Description

Ticker: GLPI (Long)

Event Type: Transformational spin ---Liquidity provider to a capital-starved space (the only company in the industry that is able to leverage their cost of capital advantage to consolidate the gaming/hospitality space)

Risk / Reward: Down 2 Up 'a lot' 

Duration: undefined

Situation Overview:

GLPI is the propco, which was spun-off from Penn National on November 4, 2013. GLPI is headed by Peter Carlino (owns ~10%) and CFO Bill Clifford both were previously CEO and CFO of Penn National. Fortress is also involved in GLPI. GLPI initially had PENN as a single tenant across 19 of 20 properties in the QRS with a goal of diversifying over time. The leases are triple net leases with PENN responsible for all expenses. GLPI has communicated that it will be aggressive, yet disciplined, in pursuing acquisitions. GLPI management team has been very active in acquisitions over the past 10 years at PENN.  Every $50 million of rental EBITDA acquired by GLPI is approximately $3-$4 per share of value to GLPI (using current multiples and yield). The GLPI pitch is that it is the friendly bank vs. aggressive lenders and that GLPI can do up to $40-$50 mm in acquired EBITDA from acquisitions annually at approximately 10x EBITDA.

Catalysts

• Second tuck-in transaction since spin-off ($10-$15mm of rental income)
• Proxy Filing in next few weeks: will clearly lay out management and business development professionals incentives
• Participant in buying Cosmopolitan (see article – no discussion below other than merger math) - http://dealbreaker.com/2014/04/who-wants-to-buy-a-las-vegas-resort/
• Sale of the company - more likely in 3+ years

What the market thinks

• Single tenant structure creates meaningful credit risk
• Gaming is discretionary and volatile putting rental revenue at risk
• Overlapping management at GLPI and PENN creates a conflict of interest
• Incremental government focus on REIT conversions creates risk

What the market is missing / what is the misunderstanding?

1. Single-tenant risk is overblown. Gaming is highly regulated.  In many of GLPI’s primary tenant’s (PENN) markets, the number of gaming licenses is limited by statute, which prevents new competitors from opening nearby. In addition, certain states determine specific locations where casinos can be operated, limiting operator mobility. Therefore, gaming regulation creates “sticky” tenants for GLPI, making it very difficult for the tenant to cease operations or move elsewhere.  Further structural supports to GLPI include: 

• Leases are governed by a Master Lease with full cross-default provisions (Tenant can’t voluntarily pull out of a single location w/o jeopardizing all its leases) – see 10K
• Tenant cannot revoke a lease without transferring the non-real estate gaming assets to a successor tenant
• Upon expiration of the lease, Tenant must sell the non-real estate gaming assets to a successor tenant
• Properties have significant barriers to entry, limiting competition and reducing lease volatility
• Leases are first position to Tenant debt
• Deal structure is set to maintain minimum 1.8:1 rent coverage throughout the term.

GLPI management has discussed diversifying tenants through M&A.  Per management, GLPI will pursue gaming targets at first and non-gaming acquisitions after some period.  Further management has said they have received several reverse inquiries from gaming operators and are at various stages of discussions with several parties (and are clearly hiring for M&A - http://investors.glpropinc.com/releasedetail.cfm?ReleaseID=837131).  We believe that GLPI’s M&A pipeline is fertile and have modeled 11% AFFO accretion (year-1) assuming $500mm of acquisitions at constant leverage (including Queens Casino - http://investors.glpropinc.com/releasedetail.cfm?ReleaseID=820932 ) at a 10x multiple paid on GLPI Rental Income.

Sample Acquisition Analysis

Casino Queen Acquisition Analysis – Completed January 2014

1. Resilient business.  PENN’s economic exposure is only moderately cyclical and GLPI is conservatively positioned with the REIT structure against PENN’s exposure.  Regional gaming is an accepted form of inexpensive entertainment and is much different from destination gaming markets; in the most recent economic downturn PENN’s same store EBITDA compressed 13% but operating margins and revenues remained firm.  In order to illustrate GLPI’s strength, management has detailed pro forma rent coverage assuming that all properties declined in-line with the 2008 downturn immediately post-transaction.  Rent coverage would slip from 1.9:1 to 1.6:1 – still at a healthy level and in-line with/above the REIT universe.

