business like coated paper.

The company is currently searching for a new CEO who would presumably have freshly struck options at today's depressed prices and a mandate for change, they wouldn't be tied to any of the decisions of previous management and could accelerate a shift to more profitable and less commodity specialty papers.  The ill-fated NewPage acquisition had strategic merit, the industry needs to consolidate and take capacity out of the system, Verso just had the wrong balance sheet and not enough time to experience the cost synergies of the merger.  By eliminating $200+MM of interest payments and realizing $175MM in cost synergies, new Verso should be more agile and able to adjust their business to the industry's realities.

Verso isn't a business you want to hold long term, I view this as a Graham cigar butt trade, get one last puff to the upside and move on to another one.

Risks:
  • High fixed costs, variable input/outpost costs - Verso's input costs (timber, pulp, energy) are all highly variable and it's a price taker in their end coated paper markets, pair those dynamics with a high fixed cost expense base (expensive to maintain mills, unionized labor force) and a lot could go wrong.  A $25 change in pricing per ton would wipe out their entire annual EBITDA.
  • Paper industry is in secular decline - Demand for paper decline 10% from 2012 to 2015, expected to decline another 4% in 2016, and likely will continue to decline at a similar pace for the foreseeable future.
  • Verso hasn't been profitable since 2009 - I'm somewhat relying on management's financial projections and assuming they'll be able to come close to meeting those expectations which would be a significant turnaround from their results prior to bankruptcy.
  • Continued strong US dollar - many of Verso's competitors are foreign, a strong dollar makes Verso's paper less competitive both domestically and in overseas markets.
Disclosure: I own shares of VRS

Tuesday, July 19, 2016

Leidos Holdings: Reverse Morris Trust with Lockheed Martin

Following the draw-down of U.S. troops in Iraq/Afghanistan and the 2013 budget sequestration we've seen many defense and consulting firms spinoff their headwinds facing government services businesses (EGL, VEC, CSRA to name a few) as a way to continue to show growth.  In 2013, Science Applications International Corporation or "SAIC" spunoff it's slower growth technical services and IT divisions, the parent company changed it's name to Leidos Holdings (LDOS) and the slower growth government services division kept the name SAIC.  The reason for that spinoff wasn't entirely clear to me at the time, and still isn't, especially now that Leidos Holdings is acquiring the Information Systems & Global Solutions business of Lockheed Martin (LMT) in a Reverse Morris Trust transaction that will close in mid-August.

However after the transaction closes, Leidos will be the largest pure-play IT and government services contractor in the U.S., about twice as big as CSC's government services business CSRA.  They will be broadly diversified across government agencies, and internationally, in fact they'll be one of the few businesses to touch all seven continents as Lockheed's contract to run the U.S. research base in Antarctica will move to Leidos.  This is an industry where scale matters, in today's budget environment more and more contracts are being put out to bid as "Lowest Price Technically Acceptable".  Prior to sequestration, agencies used the "Best Value" method for determining a winning bid, allowing agencies to balance the trade-off between quality and cost, greater value for a higher cost was still okay.  Now the award goes to the lowest price as long as the bid meets all the technical requirements of the contract, there's less judgment on the contracting agency's part.  By being able to spread your corporate overhead over a larger contracting base, those with significant scale will be in a better position to compete on price.

Once a contract is won, it's often difficult to unseat the incumbent in future re-competes as the incumbent has the advantage of not needing to shoulder start-up and implementation costs, putting them in an advantage on price.  If a contract is lost, many of the employees working on the contract end up with the new contractor, the cost model for these firms is more variable than other industries allowing them to experience revenue declines but maintain acceptable margins.

Reverse Morris Trust Transaction
Below is an Leidos investor relations' slide outlining the transaction.  Lockheed Martin's IS&GS business generates about $500MM in EBITDA, at the $5B headline price, LDOS paid 10x EBITDA.
Leidos will be making a special dividend prior to the transaction closing to effectively true up the ownership bases of the two firms, in order for it to qualify as a Reverse Morris Trust and be tax free, Lockheed Martin shareholders need to own more than 50% of the combined company.  RMTs have been interesting to me recently because they pair the effects of a spinoff, but with immediate/improved scale and an in-place management team.

Valuation
There will be approximately 151 million diluted shares outstanding after the transaction is complete, the Leidos special dividend will be $13.64 adjusting the pro-forma stock price down to $34.95 for a $5.3B market cap company.  Per the prospectus, the combined pro-forma EBITDA is $1.05B without any cost synergies which are expected to equal $120MM by 2018.
I have pro-forma Leidos trading for 8.2x EBITDA, 1-3 turns below most of their peers despite the company's new scale which should make them more competitive and lead to an increased win rate.  While 8x EBITDA might not be absolutely cheap for a business like Leidos, consider the U.S. Federal government has a budget for the first time in years with all sectors of government including the Department of Defense seeing increased appropriations.  The economy is still sluggish and treasury rates are near record lows, fiscal spending is likely to increase in an attempt to spur growth as deficit concerns and the risk of sequestration lessen.

Exchange Offer
There's a cheaper way to buy LDOS shares being offered right now.  Instead of spinning off LDOS shares directly to shareholders, Lockheed Martin is conducting an exchange offer where LMT shareholders can select to exchange their LMT shares for LDOS shares at a 10% discount rate (subject to an upper limit).  Even without the exchange offer this is an attractive deal and LDOS should be worth ~$44 per share (adjusted for the $13.64 special dividend) or 9.5x EBITDA.

Disclosure: I own shares of LMT (will be exchanging for LDOS) and CSRA

Hawaiian Electric: Public Utility Commission Denies NextEra Merger

Late last Friday, Hawaii's Public Utility Commission voted against NextEra Energy's (NEE) 19 month old deal to purchase Hawaiian Electric (HE) which provides electricity to 95% of the state.  I held out brief hope that the initial rejection would be a political move as the merger is deeply unpopular in Hawaii (they don't like outsiders) and both sides would come back to the table, make some concessions and the deal would get done.  No luck.  NextEra threw in the towel on Monday and terminated the merger transaction, Hawaiian Electric will receive about $95 million in a termination fee and deal expenses.  As part of that transaction, Hawaiian Electric was going to spinoff their bank subsidiary, American Savings Bank (ASBH), to HE shareholders but now that has also been shelved.

The shares sold off about 7% (to be fair they sold off about the same two weeks ago in anticipation of a no vote) as merger arbitrage investors exited the trade, when a deal breaks it often creates opportunities, time will tell if this is one with HE.  So what now?  Who would go through the pain of dealing with Hawaiian regulators to buy HE?  It's fairly clear that the utility can't go it alone and make the state's desired clean energy mandate by 2045.  Reports show that Berkshire Hathaway's energy subsidiary recently registered a business in Hawaii.  Berkshire has the brand recognition, deep pockets and commitment to moving towards clean energy that could appeal to the Hawaiian populace; Warren Buffett again playing the "friendly" acquirer role.

I continue to hold for the time being, if they were to find another buyer or just spinoff ASBH outright it could be a very attractive transaction.  To summarize the spin's appeal:
  1. Regulatory spinoff - 1) Anyone besides HE isn't allowed to own ASBH per Federal banking regulations, it's a strong bank that's capital allocation is being driven by the needs of a weakly positioned utility; 2) As part of HE, ASBH's debit card exchange fees are capped as part of the Durbin Amendment due to the overall size of HE.  If ASBH was independent it would fall under the threshold and regain $6MM in net income annually from debit card exchange fees (about a 11% increase).
  2. Differing investor bases, potential forced selling - 1) HE is primarily a utility and owned by many utility focused funds and ETFs, post deal these funds would be forced to sell ASBH; 2) HE is owned by many retail dividend focused investors who will likely sell ASBH as it only makes up a relatively small portion of HE's enterprise value.
  3. Strong local market - The Hawaiian banking market is strong, loans are growing at 8+% and deposits are growing at 5%, the two other publicily traded Hawaiian banks trade for 1.7x BV and 2.75x BV, choosing the lower of the two would put ASBH at about $8-9 per HE share.
Disclosure: I own shares of HE

