PNK: NOTHING IS FREE ANYMORE

The federales are unlikely to approve a tax-free spin

 

 

 

CALL TO ACTION:

 

We believe a tax-free spinoff to shareholders of a REIT by Pinnacle Entertainment is a low probability event.  Meanwhile, back at the ranch, the fundamentals aren’t good and new competition risk remains high.

 

 

 

BACKGROUND:

 

Based on the Pinnacle Entertainment Form 13D filing by Orange Capital (“Orange”) and PNK stock price up almost 6% yesterday, we wanted to revisit the comments we made regarding PNK and a potential PNK REIT spin four weeks ago during our Goodwin Proctor REIT Thought Leader Conference Call regarding Boyd Gaming’s potential conversion.

 

 

First and foremost, similar to Orange, we believe a REIT spin is a worthy endeavor and strategy for lowering the cost of capital for a large portion of the current PNK enterprise.  However, we also believe a potential tax-free REIT spin is a low probability event for Pinnacle Entertainment.   As we stated during our conference call, PNK may be able to affect a less attractive taxable spin-off of the REIT or potentially sell real estate to an existing REIT.

 

 

Hurdles to a tax-free spin: 

 

  • Most importantly, Orange assumes the receipt of a tax-free spin Private Letter Ruling (PLR) by the Internal Revenue Service.  We note, Lamar Outdoor announced in August 2012, it would pursue a REIT conversion and as of today has not yet received an Internal Revenue Service PLR.
  • Orange also assumes House Ways & Means Committee Chairman Dave Camp’s February 25, 2014 proposed REIT rule modifications will not be enacted. 
    • The Camp Proposals would prevent these transactions from being tax-free to the distributing corporation and its shareholders by providing that a REIT cannot be a distributing corporation or a controlled corporation in a Section 355 distribution.
    • The Camp Proposals also provide that any distributing or controlled corporation involved in a Section 355 spinoff must wait 10 years before making a REIT election.
    • The Camp Proposals would apply to all spinoffs occurring after February 26, 2014 unless a binding commitment to complete the spinoff was in place prior to February 26, 2014
    • We believe there is bipartisan support for eliminating tax-free REIT spins.  The IRS is unlikely to provide PLR with the political momentum moving against these types of transactions.

 

Orange Capital’s assumptions and where we differ:

 

  • Orange assumes a $700m equity raise pre-spin.  That’s a big equity deal.
  • Post transaction valuation assumptions - Orange assumes:
    • Significantly higher REIT (Prop-Co) EV/EBITDA multiples of 13x to 15x versus our 10x, 12x and 14x
    • Significantly lower REIT (PropCo) G&A of $15m vs. our $31m assumption
    • OpCo EBITDA of $280 million vs. our $313 million
    • REIT EBITDA of $335 million vs. our $309 million (G&A differential)
    • Orange ignores the NOLs currently on PNK’s balance sheet - and the inherent value to shareholders.  PNK’s income will be mostly shielded from taxes for a long time even without a REIT spin.  As of December 31, 2013, PNK had $553 million of federal net operating losses, which can be carried forward 20 years and will begin to expire in 2028.  PNK also had $862 million of state net operating loss carry-forwards, predominantly in Louisiana and Missouri, that expire on various dates beginning in 2014.
    • Pro forma Orange assume a REIT leverage of 6.25x debt/EBITDA will have access to capital for acquisitions.
    • The PNK REIT could be 40% smaller than GLPI which could be a hurdle to a decent trading multiple

 

OTHER CONSIDERATIONS:

 

  • Future potential new competition in Illinois would adversely impact the revenues and EBITDA of Pinnacle’s Ameristar East Chicago property.
  • Casinos in Texas look inevitable to us which brings into question the sustainability of fixed rent payments from the PNK’s numerous and large Louisiana properties
  • Orange assumes the REIT will be competitive in bidding for new acquisitions while GLPI has sourced one small acquisition in its limited standalone life.