Can You Profit From This New Capital Structure Trend In Gaming?

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Most casino companies are real estate development companies that happen to place gaming and hospitality professionals in their buildings. There is new interest in splitting the real estate portion of the business from the hotel & casino portion of the business.

This is a good move in general, but investors have to consider if these firms are overpriced or if there is a cheap way to get in on these potential spin-offs.

Splitting the Businesses

The recent announcement by Penn National Gaming (NASDAQ: PENN) to spin-off a section of the company by placing most of its properties into a real estate investment trust (REIT) may influence other casino companies to make similar moves. Penn National Gaming may have kicked off the next capital structure trend in the gaming sector as it seeks to distribute profits on a basis which is more tax efficient. The company has since gotten approval from the Internal Revenue Service related to the split’s tax treatment and needs no further approvals.

The real estate investment trusts are exempted from paying federal income taxes and are instead required to distribute a minimum of 90 percent of their taxable earnings to shareholders as dividends. Based on this, analysts now predict that real estate investment trusts will soon be alluring for casino companies as they seek to free up capital.

For instance, in the case of Penn National Gaming, the split is expected to lower its cost of capital as both the operating company and the real estate investment trust will continue to pursue developments and acquisitions separately although they may form partnerships on various projects. Also, as separate entities, Penn National Gaming may be free to maneuver around regulations in some states that set limits on the number of casinos operated or owned by a single company. In the plans relayed by the executives for Penn National Gaming, the real estate investment trust part of it will be able to own non-United States assets as well as eventually expanding into non-gambling real estate.

Capital restructuring to include REITs is a smart move in a market where REITs are very rich. Property trusts have raised record amounts of cash through equity and debt sales in the past three years as investors sought yields higher than those offered by United States government notes. In the case of Penn National Gaming, the real estate investment trust shareholders are expected to receive the property company’s income as an ordinary dividend – an approximated $2 per share going by the 2013 earnings projection. The projected earnings stand at a profit of about $3 a share on revenue of around $3 billion and adjusted earnings before tax, depreciation, amortization and interest of around $905 million.

While highlighting the importance of the targeted move, Chairman and CEO of Penn National Gaming, Peter Carlino, said, “This process will unlock the tremendous value of our real estate portfolio. This is just strictly our view of how we can best take the assets we have and make the most of them.”

Valuation Considerations

None of these firms is a screaming buy:

<table> <tbody> <tr> <td> <p><span>Ticker</span></p> </td> <td> <p><span>Company</span></p> </td> <td> <p><span>P/E</span></p> </td> <td> <p><span>P/S</span></p> </td> <td> <p><span>P/B</span></p> </td> <td> <p><span>P/FCF</span></p> </td> <td> <p><span>D/E</span></p> </td> </tr> <tr> <td> <p><span>LVS</span></p> </td> <td> <p><span>Las Vegas Sands</span></p> </td> <td> <p><span>25.9</span></p> </td> <td> <p><span>3.46</span></p> </td> <td> <p><span>4.05</span></p> </td> <td> <p><span>84.89</span></p> </td> <td> <p><span>1.05</span></p> </td> </tr> <tr> <td> <p><span>MGM</span></p> </td> <td> <p><span>MGM Resorts</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.58</span></p> </td> <td> <p><span>0.96</span></p> </td> <td> <p><span>8.36</span></p> </td> <td> <p><span>2.49</span></p> </td> </tr> <tr> <td> <p><span>WYNN</span></p> </td> <td> <p><span>Wynn Resorts</span></p> </td> <td> <p><span>20.99</span></p> </td> <td> <p><span>2.12</span></p> </td> <td> <p><span>26.85</span></p> </td> <td> <p><span>374.11</span></p> </td> <td> <p><span>14.06</span></p> </td> </tr> <tr> <td> <p><span>PENN</span></p> </td> <td> <p><span>Penn National Gaming</span></p> </td> <td> <p><span>21.82</span></p> </td> <td> <p><span>1.32</span></p> </td> <td> <p><span>1.7</span></p> </td> <td> <p><span>297.76</span></p> </td> <td> <p><span>0.99</span></p> </td> </tr> <tr> <td> <p><span>CCL</span></p> </td> <td> <p><span>Carnival</span></p> </td> <td> <p><span>20.8</span></p> </td> <td> <p><span>1.9</span></p> </td> <td> <p><span>1.22</span></p> </td> <td> <p><span>1470.66</span></p> </td> <td> <p><span>0.37</span></p> </td> </tr> <tr> <td> <p><span>RCL</span></p> </td> <td> <p><span>Royal Caribbean</span></p> </td> <td> <p><span>17.16</span></p> </td> <td> <p><span>1.0</span></p> </td> <td> <p><span>0.88</span></p> </td> <td> <p><span>10.64</span></p> </td> <td> <p><span>0.89</span></p> </td> </tr> </tbody> </table>

