The gaming-REIT business model of Gaming and Leisure Properties (GLPI 2.04%) is starting to win supporters, especially since the press received a leak about the potential buyout of Isle of Capri (NASDAQ: ISLE).
The REIT status provides benefits which include decreased taxes, lower borrowing costs, and more ability to focus on operations. Foolish investors should expect Gaming and Leisure Properties to buy Isle and continue along a growth trajectory since it is a first mover in a high-value business.
Gaming and Leisure Properties was separated from Penn National Gaming (PENN 1.16%) in November 2013 through a tax-free spin-off of Penn's real estate assets.
After the completion of the spin-off, Gaming and Leisure became a publicly traded REIT and leased back most of the real estate assets to Penn under a 15-year operating lease.
Interestingly, Penn also transferred over all of the assets and liabilities of Hollywood Casino Baton Rouge and Hollywood Casino Perryville, which Gaming and Leisure now owns and operates through an indirect, wholly owned subsidiary.
As of March 31, 2014, Gaming and Leisure's portfolio consisted of 22 gaming and related facilities in 13 states. Of its 22 properties, it leases 19 facilities to Penn (including two properties under development in Dayton, Ohio and Mahoning Valley, Ohio), and acquired the Casino Queen in St. Louis in January 2014.
Gaming and Leisure expects to grow its portfolio by acquiring additional gaming facilities to lease to gaming operators.
Gaming REIT benefits
Penn's gaming REIT spin-off was the first of its kind and required a positive "private letter ruling" from the IRS, which it gained in 2013. This new REIT model has a couple of benefits for the gaming industry.
1. Due to the pass-through treatment provided to REITs, they do not have to pay corporate federal income tax on earned rent.
2. REIT's have lower borrowing costs, or cost of capital, than gaming companies. For example, Gaming and Leisure has a long-term average interest rate of 4.6% on all of its long-term debt until March 2019. On the other hand, Isle has an average interest rate of approximately 7.4% on its long-term debt until 2019.
3. For a gaming company strapped with debt, a REIT spin-off opens up borrowing capacity and allows management to focus on other issues, so it can compete more aggressively for state gaming licenses and casino development.
Isle-GLPI deal specifics
Reuters recently reported that unknown sources had told it about a deal between Isle and Gaming and Leisure which could finalize within weeks. Since there are currently no SEC filings regarding an acquisition, Foolish investors are left to a great deal of speculation.
Deutsche Bank gaming specialist Carlo Santarelli explained why GLPI would pay around $15.80 per share for ISLE:
For starters, we assume a straight sale of ISLE. While a sale leaseback is a possibility, we see a straight sale as more likely. Ultimately, the math to GLPI is largely unchanged regardless of the setup, though a straight sale likely elongates the process given our view that multiple operators are likely to be needed. Under our sale assumptions, we believe GLPI could pay 9.0x for ISLE, which values ISLE shares at ~$15.80.
The idea of a REIT buying a gaming company is interesting because the REIT will not be able to directly operate the casinos. Gaming and Leisure will need an operating partner for the gaming operations. One route Gaming and Leisure might take is splitting up the operations using a taxable REIT subsidiary like it does with its other two casinos.
I believe a deal between Isle and Gaming and Leisure will go through because it would provide the following benefits:
1. Gaming and Leisure Properties would increase its asset base and receive more rent payments.
2. Isle would get bought out at a premium.
3. The domestic gaming industry would become less saturated. Since Penn National shareholders received Gaming and Leisure shares from the spin-off, much of their ownership overlaps. For instance, Gaming and Leisure's CEO Peter Carlino is the chairman and largest shareholder of Penn National Gaming. This should ease the competitive gouging that has occurred in the gaming industry in recent years.
The versatility provided by Gaming and Leisure Property's REIT spin-off is creating value for shareholders of both corporations. Benefits like decreased taxes, lower borrowing costs, and a lower debt load make the gaming-REIT business model strong.
Although no official release has appeared on the Isle acquisition, the deal appears likely given the value it would create. Foolish investors should stay away from the craps tables and put their chips on this win-win-win scenario.