NEW YORK--(BUSINESS WIRE)--Link to Fitch Ratings' Report: Gaming, Lodging & Leisure Global
Despite the warm reception from credit and equity investors alike for two gaming REITs and three gaming operating companies (OpCos) created in the past two years, investors do not receive the same level of credit protection, according to Fitch Ratings. Most notably, the OpCos become saddled with sizable long-term leases owed to the REITs, increasing the OpCos' vulnerability to potential operating pressure.
Companies employed differing strategies to exploit this opportunity. Penn National Gaming (PENN) decided to spin off its assets tax free and created a REIT called Gaming and Leisure Properties (GLPI) in 2013. Pinnacle Entertainment (PNK), potentially driven by the tighter IRS rules on tax-free spins, opted to sell its assets to GLPI in exchange for stock. MGM Resorts International (MGM) pursued a different path and contributed its assets to a new subsidiary, MGM Growth Properties (MGP). MGM leased the assets back from MGP and sold 27% of MGP's stock to the public, enabling MGM shareholders to benefit from the higher REIT valuation of the 73% owned unit.
From MGM's perspective, Fitch has a neutral credit view on MGP's creation. On a consolidated basis, the reduction in debt enabled by MGP's equity raise offsets the leakage of distributions to MGP's minority shareholders. Besides its 73% interest in MGP, MGM retained two core Las Vegas assets, Bellagio and MGM Grand, as wells as equity ownership in MGM China, CityCenter and Borgata.
We view MGP's credit strength to be between MGM's and GLPI's. MGP's leverage is comparable with GLPI's and its assets are arguably better, albeit less diversified. Its credit profile is tied to MGM's since MGM owns 73% of MGP. However, some ring-fencing mechanisms enhance MGP's credit profile, including covenant restrictions and an independent vote requirement for material transactions. Furthermore, Fitch's more positive view of MGP relative to MGM is supported by the senior position of MGM's lease payments relative to its conventional debt, although we recognize the risk that the leases could be renegotiated.
PNK's and PENN's weak pro forma discretionary FCF relative to revenues of about 5%, means an 10% cumulative revenue decline with a 50% flow through would wipe out its FCF. This could be especially problematic if stemming from secular or competitive pressure, as opposed to cyclical, and/or come at a time when the company needs to refinance a tranche of its traditional debt. The increased sensitivity to revenue declines stems from higher fixed costs after factoring in the leases. PENN's and PNK's combined fixed costs, including lease and interest expenses, increased by approximately $370 million and $180 million, respectively, after the two companies shed their assets.
The main reason for splitting the companies' assets from their operations is multiple arbitrage. The markets currently value the real estate companies higher due to the perceived stability of the leases paid by the operating companies. Meanwhile, the OpCos still trade at similar multiples to traditional gaming companies that still own their assets. Gaming REITs trade at around 14.0x EV/EBITDA relative to traditional gaming companies' 7.0x-10.0x trading multiples.
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The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.