Description
TigerStyle had a great call on VICI back in 2018 on both entry in March and exit in November. Since that time, VICI has underperformed its closest gaming REIT peer, MGP, by 20% and GLPI by 17%. We won’t bore you with a rehash of the overview of VICI’s business. Please see TigerStyle’s write-up for that. In a nutshell, this is an extremely simple business: no capex, no taxes, 15-year lease terms, 2% annual rent bumps, and strong tenant income coverage with proven relative stability during even severe recessions.
We believe that a few things have resulted in VICI’s recent underperformance vs gaming REIT peers:
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First, VICI issued a significant amount of equity (increase in shares outstanding of 9.3%) on November 14, 2018. The proceeds have sat largely idle since and VICI ended the year with $1.1b in cash and leverage 20%+ below peers (almost unheard of for a REIT as they typically raise capital coincident with a deal). From the date of equity raise, negative sell-side AFFO estimate revisions have been small, but constant for four-plus months.
We believe these estimate revisions are on the cusp of inverting up as sizeable announced, but incomplete, deals close in coming months. These deals, Greektown Detroit and Jack Cincinnati, amount to $1.3b of capital deployment and $0.12/sh of AFFO accretion (8%). Greektown should close in the next couple months and Jack by year-end. Even assuming no incremental acquisition activity by VICI through year-end 2020 or option exercises (unrealistic), we believe less than half of this accretion is in Street estimates.
The deals will not only be accretive but will also require dividend increases of approximately 10% to get to the middle of VICI’s targeted AFFO payout range.
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Second, given recent uncertainty with VICI’s main tenant, Caesars, there has likely been skittishness to put incremental or new capital to work from REIT dedicated investors. This uncertainty has included an uncertain CEO succession, Icahn involvement / strategic alternative announcements, and an inability of management to manage the Street. The first bit of uncertainty has been quelled with the announcement of a tried and true CEO in Tony Rodio – a strong upgrade in our opinion from Mark Frissora, especially on the operations side. The second resolution will be clarity around the exploration of strategic alternatives. We would not be surprised to see a transaction with Eldorado Resorts (ERI) given the potential accretion there. A transaction with ERI could also give VICI an additional pipeline of future deals given ERI’s primarily owned portfolio.
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Third, given VICI’s emergence from Caesars bankruptcy as a standalone REIT, its investor base was / is overly weighted to the event driven / distressed crowd. As the market swooned later in 2018, the stock was likely a source of liquidity. While the shareholder base won’t change overnight, we believe that VICI and the overall gaming REIT space will become more “institutionalized” over time and trade tighter with its triple-net REIT peers.
The general gaming space has been experiencing some recent issues on top of VICI’s own:
The general gaming space has also underperformed traditional retail triple net REITs due to issues that we believe are largely transient. China New Year inbound activity to Vegas has been weak from trade impacts, weather has been a real hit to regional gaming trends, and lastly regional competition in markets like New Jersey and the Midwest has picked up. We are not overly concerned on sustained China impact, we expect there to be some sustained regional competition in certain areas of the Midwest and NJ that will limit overall regional growth but won’t be detrimental, and we believe it will be challenging for weather trends to get much worse. As a result, we believe that 2Q-4Q19 will look a lot better for the gaming sector than 1Q19 did. We think the enticement to be involved with “experiential” REITS will once again emerge as the year progresses.
So where should VICI trade to as a starting point?
When thinking about where VICI should trade, the company is most similar to MGP as they both have corporate guarantees attached to the vast majority of their earnings with similar tenant EBITDAR coverage ratios that are about double that of GLPI (GLPI has no corporate guarantee). Arguments for VICI to trade at a premium to MGP are its true independence as CZR has no ownership interest in VICI and has no board representation (MGM still owns ~70% of MGP, has board representation and could do things that are good for MGM but not MGP), three call option properties with over $100m of imbedded NOI at a guaranteed 10% cap rate (vs market value in the +/- 7.5% range), new tenant diversification from recent deals, and rights of first refusal on Centaur in Indiana ($80m-$100m NOI opportunity) and future non-Vegas CZR acquisitions to name a few.
We also believe that the gaming REIT sector valuation will converge with traditional triple net REITs over time as traditional REIT investors gain more comfort in the security of their tenant’s cash flows and they appreciate their “experiential” cash flows vs those of drugstores and other retail tenants that are under pressure from ecommerce secular threats. We don’t include this assumption in the price upside opportunity below.
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On an AFFO basis vs MGP (they have similar pro-forma leverage for all announced and unclosed deals), VICI is trading at a discount consistent with the all-time low back in the middle of 2018. With credit for the 3 options, which we expect VICI to start exercising in the next year, the discount widens to close to 1.0x. Even ex-option accretion, VICI is trading 0.7x (1.4x with options) wide of its historical average vs MGP. This is worth $1.10/sh just to get back to its average premium to MGP excluding option value.
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On an implied cap rate basis, we are graphing implied cap rates for VICI, MGP, NNN/O (traditional retail triple-nets) vs the 10-year Treasury yield. While the implied cap rate for VICI is wide vs MGP, the key on this chart is to focus on the black line, which is the spread between VICI’s implied cap rate-Treasury yield and that of an average of NNN/O. As you can see, VICI is trading around 50bps wide of NNN/O vs its average spread pre-equity offering. A contraction in this spread to the historical norm is worth $2.40/sh.
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Combined, this is $1.10/sh to get to the historical spread premium to MGP and an additional $2.40/sh as gaming concerns dissipate to allow VICI to trade at its average discount to traditional triple-net REITs, or a total of $3.50/sh of value from doing absolutely nothing. We think there is an additional $1.50/sh of value in its 3 options alone that should be realized or come clearly into view over the next 12-24 months.
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We expect an additional $2.10/sh of dividends through 2020.
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Adding it all up, we get mid-to-high teens annualized returns through the end of 2020 or a 26%-32% total return.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst