Gaming & Leisure Properties’ Two Birds With One Stone Offer

Gaming and Leisure Properties (GLPI) was the subject of our 10th Dividend Letter. One of the catalysts we highlighted was the further purchasing of other casino real estate at value creating prices. One of the items we discussed in the “Pre-Mortem” was Pinnacle Entertainment (PNK) spinning off their casino real estate as a REIT which would compete with GLPI to purchase other gaming real estate.

Yesterday Gaming and Leisure Properties announced a way to take care of both items. Gaming and Leisure Properties wants to buy Pinnacle Entertainment’s gaming real estate for $4.1 billion. In the deal Pinnacle Entertainment shareholders would receive 1 share of the new Pinnacle Operating Company and 0.557 shares of GLPI for each share of Pinnacle Entertainment that they own. Pinnacle Entertainment shareholders would then own 20% of of a much larger Gaming and Leisure Properties.

GLPI tried to negotiate with Pinnacle Entertainment in private but they’ve been ignored. GLPI is now taking their proposal to Pinnacle’s shareholders. Since announcing the REIT spin-off in November 2014, Pinnacle’s management hasn’t followed up with any details. GLPI is using Pinnacle’s lack of communication with its shareholders as an opportunity to present the value in its offer.

Compelling strategic rationale: On a combined basis, the companies’ real estate businesses would constitute the third largest US publicly traded triple-net REIT with extensive scale, a diversified tenant base, broad financial resources, and access to far-ranging growth opportunities (including outside of the gaming industry). On a combined basis, GLPI would have more than twice the assets and cash flows compared to the standalone real estate company proposed by Pinnacle, with more efficient and cheaper access to the capital markets.

Superior value creation: Based on today’s market multiples and conservative assumptions for pro forma business performance, we would expect our proposal to provide Pinnacle shareholders with aggregate value of $35.77 per share at closing (detailed in Appendix A), which represents a 30% premium to the Company’s current share price of $27.42, a 47% premium to the volume weighted average price of $24.34 for the last 30 days and a 59% premium to Pinnacle’s price on the date when GLPI made its first offer to Pinnacle (January 16, 2015).

This transaction will be well understood and rewarded by the market and, post-merger, we believe GLPI will have a stronger, more stable currency and trade at a quantifiable premium to standalone Pinnacle PropCo. As you know, valuation multiples for REITs are closely correlated to the diversification and size of their lease streams, access to capital and ability to pursue growth opportunities. Consequently, the value proposition to Pinnacle shareholders from our proposal is further enhanced over time versus that achievable through your Company’s standalone plan; the potential for further valuation upside through a multiple re-rating is real, though not factored into our analysis.

Greater transaction certainty: In contrast to the major risks, contingencies and delays which we believe are inherent in Pinnacle’s undeveloped standalone separation plan, GLPI’s proposal is straightforward and offers substantially less risk. Our proposal would not require the receipt of a private letter ruling from the IRS and the combination of GLPI’s existing REIT structure and approvals will mitigate the regulatory uncertainty present in Pinnacle’s standalone plan. Furthermore, we would be prepared to enter into a definitive agreement without any financing condition. Our proposal would be fully underwritten to maintain our optimal capital structure. In contrast, Pinnacle is too highly levered in its current configuration for a separation and therefore, your plan is reliant on the future placement of up to $700 million of equity (~40% of Pinnacle’s current market capitalization). As detailed in your latest earnings release, Pinnacle has already been required to make material changes to its plan and presumably could be subject to further changes, not least given your Company’s absence of financial guidance and macroeconomic uncertainties.

Faster path to completion: Our proposal is structured as a taxable transaction. Therefore, unlike the proposed Pinnacle transaction, our proposal is not reliant on nor would it face the challenges inherent in obtaining a favorable IRS tax ruling. In addition, we and/or our principals have been, or are, licensed in each of the jurisdictions where Pinnacle currently has operations. Consequently, we expect to close our transaction in 2015, well in advance of the publicly announced expected completion date of your standalone plan, which you have described as not occurring until sometime in 2016. Even if Pinnacle were to obtain an IRS ruling this year, which is highly uncertain, a successful spin-off within the next twelve months is unlikely.

Reduced management burden: The inclusion of our experienced management and resulting elimination of Pinnacle’s need to design the separation would allow management to devote its attention to optimizing the performance of Pinnacle’s gaming operations. Furthermore, our experienced team eliminates the requirement to identify and appoint senior executive leadership and a new Board of Directors for standalone PropCo, and the substantial incremental corporate costs associated with these new hires. Under our proposal, Pinnacle’s current management team and Board of Directors would continue in their respective roles and focus their efforts on building value for Pinnacle OpCo shareholders post-closing

We like the deal. REITs grow by either building more real estate assets, costly and time consuming, or buying existing real estate assets. Buying existing real estate needs to be done at a good price that adds value to the acquirer. Based on Gaming and Leisure Properties estimate of Pinnacle’s 2016 real estate EBITDA and EBITDAR, buying Pinnacle’s gaming real estate for $4.1 billion is a value adding purchase price. Plus, it is a good deal for Pinnacle shareholders. They would end up owning 100% of Pinnacle Operating Company and 20% of the larger GLPI. Pinnacle shareholders also finally get action on monetizing the real estate assets.

It is not a done deal but one of Pinnacle Entertainment’s largest shareholder, Orange Capital, likes the deal in principal. Orange Capital just wants a little more money for the real estate. Gaming and Leisure Properties offered a multiple of 11.3x EBITDA for Pinnacle’s real estate. Paying below a 13x multiple would add value to GLPI so there is room to negotiate.