MGM Resorts Surges On Activist REIT Plan That Counts On Las Vegas Rebound
MGM Resorts MGM +10.22% surged over 10% on Tuesday after an activist hedge fund run by Jonathan Litt, a former top gaming and lodging analyst at Citigroup C +0.11%, called for the company to convert its land assets into a real investment trust (REIT) and spin off its lodging and entertainment business in a tax free manner. The hedge fund, named Land and Buildings, also asked MGM Resorts to prepay its debt and pay a special dividend, financed by the sale or spin of its operations in Macau, the offshore gaming market for China.
Land and Buildings believes MGM Resorts holds a base net asset value of $33 a share, or 70% upside to Monday closing prices, and the potential to rise as high as $55 a share, or 180%, if its proposals are enacted by CEO Jim Murren. “Land and Buildings believes MGM’s high-quality real estate portfolio is substantially undervalued in the public markets,” Litt said in a statement, while adding the fund is pleased Murren has shown a willingness to considering a REIT conversion.
Penn National Gaming, a small Pennsylvania-based casino operator, spun its real estate into a REIT called Gaming and Leisure Properties in late 2014 and Pinnacle Entertainment PNK +0.63%, the operator of the Boomtown Casino and Hotel in New Orleans, said in November it planned to pursue a REIT conversion. Larger industry players such as Boyd Gaming and MGM Resorts, which operates the Aria, Bellagio and MGM Grand on the Las Vegas Strip and MGM Macau in Asia, have indicated they are considering similar moves
MGM Resorts CEO Murren said on a fourth quarter earnings call, “the concept of converting gaming assets to REITs is not a new one. It was very active, we discussed it before the recession. In fact, a couple of companies pursued that and then cancel(ed) those plans. And more recently, the dialogue is there again. We look at this all the time. We’re pitched by every bank that is out there in terms of whether or not we should do that. And there’s some merit to it.”
However, Murren said he had nothing to report as of the fourth quarter, stating “there’s nothing definitive.”
If Murren doesn’t adopt Land and Buildings REIT conversion and its other proposed financial acrobatics, the small-sized activist fund, which owns significantly less than 1% of MGM Resorts outstanding shares, said on Tuesday it will propose a slate of four board nominees at MGM Resort’s 2015 annual shareholder meeting. The nominees include Litt, in addition to Matthew Hart, former CFO of Hilton and Host Marriott, Richard Kincaid, former CEO of Equity Office Properties, and Marc Weisman, former CFO of Oppenheimer & Co.
Part of the Land and Buildings plan stems from MGM’s poor performance over the past 12-months, amid a slowing of the red hot Macau gaming market, which helped casino giants like Las Vegas Sands LVS +1.32% survive the financial crisis. Land and Buildings believes MGM’s stock has been unfairly hit by the Macau slowing, even though the vast majority of the company’s profits come from the recovering Las Vegas market, according to a source with direct knowledge of the fund’s thinking. Were shares to recover, ideas such as REIT conversion would be less pressing, that source said.
In 2014, 85% of MGM’s EBITDA came from domestic markets, while offshore casinos only contributed a fraction of total earnings and cash flow. Land and Buildings wants MGM to spin or sell those offshore operations, providing cash that could allow the company prepay up to 50% of its outstanding debt. When coordinated with a REIT conversion of U.S. assets, it might also minimize tax burdens.
Land and Buildings believes REIT conversion is an urgent issue because MGM is expected to return to profitability on a GAAP-basis in 2015, causing the company to be a net tax payer for the first time since the downturn. If MGM doesn’t convert to a REIT and spin its management company into a C-C0rp, some of those expected profits will leak into government coffers.
The fund believes MGM’s Las Vegas EBITDA will grow 10% in 2015, as the market on the Strip continues to push towards pre-crisis peak levels. Furthermore, Las Vegas casinos have diversified to adapt to changing consumer trends, causing 70% of revenue to come from non-gaming sources, making them more attractive than hot gaming international markets.
“The Las Vegas Strip lodging market is back for the first time since the financial crisis… In Land and Buildings’ view, spinning out or monetizing MGM China would focus investors on attractive domestic trends,” the fund said.
Robert Willens, an independent tax expert told Forbes by email the Land and Buildings REIT conversion proposal fits the letter and spirit of the law. That comes as lawmakers have shown a penchant to scrutinize and even block tax saving corporate maneuvers such as so-called inversion transactions. Meanwhile, the Internal Revenue Service has slowed rulings on REIT conversions and master limited partnerships (MLPs) in recent quarters.
“There’s little doubt that the assets to be placed in the REIT are ‘real estate assets’ and that the income to be earned by the REIT will be ‘rents from real property.’ I think the proposal to convert MGM to opco and propco configuration is a good one and would have the tax advantages that Land and Buildings suggests it would,” said Willens by email.
Even if there is confidence in the legal aspects of Land and Buildings’ REIT conversion proposal, some highly followed activist investors in the casino market are skeptical of its benefits.
Jason Ader, co-head of long-short activist fund SpringOwl Asset Management and an independent director on the board of Las Vegas Sands, characterized Land and Buildings’ proposal as short-term financial engineering.
“I think its short-term financial alchemy that can create long-term problems,” said Ader, who noted in a correspondence with Forbes casinos are notoriously capital intensive businesses that might not be a great fit for REIT structures.
Casinos get beat up, they need to restyle, and they often need to spend big to grow or shift to changing consumer trends. All of those capital expenditure needs, reflected in the cash flow statements of casino giants, may undermine their fit for dividend hungry REIT investors.
For instance, at the height of the Las Vegas casino market, MGM reported significantly negative free cash flow, as it blew out capex budgets to build its CityCenter in Las Vegas and refurbish the MGM Grand. In 2006, MGM posted free cash flow of negative $642 million as a result of nearly $2 billion in capex. A year later, at the height of the Las Vegas market, it generated negative $1.9 billion in FCF on nearly $3 billion in capex.
Capex at MGM has steadily risen in the years since the financial crisis, growing from $136 million in 2009 to $872 million as of the end of 2014. However, those figures may understate spending needs for Las Vegas casinos in a market where demand is growing and financing remains cheap. Analysts polled by Bloomberg expect MGM’s capex to hit $1.45 billion in 2015, causing FCF to fall below $180 million, a 20% year-over-year drop.
Additionally, Ader notes that an arms length relationship between Land and Buildings’ proposed REIT and management company could create frictions that put MGM at a disadvantage relative to owner operated businesses like Wynn Resorts and Las Vegas Sands, who could easily finance expansion or upgrades. In contrast, a lodging business separated from its real estate and paying occupancy costs might need to negotiate hard on rents and capital plans to find spending room.
Land and Bulidings, however, believes that casinos would be similar to traditional lodging REITs, holding an ample financial cushion to maintain assets and drive revenue growth, while passing on corporate profits to investors.
MGM shares rose over 11% in early afternoon trading. A spokesperson for MGM didn’t immediately respond to an email seeking comment.
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