• GLPI and PENN have a common chairman and one other overlapping board member, however we believe that PENN’s historical operating performance points to prudent, arms-length management post-conversion.  GLPI and PENN have overlapping board members but each company’s management team is independent and will have its own board and shareholder base.  Historically, GLPI management has prudently managed and has allocated capital very well – including negotiating very favorable terms regarding their private equity suitors’ investment after their go-private deal broke in 2008. Going forward, it is in GLPI’s best interest to have a strong, growing PENN as a tenant and we believe that PENN management agrees based on the rent coverage limits in the Master Lease (i.e. no escalator in base rent if rent coverage slips below 1.8:1).  Ultimately, we don’t view overlapping personnel as an impediment and think management’s experience might be a tailwind as PENN and GLPI may work together to pursue growth opportunities in the future.

• Incremental government scrutiny regarding REIT conversions- this needs to always be closely monitored from a comprehensive tax reform perspective (http://waysandmeans.house.gov/news/documentsingle.aspx?DocumentID=370987 ). We have spoken with several tax advisors who expressed the view that the Camp proposals will not be enacted anytime soon (“not getting done this year”), but nevertheless they should be monitored. Camp’s proposal was issued as a “discussion draft” meaning that there technically isn’t any formal legislation.

Risks

• PENN / GLPI - Consumer exposed.  Economic uncertainty could lead to lower consumer spending.  Dollars wagered are highly discretionary and compete with other forms of entertainment; if consumer spending declines earnings growth and valuation would compress at PENN, but not impact GLPI (yet). 80% of GLPI’s rental revenues is from fixed rent which escalates annually by 2% subject to a cap that won’t escalate should Rent/PENN EBITDA fall below 1.8x coverage. Based on PENN’s 2014E EBITDA, PENN currently has a cushion of $30 million (on a $780 MM base) prior to falling below 1.8x rent coverage. Variable rent contributes approximately 20% of total rental revenues for GLPI.  50% of this variable rent revenue is exposed to PENN’s Columbus and Toledo facilities on a monthly basis with the remaining 50% of the variable adjusted every 5 years.  To the extent Columbus and Toledo revenues were to drop by 10% annually this would translate to a 2% decrease in total rental income and 1.5% decrease to the dividend or at current yield of GLPI an impact of $0.75 to the stock price. 

Note: January and February 2014 regional gaming revenues were down meaningfully as payroll taxes, gas prices, delays in tax refunds and worse weather weighed on consumer spend relative to 2012/2013.

GLPI Exposure to Variable Rent from Ohio:

Current Takeaway: GLPI’s exposure to PENN’s consumer and gaming competition in the near term is primarily in the Columbus and Toledo markets.  These markets represent approximately 10% of total GLPI’s EBITDA from PENN.  Further, 2014 is largely understood to be a low year for PENN EBITDA as 2013 EBITDA was $70 million higher and 2015 is projected to be $80 million higher as new expansion projects come online in late 2014. 

• Single Tenant Risk: Regarding GLPI, we believe that the diversification issue is overblown and the company will announce/complete diversifying M&A transactions over the next 3 years as they have a first mover competitive advantage.  GLPI could see its price increase and yield compress as it diversifies.

Current Takeaway: GLPI’s single tenant exposure will be reduced as the Company makes acquisitions in the coming months/years. GLPI has communicated the desire to diversify its tenant base via acquisitions. Penn is currently in stable financial condition with rent coverage ratio north of 1.8x and debt/ebitda less than 4.5x.

• Lack of execution on M&A from competition and lack of appeal by gaming owners: GLPI is the first “gaming focused” REIT providing a vehicle for industry participants to gain access to lower-cost financing, while still maintaining control over the operations of their businesses. As GLPI succeeds in the acquisition strategy there is likely to be additional competition to GLPI.  However, there are significant barriers to likely dissuade other REITs from competing with GLPI in the medium term including: (1) requirement that owners of gaming real estate be licensed (EPR another existing REIT which has expressed interest is not licensed); technical nature of gaming real estate (GLPI mgmt execution history); and (3) small industry size, relative to others such as industrial and office. 

In terms of other gaming companies looking to emulate GLPI structure, Pinnacle (PNK) and Boyd (BYD) have been mentioned as potential REIT candidates in the medium term. Both PNK and BYD have NOLs which likely won’t expire for several years (PNK- 2017/18 with over $500 million in NOLs) and BYD (2020/21- with over $1 billion in NOLs).  Management of both PNK and BYD will not comment specifically on copying GLPI’s REIT model but have indicated a desire to exhaust NOLs in the short to medium term (BYD activist investors would like to see GLPI work with BYD management on a sale lease-back transaction to free up liquidity). Further, GLPI/PENN took nearly 2 years to successfully convert to a REIT. Our understanding from tax advisors is that should PNK or BYD choose to convert to a REIT it would likely take 12 months, and there have not been any pre-notifications or exploratory talks as there were with PENN.

