Inside Gaming: Pinnacle, GLPI deal could be a model for the industry

The $4.75 billion merger of Pinnacle Entertainment and Gaming and Leisure Properties isn't your typical casino industry buyout.

But the transaction might be a model for other gaming companies moving forward.

Pinnacle isn't disappearing once Gaming and Leisure takes ownership of the real estate and buildings associated with 14 of the Las Vegas-based company's regional properties. Pinnacle will sign a 10-year lease, with five-year renewals, to manage and operate all aspects of the hotel-casinos when the transaction closes in early 2016. In the first year, Gaming and Leisure will receive $377 million.

Wells Fargo Securities gaming analyst Cameron McKnight said the transaction was "strong" for both companies. The casino operator "benefits from the 'bird in the hand.' " The value was in the real estate.

Pinnacle CEO Anthony Sanfilippo said the agreement places it in an advantageous financial position. In addition to the casinos and real estate, Gaming and Leisure will assume $2.7 billion of Pinnacle's debt, leaving the operating company with an stronger balance sheet and an improved debt-to-cash flow ratio.

"There will be plenty of opportunities for Pinnacle to grow," Sanfilippo said.

Gaming and Leisure was spun off from Penn National Gaming in 2013 and is the gaming industry's only true real estate investment trust. Gaming and Leisure will be the third-largest publicly traded REIT in the U.S., owning 35 properties in 14 states.

The REIT counts on Penn for 97 percent of its rental income (a company subsidiary and an Illinois casino operator provide the other 3 percent). Adding Pinnacle's casinos reduces Penn's contribution to 52 percent.

Credit Suisse gaming analyst Joel Simkins said Gaming and Leisure will be more diverse geographically and have a stable earnings stream.

"While other gaming REITs could eventually emerge, it's hard to see one of comparable scale and diversity emerging anytime soon," Simkins said.

The REIT idea was first proposed to Pinnacle in April 2014 when activist investor Orange Capital urged the company to separate its real estate from the casino operations. Pinnacle announced its initial plans in November. Gaming and Leisure entered the picture in March, proposing to save Pinnacle the trouble and $700 million in costs of forming a publicly traded REIT.

After several months of negotiations, the two companies' boards approved a deal that gives Pinnacle shareholders 0.85 per share in Gaming and Leisure for each Pinnacle share they own. Also, Pinnacle shareholders will receive one share of the remaining Pinnacle Entertainment casino operating business. Pinnacle shareholders will own 27 percent of Gaming and Leisure once the transaction closes.

"We created value for our shareholders," Sanfilippo said. "They can keep the stock or turn into cash."

REITs don't pay federal income taxes and distribute 90 percent of their taxable earnings to shareholders.

Moving into a REIT structure won't preclude Pinnacle from expanding. The company retained ownership of its Cincinnati-area racetrack casino and has free cash for additional acquisitions, with or without Gaming and Leisure. Penn National, for example, bought the Tropicana for $360 million, opened the Plainridge Park Casino in Massachusetts for $250 million, and is spending $390 million on a San Diego-area Indian casino — all without Gaming and Leisure.

Wall Street says Gaming and Leisure is still shopping for regional casinos and Chairman Peter Carlino confirmed opportunities exist. Simkins said Pinnacle was one of the last "high quality assets" on the market. Still, other regional properties could be ripe for the taking.

Gaming and Leisure "should be the first call for any potential seller," Simkins said.

The REIT will have to find other operators. Conflicts and various state gaming regulations against multiple licenses could keep Penn and Pinnacle out of some management deals. There is a growing list, however, of emerging casino operators.

Golden Entertainment CEO Blake Sartini, fresh off its merger with Lakes Entertainment, is looking to expand and might be interested if Gaming and Leisure comes calling.

"If an opportunity is presented to us, it's something we would certainly want to explore," Sartini said.

Union Gaming Group analyst Christopher Jones said regional gaming valuations are supported "by transaction activity and the focus on real estate value." He said Boyd Gaming Corp., which said last year it was investigating the REIT process, might consider selling some of its regional casinos or spinning off the properties into a REIT.

Jones said Boyd has "less of an appetite" to fold its Las Vegas holdings into a REIT "given the bullish outlook for (cash flow) growth in that market."