AMM Dividend Letter Issue 10: Your Brain on Rewards (GLPI)
This is from the AMM Dividend Letter released August 2, 2014. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing list here.
If you won over $1 million in the lottery would you keep buying lottery tickets?
You would think the answer would be no. A survey was conducted on people who won $1 million or more in the Ohio state lottery and over 82% of them kept buying lottery tickets. Then there is this Arizona couple that has won their state lottery twice. They have been spending $200 each week since 1984 on lottery tickets and they don’t plan to stop.
They are hooked on the thrill of winning the jackpot. In our brains the anticipation of a reward, like a large financial gain, actually feels better then when you receive the reward. It is a quirk in the structure of brain’s reward system.
The Nucleus Accumbens is a part of our brain that plays a key role processing rewards like sex, food, and financial gains.
Experiments have been designed to measure the activity level of the Nucleus Accumbens in regards to earning rewards. During the anticipation phase, knowing a reward is coming but before receiving it, the activity level in the Nucleus Accumbens is very high. It is during this time we fantasize about what we’re going to do with our reward. When we actually receive the reward activity levels in the Nucleus Accumbens drop off. Rewards, like making money, feel good but we are more mentally stimulated by the anticipation of the gain.
A benefit of this quirk in brain reward circuitry is it helps us pursue longer-term goals. Dreaming about future rewards helps us stay motivated to achieve goals that can only be earned through patience and commitment.
The downside to this part of our reward system is it is very reflexive and highly responsive to changes in the amount of the reward at stake. It is also extremely insensitive to changes in the probability of receiving the reward. This is a dangerous combo for investing because they can lead to “irrational exuberance” and asset bubbles.
Researchers at the California Institute of Technology set up a simple experiment in which they controlled the fundamental and actual value of a risky asset traded amongst its test subjects. The researchers held the fundamental value of the asset at 14 currency units but in many sessions the traded price reached 3-5 times as high, the “traders” created bubbles. The researchers kept track of which “traders” earned the least and which ones earned the most. The “traders” who earned the least bought when prices went up and kept buying as the prices tanked. Low earners were also extremely sensitive to activity in the Nucleus Accumbens. High earners bought early and sold into the rising market. The high earners also had a lower sensitivity to activity in their Nucleus Accumbens.
The hardest thing in investing is being greedy when others are fearful and fearful when others are greedy. The high earners in this experiment did just that.
We strive to manage your portfolio like the high earners above. Investing in the real world is far more complicated than the controlled environment of a research lab. Sometimes we will sell too soon and other times not soon enough. We are just as susceptible to the basic nature of our reward system as everyone else. We gain some control over our reflexive thinking by being conscious of our biological short-comings and by sticking to our investment process.
Knowing when to sell a stock is much harder than buying it. Selling a stock into a rising market is even harder. Sticking to our investment process and staying focused on valuations helps us to overcome this hurdle. When a position has appreciated far above our assessment of its fundamental or fair value we will sell some or all of the position. Also, if a position has appreciated to the point that it has become too big in accounts we may reduce the position size. We recently reduced a few positions for this reason.
When we do sell a position and raise cash levels it is not because we think a pull back or a crash is imminent. We know our strengths and timing market dips is not one of them. Our selling is simply a function of our views on the current risks versus reward in each individual investment, and prudent position sizing. In general we like having cash on hand for any future investing opportunities. If market participants do become fearful again we will have the cash available to be greedy at the right time.
Your Portfolio Management Team
Dividend Stock in Focus
Gaming and Leisure Properties (GLPI): $33.78*
*price as of the close August 1, 2014
Gaming and Leisure Properties was created when Penn National Gaming (PENN) spun off its casino real estate holdings in November 2013. We told you we like spin-offs. Gaming and Leisure Properties then applied and received a private letter ruling for the company to operate as a Real Estate Investment Trust or REIT for short. A REIT does not pay corporate tax as long as the bulk of its assets and income are connected to real estate investment. The company must also distribute at least 90% of its taxable income to its shareholders in the form of dividends. The company is also a triple net lease REIT. The tenant is responsible for paying real estate taxes, insurance, and maintenance.
