18 Jul US casinos unlock the value in their real estate
It has been more than a decade in the making, but US casinos seem to have found a way to unlock the value in their real estate, unleashing a wave of mergers and acquisitions across the sector.
Casino operators are increasingly splitting off the land on which their giant entertainment complexes sit, taking advantage of investors’ desperate hunt for income in a world of ultra-low interest rates to juice their share prices and pursue swashbuckling dealmaking.
James Goldstein, an analyst at research firm CreditSights, said the sale and leaseback of property is making up for the difficulty of getting new casinos off the ground in the US.
“Given the lack of domestic greenfield opportunities, the availability of property finance has facilitated recent sector M&A, a necessity for growth,” he said.
The question now is whether the tactic has made gaming companies themselves an unduly risky proposition for investors, and how they — and their associated property companies — will perform in an economic downturn.
Nowhere has the financial engineering been more thoroughly pursued than at Caesars Entertainment, the company behind Caesars Palace, its flagship property on the Las Vegas Strip, and a portfolio of other casinos from Mississippi to Illinois.
An audacious $31bn leveraged buyout by the private equity firms Apollo Global and TPG in 2008 exploited Caesars’ property value to help fund the deal. In addition to issuing traditional cash flow-based loans and bonds, the firms also mortgaged Caesars’ properties, issuing nearly $7bn of debt in the form of commercial mortgage-backed securities linked to a handful of casinos that included Harrah’s and Rio. Backed by the appraised value of the properties, rather than by Caesars’ cash flows, the CMBS allowed for greater leverage.
The deal was signed on the cusp of the financial crisis, and the debt load quickly proved to be excessive. The Caesars CMBS debt ultimately was refinanced into a different structure in 2013 and the core Caesars operating company filed for bankruptcy in 2015.
However, savvy investors still believed in the Caesars property portfolio as a way to lower the company’s borrowing costs.
The hedge fund creditors that seized control of Caesars in the bankruptcy separated the reorganised businesses into an “OpCo/PropCo” structure with two distinct public companies. The PropCo, a real estate investment trust, or Reit, called Vici Properties, owns the land and buildings of several Caesars properties scattered across the US, including the flagship Caesars Palace in Las Vegas. Vici earns income by leasing those facilities back to the Caesars OpCo, which manages the casinos day-to-day.
Caesars annual rent expense is formidable, totalling nearly $800m a year to Vici. Adding the implied present value of those rent payments to Caesars’ other bonds and loans, its total debt approaches $15bn.
Reits have been popular with investors because they pay out the bulk of their income in the form of dividends, making them a high-yielding alternative to corporate or junk bonds. They have long been a feature of the financial landscape in the real estate sector — some of the largest publicly traded Reits own vast portfolios of shopping malls or office buildings — and their emergence in the gaming sector has wrought a revolution.
As investor demand has driven Reit valuations higher, and the vehicles have been hungry to buy more property, they have become a cheap source of M&A financing and fuelled a dealmaking wave.
In June this year, Caesars Entertainment was once again acquired, in part at the urging of activist investor Carl Icahn, who had amassed a 15 per cent stake. The buyer was an obscure casino operator based in Reno, Nevada, called Eldorado Resorts.
Eldorado was able to pay $11bn, a generous 30 per cent premium to the prevailing share price — but it had help. Vici agreed that it would simultaneously buy the underlying land and buildings of three additional Caesars casinos for $3.2bn, providing Eldorado with extra cash to fund the deal.
“The Caesars/Eldorado deal represents the continuation of consolidation in the sector and was only made possible by the Reit,” said one longtime gaming investor.
Enterprise value: $14bn
Number of properties: 22
Select casinos: Caesars Palace Las Vegas, Bally’s Atlantic City
Gaming and Leisure Properties
Enterprise value: $14bn
Number of properties: 44
Select casinos: Tropicana Atlantic City
MGM Growth Properties
Enterprise value: $13bn
Number of properties: 13
Select casinos: Mandalay Bay, Mirage
Eldorado began as a single Reno property in 1973, and just five years ago its shares traded at under $5. But chief executive Tom Reeg, a former junk bond investor at AIG, has executed a series of acquisitions that have helped Eldorado shares rocket to nearly $50, giving the company an enterprise value of greater than $7bn. Fresh from inking the Caesars deal, Mr Reeg announced the company was raising additional cash by selling three of its own properties in Missouri and West Virginia to Vici, with the associated OpCos going to Century Casinos.
The structure has sprung up at other casino businesses. MGM Resorts and Penn National Gaming have also established Reits. Penn National and another casino business, Boyd Gaming, jointly acquired Pinnacle Entertainment for $3bn in 2018 using the Penn National Reit to help fund the deal. That Reit, called Gaming and Leisure Properties, now boasts 44 regional properties. MGM Growth Properties owns just 11 properties, but they include the luxury Mandalay Bay and Mirage casinos in Las Vegas.
These three Reits have together executed more than $15bn in property acquisitions over the past six years, according to data from Dealogic.
Lease obligations to their Reit landlords leave the OpCos highly sensitive to the fortunes of their gaming businesses. While Vici shares are up more than 20 per cent since it began trading in October 2017, roughly in line with the S&P 500 index, Caesars shares are down 3 per cent over the same period. In part, that is because of worries about its heavy rent payments.
Eldorado shares have fallen nearly a tenth since the Caesars acquisition was announced in June on worries about the new operating leverage and scepticism that it can wring out $500m in annual synergies promised by Mr Reeg. One former Caesars executive wondered if slashing the company’s famously large centralised marketing budget in favour of Eldorado’s leaner approach “would put revenue at risk”.
Meanwhile, the gaming Reit model is untested in a financial downturn. “It does introduce some risks,” said Mr Goldstein of CreditSights. “Leases reduce the ability for operators to individually address underperforming locations. The absence of owned real estate assets gives operators fewer options in the event of unanticipated financial challenges.”