Thursday, June 30, 2016

Mid Year 2016 Portfolio Review

Brexit free discussion ahead, it was a fairly crazy first half of the year even before the last week, at one point in February my blog portfolio was down almost 20% before climbing back to gain of ~6% at the halfway point of the year.  The significant winners have been MMA Capital, NexPoint Residential, American Capital and Gramercy Property Trust - the significant losers have been CSRA, Liberty Global's LiLAC Group and Par Pacific Holdings.
Current Position Updates:
  • Crossroads Capital (XRDC) is soliciting a shareholder vote to convert to a liquidating trust, cash makes up about $1.40 of the $2.05 current share price, it may take a few years to fully liquidate but I assume much of the cash will be distributed to shareholders (technically unit holders) shortly after the liquidating trust conversion reducing the basis and pulling some of the potential return forward.  I added a little more since I first discussed the idea, there might be some indiscriminate selling from those who don't want the illiquidity of a non-tradeable security ahead of the conversion.
  • Another current position I recently added to is CSRA (CSRA) which is the U.S. government services spinoff of Computer Sciences Corp (CSC).  I had the original idea right that CSRA should be sold after the spin and CSC held as it was the buyout candidate of the two (HPE is doing an Reverse Morris Trust with CSC) but ended up calling a poor audible and holding CSRA instead for tax reasons.  CSRA is down 25-30% for little reason since then.  The U.S. government has a budget for the first time in years and most government agencies (including the Department of Defense) have seen funding increases.  Leidos (LDOS) is buying the services business of Lockheed Martin (LMT) later this year in a Reverse Morris Trust transaction (could be an interesting split off special situation) for 10x EBITDA, no reason that CSRA should trade for a couple turns below that.
  • NexPoint Residential Trust (NXRT) has had a nice run recently on minimal news and is basically at my estimation of fair value in its current external management form.  I want to continue to hold as I like the strategy and their target markets in the Southeast and Southwest but it's hard to fully commit to an external management structure (despite significant insider ownership) as the principal-agent problem is strong and management's best interests are often at conflict with shareholders.  I've sold a little bit and will likely continue to do so, just being slow about it to hedge against Highland selling the company outright in the $20-22 range.
Closed Positions:
  • The spread has come in on the American Capital (ACAS) deal with Ares Capital Corp (ARCC), but in the wrong way with ARCC falling since the deal was announced.  After letting the deal settle in my head, I decided merger arbitrage isn't my strong suit so I sold around $16 and moved on.
  • I ended up selling Gramercy Property Trust (GPT) this month around $9 after owning it for nearly five years, at that time it was a busted commercial mortgage REIT that held the junior debt and equity in three CRE CDOs that were in various levels of distress.  The old board brought in Gordon DuGan and team in the summer of 2012 to transform the company into a net lease REIT focused on industrial and office properties.  New management grew the company quickly through several large acquisitions and corresponding capital raises which was topped by the merger with Chambers Street late last year.  The market didn't initially respond well to that deal, likely because of Chambers Street's previous private REIT status and corresponding messy asset base and unsophisticated retail investors.  REIT mergers are great because of the scalability of the business, once a management team is in place, there's significant operating leverage.  Gramercy was able to eliminate most of the Chambers Street expense structure and recycle the random assortment of office and industrial properties into a more streamlined portfolio that public REIT investors would assign a premium valuation.  That process is far enough along and investors are once again giving Gramercy credit, I have the shares trading for about a ~6.5% cap rate, and given it's new larger size and wider coverage, just don't see a lot of additional alpha remaining.
  • Sycamore Networks (SCMR) drew me in with it's large NOL asset and two activist investors who were looking to stop the ongoing liquidation and preserve the tax asset.  However, the company is set on a liquidation and made an additional distribution during the first half of the year, making it even more unlikely that the tax asset can be monetized (and as we see with Par Pacific and others, even with management focused on the tax asset, not always easy to actually make a dent in it quickly).  It was already a small speculative position for me and after the liquidation distribution it was even smaller, wasn't worth mental effort any longer and I sold for a small loss.
Current Portfolio:
My watchlist is a bit short on new ideas other than a few nano-caps, if any readers have their eye on anything interesting that I should be looking at, please reach out.  Otherwise, have a great holiday weekend for those in the United States and thanks for reading.
Disclosure: Table above is my blog/hobby portfolio, its a taxable account, and a relatively small slice of my overall asset allocation (most of which is restricted) which follows a more diversified low-cost index approach.  The use of margin debt/options/concentration doesn't represent my true risk tolerance.

Saturday, June 18, 2016

Pinnacle Entertainment: Tax Attributes, Remaining Real Estate, Insider Buying

This post is mostly a promo for this month's Special Situations Research Forum meeting hosted by the CFA Society Chicago, I'll be leading the discussion on Pinnacle Entertainment (PNK) and the recent sale of its real estate to GLPI.  We usually get anywhere from 6-12 people, it will be held in the loop on 6/27 at 5:30pm, if you're in the area and would like to attend, sign up here or shoot me an email.  Here's the original post from last month, and then below are some additional thoughts around assets that add to PNK's undervaluation to complete the picture.

