jroballo
Thesis
VICI Properties (NYSE:VICI) trades at a higher forward EBITDA/EV multiple than Gaming and Leisure Properties (NASDAQ:GLPI) – 20.53x and 16.30x, respectively – implying that (1) Las Vegas Strip visibility is more valuable today, or (2) VICI is growing at a much faster rate, or (3) reporting a partial quarter’s cash flow materially understated VICI’s cash flow.
The near term growth prospects appear far stronger for GLPI as a percentage impact on its portfolio (VICI is digesting the massive MGM and Venetian deals completed earlier this year), so future growth rates do not explain the difference.
We see that VICI’s Q2 cash flow has less than 50% of MGM’s full cash flow for the quarter. Had VICI received the full cash flow, we estimate the valuations would be very close to one another and the answer to our valuation question.
15x cash flow (AFFO) in the current rising rate environment feels about fair for recession resistant real estate businesses today (you can convert this to a 6.67% cap rate, too). Last year, 20x was about market, so a 25% reduction feels consistent with Bear Market territory and the rate environment.
But what about GLPI having a forward yield of 5.69% versus VICI at 4.30%? That implies GLPI investors demand a higher rate than VICI investors because it is perceived as a riskier business. Is that true?
Finally, the US Government removed Federal restrictions in 2018 resulting in total sports betting in the US growing from $430MM in 2018 to $4.33BN by 2021 (a 116% annual growth rate with fewer than half the states having legalized some form of sports gambling).
Can growth in sports gambling apps threaten in person gambling as more states legalize apps like Fan Duel and DraftKings (DKNG)?
We assume (1) continued rising interest rates into 2023, (2) continued rising legalized sports gambling and (3) a looming recession.
Given this scenario or worse, which real estate portfolio would you rather own today?
The Market says VICI is the better risk, but I think the market is backwards!
What Is Happening?
Gambling has become increasingly socially accepted as a leisure/entertainment/experiential activity that can be compared to alternatives like movie theatres, amusement parks, sports and other diversions. Like most diversions, the market divides into local and destination offerings like the best Las Vegas hotels versus local Tribal or anchored riverboat casinos without attached hotels. It’s the old local versus destination analysis.
When we look at diversions like amusement parks and ski resorts, we can see that recessions have a more negative effect on destination resorts as people trade down to stay-cation alternatives. Does the same hold true for casinos?
Looking Backwards
In general, I don’t like back testing because it assumes the world has not changed. The world always changes, so we must use caution when drawing conclusions. For example, gambling apps for sports betting didn’t exist in 2008, but they are the fastest growing force today. That needs to be added to the analysis.
Let’s start with the 2001 recession and a study published by Mark P. Legg, Oklahoma State University and Hugo Tang, Purdue University – Why Casinos are not Recession Proof: An Business Cycle Econometric Case Study of the Las Vegas Region:
“There is some evidence showing that the gaming industry could be recession proof (Linn, 2008). Even during the recession year of 2001, commercial gaming revenues rose by 3.1% (American Gaming Association, 2002). Literature on gambling has revealed a number of factors for casinos being less-sensitive to market downturns. These factors range from addicted gamblers and lack of competition from heavy regulation fueling large profits to individuals seeking reliefs from recession hardships patronizing casinos (Grinols & Mustard, 2001; Klempt & Pull, 2009; Shonkwiler, 1993).”
Moving to the Great Recession in 2008, the study notes:
“The increased reliance of the gaming industry on the lodging and convention industries has increased the gaming industry’s sensitive to economic downturns as lodging and convention industries are more-sensitive prone to market downturns (Friess, 2009; Smith, 2009). Furthermore, this sensitivity to economic downturns increased over the previous decade as the gaming industry expanded and a number of states legalized lotteries, a casino gambling economic substitute (AGA, 2008; Elliott & Navin, 2002; Moss, Ryan & Wagner, 2003)…
“All these changes combined with decreasing gaming revenues over periods during the recession of 2007 to 2010 have led some to note that the gaming industry is no longer recession proof (AGA, 2008; Linn, 2008).”
We further confirm the Great Recession hurt the Las Vegas Strip:
“external challenges such as the adverse economic impact facilitated by the recent recession in [2007][2008][2009] have resulted in the decrease of gaming revenues within the large casino hotels found in the Las Vegas Strip; statistics suggest around a 14% decrease from 2007to 2010”
Source: Buil et al., 2013;Eadington, 2011.
With respect to regional casinos (outside Nevada), our best proxy, GLPI’s largest tenant and among the largest regional casino operators with 44 casinos and racetracks is PENN Entertainment (PENN). We examine their results during the 2001 and 2008 recessions with respect to same store sales.