Gaming & Leisure Properties is the first REIT to focus solely on casinos and other gaming assets. The company currently operates in 13 states. The map below does not include the recently acquired Meadows Racetrack and Casino located in Pennsylvania.
Gaming and Leisure Properties just started trading as a stand alone company. It is currently paying $0.52 per share a quarter for a yield of 5.94%.
Catalysts for Dividend Growth and Price Appreciation
For a REIT it’s a simple equation, more real estate assets equals more growth. REITs can build their own asset base which is both time consuming and capital intensive, or they can grow their assets through acquisitions. For Gaming and Leisure Properties, acquiring more casino real estate assets is the more expedient and effective way for the company to grow. However, acquisitions still need to be done at the right price.
Paying 13x EBITDA (with the right mix of equity and debt) for other casino assets immediately adds value to Gaming and Leisure Properties. The right amount of debt according to management is 5.5x the target acquisition’s EBITDA. Gaming and Leisure Properties is only interested in owning the real estate, not running the casino. Management will sell the operations to a casino operator. The proceeds from the sale allow Gaming and Leisure Properties to pay down debt and lock-in a long-term tenant. Gaming and Leisure Properties’ agreement to purchase Meadows Racetrack and Casino from Cannery Casino Resorts is a perfect example. Gaming and Leisure Properties is paying $465 million which is 9x 2013 EBITDA of $52 Million.
According to management, there are a number of privately owned regional casino operators with too much debt. The indebted casino operators can improve their financial health by monetizing their real estate assets. Now that Gaming and Leisure Properties is no longer a part of Penn National Gaming, a competitor, the privately owned casino operators may be more inclined to do a real estate deal.
We believe that a number of gaming operators would like to de-lever or are seeking liquidity while continuing to generate the benefits of continued operations, which may present significant expansion opportunities for us to pursue. Of particular significance, we believe that a number of gaming operators would be willing to enter into transactions designed to monetize their real estate assets (i.e., gaming facilities) through sale-leaseback transactions with an unrelated party not perceived to be a competitor.
From GLPI 10Q ending March 31, 2014
It also helps the deal making process that Gaming and Leisure Properties is the only REIT and potential buyer focused on casino real estate assets right now.
Isle of Capri Deal
Reuters recently reported that Isle of Capri Casinos (ISLE) is in advanced talks to sell itself to Gaming and Leisure Properties.
St. Louis Missouri-based Isle of Capri renewed discussions in recent months with Gaming and Leisure Properties, a real estate investment trust (REIT), after a broader sale process involving several potential buyers petered out earlier this year, the people said.
Isle of Capri is another regional casino operator with 15 locations.
If a deal emerges it’s highly probable that Gaming and Leisure Properties will not own all the real estate assets. To obtain REIT status, Gaming and Leisure Properties could not operate hotels. 8 out of the 15 location above have hotel operations. However, if Gaming and Leisure Properties does buy Isle of Capri for 9-13x EBITDA and using the same deal structure as above the acquisition could add up to 16-20% in value. This is assumes Gaming and Leisure Properties ends up with 7 of the 15 properties.
A final deal will take some time. Casinos are heavily regulated and each state has its own gaming laws. Also, Gaming and Leisure Properties needs to find multiple operators to take over the locations.
Regional Gaming Improvement
Regional gaming is in a slump. The benefit of owning the company that owns the real estate is the rent still needs to be paid no matter the economic environment. The upside is when regional gaming is booming Gaming and Leisure Properties stands to make more.
From the Master Lease Agreement between Penn National Gaming and Gaming and Leisure Properties:
a portion of which is subject to an annual 2% escalator if certain rent coverage ratio thresholds are met, and a component that is based on the performance of the facilities, which is adjusted, subject to certain floors (i) every 5 years by an amount equal to 4% of the average change to net revenues of all facilities under the Master Lease (other than Hollywood Casino Columbus and Hollywood Casino Toledo) during the preceding five years, and (ii) monthly by an amount equal to 20% of the change in net revenues of Hollywood Casino Columbus and Hollywood Casino Toledo during the preceding month.
