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.