Watchlist: GLPI and Penn National Gaming

There are a number of interesting situations and potential bargains out in the markets today, I typically don't write on companies where I don't own the shares, but for the next few months (however long we're all stuck at home) I might try to push out a few more posts on ideas where I've done some work on but don't own for one reason or another (limited cash), but want to be ready to take advantage of further declines.

One such situation is Gaming and Leisure Properties Inc (GLPI) which is the 2013 REIT spin of Penn National Gaming (PENN), PENN is now the largest operator of regional casinos in the United States and rents most of their properties from GLPI, they're still attached at the hip 7 years later.  GLPI was the first of the triple-net lease gaming REITs that now also includes VICI Properties (VICI) and MGM Growth Properties (MGP); GLPI owns the real estate of 40+ casinos and leases them back to casino operators who pay all the maintenance, taxes, insurance and other property level costs of the property.  The leases are typically structured as master leases and are functionally senior to the traditional debt as their physical casinos are critical to the operation of the business (although mobile will increase in share going forward).  In addition to the triple-net lease business, GLPI owns and operates two casinos due to tax rules at the time of the spin requiring an active business, one in Louisiana and the other in Maryland, both under PENN's Hollywood brand.  Their leases are primarily with PENN, around 80%, they did previously diversify by doing a PropCo/OpCo transaction with Pinnacle Entertainment (PNK) in 2016, but PENN ended up buying PNK in 2018 causing GLPI's tenant concentration to revert back.  GLPI also has Elderado (ERI) as a tenant from when GLPI paired with ERI in the acquisition of Tropicana Entertainment (TPCA), Boyd Gaming (BYD) due to forced divestitures from the PNK tie-up, and Casino Queen (smaller distressed player) on the rent roll.

Obviously, Penn National is in a considerable amount of distress with coronavirus and social distancing, they have closed all of their casinos and furloughed much of their employee base for an indefinite amount of time.  PENN is highly levered, their annual rent is significant at ~$900MM/ year (plus another $105MM in interest on regular debt), with $820MM of that going to GLPI, PENN is current on rent through the April payment, but would be unable to manage through this crisis without some forbearance or risk being restructured which would be disastrous for both GLPI and PENN.  This past Friday, GLPI and PENN entered into a unique transaction:

• PENN will be free delivering the Tropicana Las Vegas property and operations to GLPI, plus the land under their Hollywood Morgantown development that is scheduled to open around year end for $337MM in credits to be applied to the May, June, July, August, October, and a partial payment towards their November rent.
• PENN will then lease back the Tropicana Las Vegas from GLPI for $1/year and continue to run the operations and maintain the property.
• GLPI will engage in a sale process over the next 2 years to sell both the real estate and operations of the Tropicana Las Vegas in order to recoup the rent credits.  $307MM of the $337MM in rent credit is to be assigned to the Tropicana. If the property sells for more than $307MM then the excess would be split with PENN, 25% of the excess would go to GLPI if it sold in the first 12 months, and there would be a 50/50 split in year two, beyond year 2 GLPI would get 100%.  PENN had been rumored to have gotten inbound bids in the $700MM range as recently as this past January for the property, but those buyers are likely long gone.  PENN did purchase the Tropicana for $360MM in 2015 providing some assurance that the property is worth more than the rent credit GLPI is receiving (assuming Vegas isn't permanently impaired by the coronavirus).
• PENN additionally agreed to exercise their 5 year extensions on their master leases and entered into an option to purchase the operations in 2021 of one of GLPI's owned and operated casino, Hollywood Perryville (MD), for $31MM and enter into a $7.8MM annual lease for the property.

No one will confuse the Tropicana with a high end casino like the Wynn or Bellagio, but it is 35 acres and over 1400 rooms on one of the busiest corners on the strip.  Another tired casino in much worse location, Circus Circus, was just purchased for $825MM by Phil Ruffin in January.  Again, the world has changed, but if things return to any reasonable normalcy, GLPI should eventually get their deferred rent paid via the sale of the Tropicana.  And then PENN gains itself some breathing room with the rent credits at least into the fall, if they can open up the majority of their casinos sometime in the summer, they're likely to survive, if social distancing lasts deep into the third quarter or early fourth quarter it is likely game over.  PENN might be able to raise additional cash by selling their distributed gaming business or other non-casino related assets, but following moving the Tropicana over to GLPI, essentially all their properties are leased.

