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.
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
- 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.