Big changes seem to be coming to the casino industry as gaming companies consider converting their properties into more tax-efficient real estate investment trusts (REITs). The recent $4 billion buyout offer for Pinnacle Entertainment's (NASDAQ:PNK) property is one example of this REIT trend.
Pinnacle Entertainment, though it does not have any properties in Las Vegas itself (the company owns properties elsewhere in Nevada and around the U.S.), was offered a stock deal valued at over $4 billion, including the assumption of debt, to sell its properties to Gaming and Leisure Properties (NASDAQ:GLPI). In 2013 Penn National Gaming (NASDAQ:PENN) decided to spin off part of its business as a REIT that specializes in casino and resort companies, which is how Gaming and Leisure the REIT company was created, holding the Penn properties and buying new ones to then turn into real estate investments.
Gaming and Leisure's story and recent buyout offer to Pinnacle are good reasons for Las Vegas investors to watch this REIT trend, which could really impact their Las Vegas investments. Caesars Entertainment (NASDAQ:CZR) and MGM Resorts International (NYSE:MGM) both have significant properties in Las Vegas, both are considering REIT options, and changes to either companies' property structure could have significant impact for Las Vegas investors in the short and long term.
REITs in Las Vegas could be a short-term win
Here's the first thing investors probably want to know about REITs: Investors who own shares of a casino with property converted to a REIT stand to earn higher overall returns in the short term.
REITs don't pay income tax like regular companies do, and instead can send more of their EBITDA to net income and back to shareholders, in fact they are required to pay 90% of income to shareholders. Furthermore, if you are invested in a company that converts to a REIT, you could be in for a special one-time dividend from the conversion that could boost returns significantly.
Caesars plans a REIT move
Following years of income losses and crushing levels of debt, Caesars Entertainment recently took drastic action to avoid defaulting on its debt obligations by allowing its largest operating segment, Caesars Entertainment Operating Co. (CEOC), to file for bankruptcy protection while restructuring the other parts of its organization.
Next, the company is preparing to turn many of its properties into a REIT. CEOC's bankruptcy plans include allowing some properties to remain under CEOC operation as before, but converting as many as 18 separate properties, including Caesars Palace in Las Vegas, into a REIT that owns the properties and leases them out for their continued Caesars-branded casino operations. The plan is still contingent on legal approval, which could take up to a year.
MGM shareholders want their slice of the REIT pie, too
MGM Resorts' stock price jumped on March 17 when it was announced that one of the company's activist investors was pushing to get management to spin MGM's land assets into a REIT. MGM had already been considering this action for some time, and CEO James Murren even talked about REITs in the most recent earnings call, saying that it's something the company has considered, but there has been nothing definitive on the subject yet.
Still, investors are showing their excitement over REITs and what they can bring to shareholders, as was shown March 17 when MGM shares popped 11% on this REIT request news. If MGM Resorts pursues this option, expect more investors pushing for other casino companies to follow Caesars Entertainment and MGM Resorts with their own REIT conversions.
But beware: The REIT structure could be a long-term losing bet
Both Caesars and MGM have a lot of domestic property assets, and both have struggled over the last few years to make net profits on these properties. Converting to REITs, paying much less in tax, and having more focused segments -- in order to separately operate properties and gaming/resort operations -- could be a way for these companies to become much more profitable, and return more money to shareholders.
While the short-term payoffs sound good, there are significant long-term risks. For one thing, Las Vegas is constantly changing, meaning that these companies are forced to reinvent themselves and their properties often. Just look at how much construction MGM has put into its Las Vegas Strip properties in the last year alone. With these properties under a REIT, it would be harder to have any significant capital expenditure outlays with the necessary shareholder return of a REIT.
Think of what this could mean long term for Las Vegas investors in these major companies. The risk is that once a casino loses its luster, if it can't use enough capital expenditure to make needed upgrades and stay relevant in the face of new competition, the casino and resort operations there will eventually be doomed. Then if the economy tanks (like it did in 2008) and these companies don't own their physical property assets to fall back on, they could be in serious trouble.
For casino investors, the potential short term gains on these conversions looks promising. Little wonder the stocks have risen on this news. However, separating ownership from the management of these casino properties could be a long term losing bet. For the simple reason that long term success in the casino business requires constantly updating and maintaining traffic to the casino - a lack of ownership takes away this incentive.
Bradley Seth McNew has no position in any stocks mentioned. The Motley Fool is short Caesars Entertainment. 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.