Tax Attributes
At the time of the GLPI transaction, old Pinnacle had significant NOLs along with the standard D&A tax shield that made it an insignificant federal income tax payer.  The NOLs were exhausted through the taxable spin of the OpCo and even though the D&A of the real estate will still flow through the GAAP financial statements, they can only depreciate the assets they own for income tax purposes.  But due to the structure of the spinoff, Pinnacle Entertainment will continue to be a minimal income tax payer, below are explanations from both PNK and GLPI executives:
"However, we did receive a step-up basis in our assets.  That step up just to give some shorthand for it.  You look at the enterprise value of the company as a whole.  We had a tax basis on what was spun of roughly about $1 billion and the difference between those two will be amortized over a 15 year period evenly.  That will create a deduction going forward, main point being, that our effective tax rate will be materially lower than the statutory one by virtue of the deduction" - Anthony Sanfilippo, Pinnacle Entertainment CEO
"..and the reason we did it this way [spin the OpCo and merge the PropCo with GLPI], was obviously to help solve for some tax problems.  It also, some people expressed some concern that the Pinnacle NOLs would be going away but the reality is, on the spin they will be getting a stepped-up basis of the NOLs as well as to the extent that we pay gain above and beyond the NOLs, their assets will get stepped up actually higher than their NOLs.  So in the end they should be, from a tax perspective, in very good shape going forward with a higher asset level basis for depreciation." - William Clifford, GLPI CFO
Back to the EBITDA to free cash flow bridge slide:
Pinnacle is projecting only $4MM in cash taxes annually on the current business (including the Meadows acquisition), gaming companies typically aren't significant tax payers due to their considerable fixed assets, but even with the sale of their real estate to GLPI, Pinnacle via the stepped up basis of their assets/goodwill that they'll be able to amortized over 15 years have maintained similar same tax efficiency.  I'd be curious to hear anyone's thoughts on how much their tax attributes could be worth?

Real Estate Remaining at Pinnacle Entertainment (OpCo)
GLPI is a net lease REIT and thus uninterested in development assets, their investors want predictable cash flows and not excess land sitting around generating insufficient revenue for dividends.  As part of GLPI's sweetened offer to buy Pinnacle's real estate they sent a letter to Pinnacle's shareholders outlining the increased value of the second offer, and specifically called out the property assets to be left behind at the operating company.
Belterra Park
In 2013, old Pinnacle began the redevelopment of the River Downs racetrack outside of Cincinnati to be refashioned as Belterra Park (to create an association with the Belterra Casino Resort across state lines in Indiana) a "racino" with video lottery machines and six full service restaurants.  The all-in redevelopment price was approximately $300MM, it opened in the spring of 2014 and almost immediately began to under-perform expectations.  By the time GLPI came knocking with an offer to buy Pinnacle's real estate on an earnings basis the Belterra Park property was generating almost nothing - making it a hard fit for a REIT - it would have to be valued at almost zero for it to make sense to GLPI shareholders who demand a current yield on their assets.

William Clifford, CFO of GLPI said on a call discussing the deal:
"The primary reason why we left off Belterra with the operating company is because on a historical basis it has fairly low levels of EBITDA which meant that we weren't really paying very much for it.  And what we were able to do by leaving it behind, was to take the tax basis of the property and transfer that to OpCo which will eventually save us taxes on the gain relative to spend.  That represented probably somewhere north of $50 million worth of tax savings.  So even on a multiple basis, it seemed to make sense and quite candidly, we think it adds value for OpCo and will depreciate by the Pinnacle team."
The decision to leave Belterra Park with the OpCo was made almost a year ago, since then the property has begun to turnaround its performance.  Ohio built 4 casinos between 2012 and 2013, plus granted licenses to many similar racinos, all that development at once hurt the entire market in the state and is just now beginning to recover, Beltera Park included.  Net win at the racino is up 31% year over year through April of this year.
GLPI valued it at $75MM in its letter, typically I would discount this valuation as GLPI was attempting to convince Pinnacle shareholders the deal was in their best interest.  But if anything, $75MM seems low compared to the initial development costs even considering the properties initial struggles - but improving - and additionally new Pinnacle will benefit from the depreciation tax shield in addition to the step up basis on the sold assets discussed earlier.  It's also clear that Pinnacle's management is willing to sell real estate and may look to do a sale-leaseback of Belterra Park once it fully stabilizes.

