Despite Monday’s Reuter’s headline “ISLE is in advanced talks to sell itself to GLPI” - we are skeptical as we see hurdles to such a combination despite modest value creation.
CALL TO ACTION
While the Reuter’s headline read ”ISLE is in advanced talks to sell itself to GLPI, noting that discussions were renewed in recent months after a sales process earlier this year fell apart”...frankly speaking, we found the timing of the headline unusual as well as disingenuous. Could someone simply have been “talking up their book” on the last day of the month as well as the quarter? Regardless of the headline, we are skeptical as we see several hurdles to a potential transaction between ISLE and GLPI and we outline the reasons below.
THE SET-UP
Recall on Tuesday, March 18th we held a thought-leader call with REIT Attorney Ed Glazer regarding gaming companies converting or selling assets to a REIT. During that call, Mr. Glazer outlined all the compelling reasons for why current gaming operators would not be able to either convert to or conduct a tax-free spin-off a REIT. At that time, our position was the outlying and divergent opinion. Here we are more than 90 days later and no gaming operator has announced its intent to spin-off a REIT via a tax-free or a taxable process. However, we have renewed headlines regarding a gaming operator (ISLE) in discussions with Gaming & Leisure Properties (GLPI), the PENN sponsored, gaming-focused REIT spin-off.
WHAT WE THINK WE KNOW
First, Isle of Capri owns three commercial casinos in Iowa – Isle Bettendorf (Bettendorf), Isle Waterloo (Waterloo) and Isle Lady Luck (Marquette). During 2013, the properties generated the following GGR: Bettendorf $72.3 million, Waterloo $85.7 million and Lady Luck $28.8 million while on a last twelve month basis through May 2014 GGR was: Bettendorf $70.5 million, Waterloo $85.5 million, and Lady Luck $27 million. Approximately 20% of ISLE's net revenues come from Iowa.
As background, Iowa currently has 18 commercial casinos and recently approved a 19th casino license for the development of Wild Rose Entertainment Jefferson casino with more than 500 slots and up to 15 table games. Beyond cannibalization from additional Iowa casinos, Iowa GGR is adversely impacted from the addition of VGTs in Illinois. During 2013, Illinois VGTs generated more than $51 million in GGR from Western Illinois counties viewed as feeder markets to the casinos located along Eastern Iowa on the Mississippi River. The ultimate death knell to Iowa will be when Nebraska approves commercial gaming.
Second, on Tuesday April 29th, GLPI’s Senior Vice President, Corporate Development, Steven Snyder, while speaking at a Goodwin Proctor-sponsored REIT discussion regarding “Competing in the New York Resort Casino Market” said “GLPI is very concerned about the Iowa Superior Court interpretation and ruling (in the IRGC vs. Argosy dispute) and as a result GLPI would NOT pursue any additional gaming acquisitions in Iowa.” As background, the Iowa Superior Court ruled that, in Iowa, a gaming license is held by the non-profit business partner and not the gaming operator – in a ruling between the Iowa Racing & Gaming Commission and Argosy Sioux City.
Third, at the end of 1Q 2014, GLPI had $48 million of cash on its balance sheet and $550 million remained available under the Credit Facility. At March 31, 2014, GLPI had $150 million drawn in its $700 million revolving credit facility and a fully drawn $300 million Term Loan A facility. GLPI has limited cash on hand but could draw down on its corporate credit facility.
Fourth, GLPI announced its intent to acquire The Meadows for $465 million, with a targeted closing date during 1Q15. The acquisition will likely involve an equity issuance as well as debt assumption. The May 14th GLPI press release reads "The purchase price, which the Company (GLPI) intends to fund with a combination of equity and debt". Enter the equity overhang!
Next, we believe any transaction (despite a low probability because of the Iowa issue) would involve a sale/lease back by ISLE and not the acquisition/sale of the entire ISLE entity.
In the event GLPI were to buy the entire ISLE entity, GLPI would need to complete a second transaction which is the sale of the OpCo - given the rules that govern Taxable REIT Subsidiaries. Given the negative feedback GLPI management received following the announced Meadows acquisition - and required second step of selling The Meadows OpCo, we view any transaction involving a second step as less desirable and a lower probability event.
This said, in the event GLPI were to consummate a sale/lease back with ISLE, such a transaction would likely require a sizable GLPI equity issuance - about 10.8 million shares (enter a larger equity overhang!) at today's GLPI share price as well as the assumption of approximately $612 million in debt.
Consequently, we model a theoretical sale/lease back along the lines of the PENN/GLPI spin-off where PENN pays GLPI 16.5% of Net GGR in the form of rent, which approximately translates into a 75% EBITDA margin. However, given the size of ISLE we assume a slightly lower 70% EBITDA margin on the GGR.
Finally, in our opinion, Mr. Carlino moved from PENN to GLPI as a means to "preserve" his personal and family wealth - not put the family fortunes more at risk in an industry experiencing both cannibalization as well as contraction. That said, why would Mr. Carlino "go all in" both in terms of acquisition strategy as well as increase the pressure on GLPI stock from a massive equity overhang?
CONCLUSION
While a sale or sale/lease back transaction involving ISLE would create incremental shareholder value for current ISLE shareholders, we view such a transaction with GLPI as a lower probability event - primarily since GLPI publicly said it would not pursue further gaming acquisitions in Iowa (a declining market) and a transaction with ISLE would require both a large assumption of debt as well as a sizable equity issuance, in addition to the equity issuance required to complete the acquisition of The Meadows for $465 million. This said, maybe GLPI pursues a strategy to sale/lease back a single ISLE asset such as Pompano.