But how does GLPI itself navigate the remainder of 2020?  GLPI has $5.7B of debt and pays out approximately $600MM in annual dividends to shareholders.  Below is a quick analysis on GLPI's liquidity and ability to pay their dividend.  Both Boyd and Elderado (at least pre-CZR deal) have a stronger liquidity position than PENN, but let's assume both receive similar rent forbearance arrangements and then GLPI's operating casinos are a net cash drag on the year.

As always, I'm sure I've made a few mistakes in the above, so feel free to pick it apart, but it appears that GLPI could be in a position to continue its $2.80/share dividend, which is an 11% yield at today's $25/share price. 

A lot depends on when PENN can reopen their casinos and how receptive people are to returning to gambling following both a health crisis and for many people an economic one.  Regional casinos like PENN's might hold up better than destination ones as they rely on regular customers and focus on slot machines (~93% of their gambling revenue) versus convention business travelers or high rollers.  PENN is also making an aggressive move into sports gambling with their $163MM investment for a 36% stake in sports and pop culture media company Barstool Sports in February.  Barstool has an army of loyal followers, they're truly marketing experts, and Barstool personalities pumped up the stock in the weeks following the acquisition and before coronavirus realities set in for the company.  The plan is to rebrand PENN's sports betting operation to Barstool and launch an online sports betting app, where legal, in August ahead of the NFL season.  With sports essentially cancelled for the near term, that's another blow to PENN's plans, any delay to the NFL season would be particularly painful given their investment in Barstool.

Back to GLPI, original 2020 guidance was for $1.05B in EBITDA on about an $11B enterprise value, or 10.5x, in simpler times these gaming REITs trade at 13-15x EBITDA, 14x a normalized 2021 EBITDA would make GLPI a ~$42 stock versus $25 today.  In a dream scenario, there might be an extra $1/share in the Tropicana if sold for $700MM in year two, but that feels unlikely today.  There are certainly stocks with higher upside in this market, but once the smoke clears on PENN's casinos reopening, GLPI should re-rate pretty quickly once the disaster scenario of getting the keys in the mail is off the table.  Whereas PENN clearly has more upside, but may take longer and is more exposed to how quickly the economy recovers.  Why don't I own GLPI or PENN?  Not 100% confident the dividend remains at GLPI, if its cut, might actually be the buying opportunity as other investors sell if you believe in the long term durability of their leases.  Others thoughts welcome.

Disclosure: No current position as of posting

Pinnacle Entertainment: GLPI Deal Complete, OpCo Spinoff

In the fall of 2013, regional casino operator Penn National Gaming spunoff Gaming & Leisure Property Inc (GLPI) to hold their real estate assets and lease them back to Penn on a triple-net lease basis where the tenant is responsible for all the maintenance, taxes, and insurance.  The idea behind the move was a simple one, the market places a higher multiple on net lease REITs than it does gaming companies, so by separating the two, value is unlocked.  More recently, MGM did a similar move with MGM Growth Properties, and Caesars is contemplating the same within bankruptcy, it's becoming the industry standard operating model.  However, the IRS is starting to take a harder stance on REIT spinoffs which may lead to more scrutiny and give an advantage to those like GLPI who are already operating as REITs.

Following the Penn transaction, many investors looked to Penn's closest rival in the regional gaming sector, Pinnacle Entertainment (PNK), and pressured them to do a similar real estate spinoff transaction.  Concurrently, GLPI investors had been pressuring the REIT to diversify their tenant base as nearly all their casinos were leased back to Penn, a more diversified tenant base would lead to a higher valuation.  In July 2015, Pinnacle and GLPI came together in a deal that closed last month where GLPI acquired all of Pinnacle Entertainment and then simultaneously spunout the operating business under the same PNK ticker, creating "new" Pinnacle.