Excess Undeveloped Land - Lake Charles & Baton Rouge
Staying with Pinnacle Entertainment is roughly 500 acres of undeveloped land, about 50 of those acres are adjacent to their flagship L'Auberge Lake Charles resort which is positioned as a regional destination with non-gaming amenities (concerts, restaurants, golf course) and has an equally positioned Golden Nugget resort next door (which was supposed to be an Ameristar Casino, but Pinnacle had to divest it at the time of the Ameristar-Pinnacle merger).  This land could potentially be valuable as an additional redevelopment asset for this growing market and could benefit from the Golden Nugget casino as well building up the overall market and land value around the two casinos.

The other 450 acres around the L'Auberge Baton Rouge resort looks a bit more uncertain given its size and isolated location (at least according to Google Maps).  GLPI valued the excess land near both properties at $30MM or roughly $60,000 per acre which seems within reason.

Insider Buying
While the new Pinnacle Entertainment isn't your normal spinoff since all the employees came with the spinoff, it's still encouraging to see management has been buying shares in recent weeks (maybe with proceeds from GLPI shares?) giving more validity to their own thesis that the shares are undervalued.
In addition to the insider buying, the company also announced a $50MM share repurchase plan signaling both confidence in their free cash flow and again that their shares are undervalued.

Summary
Profroma for the Meadows acquisition that should be completed this fall, Pinnacle Entertainment trades for 6.5x EBITDA whereas its near identical peer in Penn National Gaming trades for 7.5x EBITDA.  Yes, the structure is leveraged unconventionally and has some risk, but for a $700MM market cap company with almost no tax liability going forward and ~$105MM in real estate provides additional margin of safety at this valuation.  Additionally, management and the company itself are significant buyers of the company's shares.

Disclosure: I own shares of PNK

Par Pacific Holdings: Wyoming Refining Acquisition, Rights Offering

I wrote a poorly timed update of Par Pacific Holdings about six weeks ago, since then the shares have dropped over 20% as crack spreads continued to tighten at the same time as Par Pacific's principle refinery asset in Hawaii is shutting down for a period to undergo significant maintenance.  Crack spreads are of course volatile, however management has guided to the Hawaiian business generating $100MM in mid-cycle EBITDA keeping the valuation thesis largely intact.  The growth story relies on Sam Zell's handpicked team making additional acquisitions in the currently distressed energy sector in order to finally start making a dent in the large tax asset.

This past week, Par Pacific announced the acquisition of Wyoming Refining, it operates a small refinery (18,000 bpd) and related logistics assets in Newcastle, WY which supplies the Rapid City, SD market and nearby Ellsworth Air Force Base.  The refinery is in the attractive Rocky Mountain region (PADD IV) where oil supply outstrips local refining capacity and where demand is growing due to the increased industrial activity (although much of it is oil and gas related) in the region, this creates wider average crack spreads.

Par Pacific is paying $271MM for Wyoming Refining from a private equity owner and its expected to generate $50MM in EBITDA, or a 5.4x multiple, which unfortunately doesn't appear like a particularly distressed asset.  The previous owners have invested significant capital recently to increase the capacity of the refinery which should minimize near term capex needs, but I was hoping the next deal would be a fire sale asset from a distressed E&P company, but onto the deal details and resulting change to the valuation.
Note the rights offering and quick July 15th close, more details will follow on the structure of the rights offering but any current shareholders should be prepared to fully participate or face dilution.
The crack spreads for this niche refinery are pretty huge, at least in comparison to the high single digits seen at Par's Hawaiian refinery, much of that can be attributed to difference in the supply chain, Hawaii has to source crude oil from at least half an ocean away whereas the Wyoming refinery is close to new fracking supply that's come online in recent years.

Proforma Valuation
Using the same basic frame work from a couple months back and updating for the recent Q1 results and Wyoming Refining acquisition:
The market is roughly assigning no value to Par Pacific's ownership in Laramie Energy (which is maybe right? I'm not smart enough to value an E&P) and no value to the NOL as well (which could be right as well, quickly finding out its not easy to generate taxable income in the energy sector).

Disclosure: I own shares of PARR