While we have yet to see a significant deal by GLPI we believe that GLPI’s terms are likely to appeal to many owners of gaming real estate as a result of: 1) industry leverage which motivates owners to de-lever and pay maturities; 2) fragmented ownership of gaming assets with many non-strategic owners looking to monetize; 3) weakening general regional industry trends. GLPI in conference calls and management presentations has commented on the significant interest from operators on structuring acquisitions either via sale-and-leaseback transactions or partnering with a third-party operator to purchase an asset together. Further, industry contacts and recent news reports indicate GLPI has been bidding on several transactions including a deal with Foxwoods to fund 55% of its proposed $1B Massachusetts development (deal ultimately didn’t get voter approval) and a $150 million purchase of a Miami Jai-Lai facility (GLPI lost in bid similar to Casino Queen style transaction).

GLPI M&A Opportunity:

• Change in Regulatory Landscape: Legislation for new or expanded gaming in GLPI’s or tenants (PENN, Casino Queen) could ultimately pressure its lease creditworthiness. Several states have recently passed land-based gaming bills with potential casinos to be awarded included Massachusetts, Pennsylvania and New York. Further, several states are worth following as they have introduced land based gaming bills including: Kentucky, New Hampshire, Illinois (expansion), Connecticut and New Jersey (Meadowlands).  The growth of internet gaming could also impact tenants credit risk including recent bills introduced in California, Hawaii, Iowa, Massachusetts and Pennsylvania.

In addition, changes in taxes by states on the gaming industry, which vary widely by state is a risk that can directly affect the financial status of tenant’s profitability and competitive positioning.

• Turnover of Investor Base- From Event/Gaming to REIT Investors: GLPI was added to the MSCI REIT index on February 28, 2014.  We believe the transition from Special Situation/Gaming Investor to REIT investors is underway. Our conversations indicate that a prevalent view from the Special Situation/Gaming Investor is when is the “big deal coming?”  Further, our conversations with analysts covering GLPI is that significant work is being done by REIT investors but that they move slowly and the execution of an acquisition and the translation to dividend growth will validate GLPI’s business plan for many REIT investors. REIT analysts have communicated that most equity REITs with $3-$5 billion in equity market capitalization tend to have about 5-6% of their free float shares held by a REIT index and ETF funds, which would equate to 5-6 million shares of GLPI. 

Net/Net: We believe after various discussions with investors and counterparties that GLPI is on several REIT investors’ screens and is being actively researched. Upon execution of a deal GLPI will become more attractive to REIT investors both through the equity offering via increase in the float as well as the growth of the dividend.

• Interest Rate Exposure – We would expect as rates rise from current levels, that dividend yields of triple-net lease dividend yields would adjust accordingly. Although interest rates will certainly impact valuation (see table below), we believe that ultimately GLPI’s ability to consummate accretive transactions will more than offset any increase in GLPI’s dividend yield.

Underwriting:

Downside: 12.5x 2014E AFFO or 6% Dividend Yield = $33+ divi = $35 (~6% yield)

Base Case: ~15x 2015E AFFO (~$2.90 base AFFO + M&A = $3.3+-) and implied divi yield of 2.65 (80% payout) or 5.25% = $50 (with $50 million annual rental income from M&A, although 2014-15 they prob generate $150mm ex large scale transformational deal)

Upside Case: no reason to even discuss in detail - we can get to $7-$8bb equity value and could be a takeout candidate. At some point Peter will be ready to exit stage left like Sam Zell (my best guess is in early 2017)

Additional Levers not discussed

• Non-gaming transaction opportunities exist for GLPI. There was an estimated $150 Billion in office, industrial and retail property transactions in 2012. Further, opportunities exist in theme parks, stadiums, ski resorts and other leisure land/building.
• GLPI’s management has discussed their desire to pursue acquisitions including a potentially landmark Vegas strip deal. GLPI would certainly be considered a preferred financing source with the potential for some Vegas properties to bring in $75-$125 MM in rental EBITDA to GLPI (Treasure Island, Mirage, Cosmo (see story above) etc.).

Catalyst