From GLPI 10Q ending March 31, 2014
We’re investing in the regional gaming market while it is down and we’re mitigating some of the risk by owning the real estate. When the cycle turns positive we get to participate due to the performance based rent escalators.
The perception is that Gaming and Leisure Properties is dependent on one casino operator, Penn National Gaming. Gaming and Leisure Properties is in contract with the subsidiaries of Penn National Gaming. Each subsidiary operates a different location. Gaming and Leisure Properties is not dependent on Penn National Gaming as a whole but on the subsidiaries. Reality is one thing and perception is another. The perception is a large customer risk for Gaming and Leisure Properties. Further deals with other casino operators will alleviate this perception. Buying Isle of Capri casinos and leasing the casinos out to multiple operators would be even bigger.
We’re adding a new section the “Pre-Mortem”. It is a brief run down of what could go wrong with our investment. If we notice the company doing these things we won’t have to think about it, we’ll know that we made a mistake right away and cut our position.
- No one wants to do a deal. Part of the attraction of owning a casino is the real estate. If casino operators believe they can manage current debt levels and can hold onto their real estate assets then Gaming and Leisure Properties can’t grow.
- Isle of Capri deal talks break down. The two companies were in talks earlier this year but negotiations broke down when news leaked. Current negotiations could breakdown again.
- Management pays too much. Building value through acquisitions only works if the deals are priced right. The lower the price paid by Gaming and Leisure Properties the more value added by the deal. If the price is too high then value is destroyed. Right now we like to see deal multiples in the 9-13x EBITDA range anything above that and management is reaching for deals.
- Gaming and Leisure Properties is no longer the only REIT focused on gaming real estate. Being the only company looking to acquire casino real estate is helpful in the negotiation process. Pinnacle Entertainment (PNK) is another regional gaming company. The shareholder activist Orange Capital is pushing for Pinnacle to spin-off its real estate holdings too. For the time being Pinnacle has fought off the campaign but if another name gaming REIT emerges then there will be competition for deals.
If Gaming and Leisure Properties continues to build out its real estate holdings through sound financial deals its intrinsic value will keep growing along with its dividend. A deal for Isle of Capri Casinos would be an immediate catalyst for both its intrinsic value and removing the stigma of depending solely on Penn National Gaming as a casino operator. Another breakdown in talks with Isle of Capri would be an immediate negative for Gaming and Leisure Properties’ stock price but even without the deal we still value Gaming and Leisure Properties at $42 per share.
Books of Interest
Your Money and Your Brain by Jason Zweig. A must read book on how our neurology gets in our way of making sound investment decisions.
You Can Be a Stock Market Genius by Joel Greenblatt. The book for spin-off investing.
The $30,000 Bequest and other stories by Mark Twain. A satire on how much affect the anticipation of a reward can have on people.
Selling Hope: State Lotteries in America by Charles Clotfelter & Philip Cook. The economics and controversies behind state run lotteries.
Links of Interest
Brain Saves Best Traders from ‘Bubble’ Markets (Futurity)
Good advice for anybody you know in their 20s or 30s on why they need to start investing now. (Joe Mansueto)
Why does buy and hold have to be impossible? Can you accept short-term unhappiness for long-term results? (A Wealth of Common Sense)
Why does value investing work? (Yahoo! Finance)
What Will Visa’s Dividend look Like in Five years? (Total Return Investor)
Visa is only Expensive if You Can’t Think 5 years Ahead (Seeking Alpha)
What Makes a Moat? An excerpt from the book Why Moats Matter: The Morningstar Approach to Stock Investing (Morningstar)
Gaming & Leisure Properties (GLPI) is one of Leon Cooperman’s top stock picks for 2014 (AMM Dividend Letter)
Alpha Addict: The Amazing Career of Leon Cooperman (CNBC)
A big part of Leon Cooperman’s success is being greedy when others are fearful (The Reformed Broker)
All previous letters are archived here.