In the transaction, Pinnacle shareholders received 0.85 shares of GLPI and 1 share of new PNK for every share of old PNK they owned.  In effect, its a special dividend that recapitalized the company, much of the old debt moved to GLPI with the real estate and was replaced by a big capitalized lease payment.  The master lease has an initial term of 10 years, plus 5 options periods at Pinnacle's option for 5 years each.  The lease payment functions as an interest payment, except Pinnacle doesn't have to repay or refinance the debt, making it less risky in the event capital markets shutdown for a period of time.  While the lease is essentially debt, and I would treat it that way, it's not quite the same and when looking at the implied leverage ratio including the lease.

New Pinnacle Entertainment

The company now operates 15 properties (casinos, racetracks, hotel combinations) across 7 states but is relatively concentrated in Missouri (both Kansas City and St. Louis) and Louisiana with no exposure to Las Vegas or Macau as its larger peers.

Their biggest revenue generating casino is the L'Auberge Lake Charles in Louisiana that opened in 2005, in 2014 the Golden Nugget Lake Charles opened up next door creating competition, but in a "frenemy" sort of way as it's expanded the market, creating more of a regional weekend destination.  Visitors from nearby Houston (and it's energy economy problems) like the ability to easily go from one venue to the next, both have golf courses, spas, complementary restaurants and shuttles between the two properties.  In listening to recent earnings calls across the sector, gaming appears to finally be picking up around the country as consumers have more money to spend and have been moving away from retail to more experienced based spending.

One benefit of having casino REITs is their ability to acquire gaming assets at accretive prices given their low cost of capital, turn around and sell the operations to someone like Pinnacle and make the deal a win-win for both, essentially doing the REIT spinoff in reverse with the same benefits.  GLPI is doing just that with a racetrack and casino property, The Meadows, in Pennsylvania where it paid $440MM in December and sold the operations to Pinnacle for $138MM, which will close in the third quarter.  Ideally, the casino REITs aren't going to want to run the casino operations (GLPI has two they operate for spinoff tax reasons), but they'll be the most flush acquirers of properties that come up for sale giving operators like Pinnacle a source of new deals.  For The Meadows specifically, Pinnacle purchased the property for 6.4x TTM EBITDA and believes they can get an additional $10MM in synergies as it has been run as standalone business dropping the multiple below 5x EBITDA.

Proforma for The Meadows acquisition, Pinnacle did $645MM of TTM EBITDAR (R is rent to account for the capitalized lease expense), they have $130MM in cash, $968MM of conventional debt, and the lease obligation is $2.78B for a total enterprise value of $4.33B or an EBITDA multiple of 6.7x.  Penn National Gaming, it's closest peer in both markets and structure, trades for 7.4x EBITDA, which doesn't sound like a big difference, but when they're both as levered as they are PNK's market cap has some catching up to do.  Without the lease obligation and subtracting out the related rent payments, Pinnacle trades just under 6x EBITDA.

If the market valued Pinnacle at the same EBITDA multiple as Penn, it would be $18-19 versus ~$11.50 today.

Management in their roadshow presentation also laid out the case that Pinnacle was undervalued based on FCF (although a highly levered free cash flow).  On a free cash flow basis bumping it up to PENN gets closer to a $13-14 share price, still a fairly significant disconnect, it's probably worth somewhere in between the two metrics at $14-18 per share.

Overall, we have a slowly improving economy that's bring back some discretionary spending, a quality management team that has consistently driven margin improvements across their properties paired with some spinoff and odd accounting dynamics that are creating a temporary (hopefully) discount in Pinnacle's share price.

Risks:

• Leverage - Management will point to their conventional debt leverage in most discussions, which isn't entirely the wrong way to look at it since it's how their covenants are structured, but it's important to view the GLPI lease as debt when considering the entire picture.  With the GLPI lease, Pinnacle is about 5.6x levered, high for a cyclical consumer company and that leverage can cut both ways in a recession.  On just the convention debt, it's 3.6x levered.
• Lake Charles - Their Lake Charles casino is facing new competition at the same time as the downturn in energy is taking its toll on the Houston and Louisiana economies.
• Competition - Regional casinos were overbuilt in the last two decades, new supply is slowing outside of the northeast, Pinnacle doesn't anticipate any significant new competition coming online in their markets soon.  But local and state governments are always looking for new tax sources and as the economy picks up and casinos do well, its probably only a matter of time before additional gaming licenses are issued.

Disclosure: I own shares of PNK