Shares of all these stocks except MGM (NYSE: MGM) are trading at high price-to-earnings ratios. In terms of revenue multiples, only MGM and Royal Caribbean (NYSE: RCL) seem attractive. Only MGM and Royal Caribbean seem to be trading at attractive discounts to their book values.

Being cruise lines, Carnival (NYSE: CCL) and Royal Caribbean are probably not going to convert to REITs. Royal Caribbean is probably the cheapest name on this list, though it has a higher earnings multiple thank the S&P 500.

The landlocked casino firms are too expensive to recommend, regardless of potential changes to their capital structures. Could they make a quick buck by converting their real estate assets into REITs? Put another way, are they cheap when compared to related REITs?

<table> <tbody> <tr> <td> <p><span>Ticker</span></p> </td> <td> <p><span>Company</span></p> </td> <td> <p><span>P/E</span></p> </td> <td> <p><span>P/S</span></p> </td> <td> <p><span>P/B</span></p> </td> <td> <p><span>P/FCF</span></p> </td> <td> <p><span>D/E</span></p> </td> </tr> <tr> <td> <p><span>BEE</span></p> </td> <td> <p><span>Strategic Hotels & Resorts</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.68</span></p> </td> <td> <p><span>1.76</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.76</span></p> </td> </tr> <tr> <td> <p><span>DRH</span></p> </td> <td> <p><span>Diamondrock Hospitality</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>2.47</span></p> </td> <td> <p><span>1.03</span></p> </td> <td> <p><span>284.93</span></p> </td> <td> <p><span>0.6</span></p> </td> </tr> <tr> <td> <p><span>HST</span></p> </td> <td> <p><span>Host Hotels & Resorts</span></p> </td> <td> <p><span>763.5</span></p> </td> <td> <p><span>2.12</span></p> </td> <td> <p><span>1.6</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.8</span></p> </td> </tr> <tr> <td> <p><span>LHO</span></p> </td> <td> <p><span>LaSalle Hotel Properties</span></p> </td> <td> <p><span>60.68</span></p> </td> <td> <p><span>2.58</span></p> </td> <td> <p><span>1.3</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.73</span></p> </td> </tr> <tr> <td> <p><span>PEB</span></p> </td> <td> <p><span>Pebblebrook Hotel Trust</span></p> </td> <td> <p><span>144.87</span></p> </td> <td> <p><span>3.66</span></p> </td> <td> <p><span>1</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.27</span></p> </td> </tr> <tr> <td> <p><span>RLJ</span></p> </td> <td> <p><span>RLJ Lodging Trust</span></p> </td> <td> <p><span>79.12</span></p> </td> <td> <p><span>2.47</span></p> </td> <td> <p><span>1.13</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.79</span></p> </td> </tr> <tr> <td> <p><span>SHO</span></p> </td> <td> <p><span>Sunstone Hotel Investors</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.61</span></p> </td> <td> <p><span>0.9</span></p> </td> <td> <p><span>84.42</span></p> </td> <td> <p><span>0.9</span></p> </td> </tr> </tbody> </table>

Hotel and motel REITs are often comparably-priced and less leveraged than many of the land locked casinos in terms of book and sales multiples. Its earnings multiples are a higher than those of the casinos.

Conclusion

If there is one casino that could really benefit from splitting its real estate holdings from its resort management business, it’s MGM. This company could use the proceeds from a spinoff to pay down some of its debt, and it is trading at much lower price multiples than hotel/motel REITs. Given MGM’s shaky balance sheet today and trailing net loss, it would be a speculative bet at best.

For the remaining gaming companies, the prices are too high to play, even with a REIT spinoff in the cards.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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