Atlantic City has been a mess for years now, the root of the problems stems from increased competition along the east coast, particularly starting in 2006 when the first casino opened in Pennsylvania. Previously Pennsylvania residents would travel across the border and spend money in Atlantic City casinos, now Pennsylvania has passed New Jersey to be the second largest gambling revenue state behind Nevada. Maryland has a bunch of new casinos opening up too and Massachusetts just granted a couple casinos licenses, competition is not going to let up anytime soon, and thus the Atlantic City market has been forced to shrink dramatically. We started 2014 with 12 casinos in Atlantic City, 4 casinos have closed so far (Trump Plaza, Revel, Showboat, and Atlantic Club) and the Trump Taj is likely to make it 5 when it finally shuts its doors in the next month or two (Icahn is Trump Entertainment's largest creditor).
The decreased competition has increased foot traffic at Tropicana's flagship Atlantic City casino and resort. The company made a savvy purchase of Atlantic Club's patron database and gaming equipment that has led to increased slot customer volumes (the most predictable kind of gaming revenue). While overall Atlantic City gaming revenue declined 9.3% across the city, Tropicana's casino revenues were up $21 million in Q3 2014 or 33% compared to Q3 2013. New Jersey has also approved the use of $18.8 million in CRDA deposits (otherwise basically restricted cash) and $4.8MM in grant money through the New Jersey Economic Development Authority to invest in the Atlantic City casino, all in, Tropicana is going to spend nearly $40MM upgrading the property while weaker players have been putting off capex and exiting the market. Previously seen a source of risk, the Tropicana Atlantic City has the potential to provide continued upside surprises as the AC market rebalances itself.
Another piece of good news happened this past January when the company received $32MM in cash as part of their property tax dispute with the city, previously it was going to be in the form of annual tax credits going out to 2017. A lot of this money will go to upgrading the Atlantic City property, but it also skews the first quarter results so keep that in mind when running your own numbers.
Real Estate Value
Most gaming companies have extensive real estate holdings, and in today's market that means activist pressure to re-evaluate capital structures and spinoff the real estate into a REIT.
- Penn Gaming (PENN) did a PropCo spinoff of their real estate assets in November 2013 which created Gaming & Leisure Properties Inc (GLPI), a REIT that triple net-leased backed the casinos to Penn Gaming and is pursuing additional acquisitions.
- Pinnacle Entertainment (PNK) announced plans to spinoff its real estate into a REIT on 11/6/14, activist Orange Capital had been pushing Pinnacle for a REIT conversion since Penn completed the GLPI transaction.
- Boyd Gaming (BYD), owner of the Borgata in Atlantic City, discussed the possibility of a REIT conversion on 10/30/14 and engaged Greenhill as an adviser.
- Caesars Entertainment (CZR) announced on 11/18/14 that they've approached their senior lenders about a plan to convert the company's 44 properties (including several in Atlantic City) into a REIT in order to help their over leveraged balance sheet. Caesars is a distressed play at this point, and the REIT conversion would likely be part of a bankruptcy reorganization.
In addition to owning most of their casinos, Tropicana also owns some other real estate assets including the two luxury hotels in St. Louis that were part of their Lumiere purchase, the HoteLumiere and the Four Seasons, the replacement cost is likely in the $150-200MM range for the combination of the two. They also own "The Quarter" adjacent to their Atlantic City casino, a 200,000 square foot Havana-themed mixed retail development featuring shopping, restaurants, nightclubs and an IMAX theatre, the development cost $285MM to build in 2004, even if its worth just a fraction of that, its still significant when compared to Tropicana's $520MM enterprise value.
The best comparable private market value transaction is still the December 2012 purchase of Ameristar by Pinnacle Entertainment for $2.8 billion including the assumption of debt for a 8.4x EBITDA multiple. But Icahn Enterprises (IEP) makes it a little easier coming up with a value by publishing a quarterly NAV estimate which gives a valuation for Tropicana at 7.5x EBITDA, about a turn lower than it's larger more liquid peers which seems appropriate.
Of course, we're tied to the hip with Icahn (plus its only a small fraction of IEP) as minority investors and might not see that valuation unless there's a liquidity event. But I also think there's plenty of potential for additional upside, we might start to see improved wage growth in 2015, and in combination with lower gas/energy prices should increase discretionary incomes in Tropicana's middle class demographic market. It might be a stretch, but just maybe with the economic recovery picking up steam, states and municipalities budget's could improve enough to not turn to casinos revenue to plug holes and restore some sanity to the competitive landscape. Even if you have a more cynical view of the industry landscape, Tropicana's valuation provides a nice margin of safety with the benefit of having Carl Icahn, an experienced gaming investor, making the capital allocation decisions and hopefully unloading it at a cyclical top.
Disclosure: I own shares of TPCA