In their February 4th 2002 Press Release, PENN reported same-store sales gains for fiscal year 2001 in every casino it has operated in 2000, so no recessionary hit in 2001.
In their fiscal year end 2008 Press Release, PENN reported flat same store revenues; for fiscal year end 2009 Press Release, PENN reported a 2% decrease in same store sales; and finally, PENN reported same store gains of 3.6% for fiscal year 2010 ending the Great Recession with a small net gain versus a 14% decline in Vegas Strip revenues over the 2007-2010 period!
We can conclude that regional casinos are not nearly as negatively impacted by recessions as the Las Vegas Strip. But why?
I believe the concept of “inferior goods” has something to offer. In a recession, the amount most of us can spend on leisure gets pinched. We still need leisure, so we pull back from the fancy Disney World or Bellagio vacation for a more local experience at a nearby Knott’s Berry Farm in Southern California or Margaritaville in Louisiana. Even the above noted 2008 study hints at this with Lottery revenues eating into Las Vegas revenue stability over time. Lotteries are a stay-at-home experience.
Given the Las Vegas model to harvest all your available dollars on gambling, fine dining, concerts, shows, special experiences, and on and on and on, we can see how a recession makes people more reluctant to “shell out for Vegas.” Local experiences cater more to the frequent visitor by not taking all their leisure dollars in one binge session – they focus on lifetime customer value to be successful.
Today
The American Gaming Association, the industry’s main association, reported in its 2021 AGA State of the States ’22 report that casino revenues exploded to $53BN, a whopping 21% higher than the pre-pandemic record set in 2019. Despite lingering pandemic effects, gambling is back all over the United States. Impressively, most states posted higher than 50% growth from 2020 to 2021 with an overall 76.9% US market growth rate out of COVID 19’s worst lockdowns.
For the first six months, PENN reported 13% same store sales increases. Meanwhile, MGM reported a huge 60% increase its Las Vegas Strip properties coming off pandemic lockdowns and restrictions (again, we see how Strip revenues have greater volatility than regional operations).
2022 looks like a monster despite inflation and lingering COVID 19 effects.
Tomorrow
Our operating assumptions are continued Fed Funds Rate rises in 2023 and we have at least a mild recession starting in 2023.
If we hit this scenario or worse, we would expect to see a drop in Vegas Strip revenues while regional casinos would likely remain flat. But that’s not all, those sports gaming apps that accounted for nearly half the US gambling growth from 2019 to 2021 are only gaining momentum. Those apps seem like a cheap alternative to visiting a casino in person.
However, we see sports gambling apps as more threatening to illegal gambling than the casino business because using an app, like illegal gambling and lotteries, is not as social an experience as going to a nice casino.
Like movie theatres, humans enjoy their leisure among strangers where the vibe of the place enhances the overall experience. We see this everywhere from live concerts to sporting events to poker rooms – we could do it at home, but it’s not as rich an experience.
Therefore, we see the local casino segment as being a solid defensive sector. It doesn’t carry the Vegas Strip upside when times are fat. The coming times are not fat for VICI’s Strip tenants who will also struggle to hit rent overage clauses tied to revenue thresholds in the Caesar’s portfolio.
Adding further risk to VICI, they recently announced investments in golf properties which takes management away from its core competency. No matter the size of the investment, any management distraction from the cash cow is a big negative during any tough economic environment.
Golf Distraction
I owned an Arizona golf course for 12 years. More accurately, it owned me. I lost my rear and a good part of my front. It’s not just my historic old course that sucked money; most luxury courses like those owned by our former president lose money hand-over-fist on an fully-loaded, economic basis. To make matters worse, when you look at transforming all that real estate to a higher and better use, local residents don’t like losing community assets and will work to block your zoning changes – tough business.
The only people I know who make money in golf are the management companies – they have scale and expertise.
Golf is a worrying management distraction. When EPR Properties (EPR) first wandered beyond megaplex theatres, they invested in a variety of ideas before landing on experiential entertainment and it didn’t go so well those first few years. Why add the risk when coming into a down cycle and digesting two massive mergers?
We get running fast to maintain momentum. We also understand the tendency for humans to overshoot after big wins as VICI appears poised to do. The pressure form Wall St. analysts to deliver again can feel very oppressive and often drives riskier choices just when the opportunity sets to maintain that momentum shrinks (marginal availability of targets).
This is very likely VICI management’s first public mistake in my opinion. But what about the financial structures of these two companies? Could that change our view?
Under the Hood
We use each company’s 2022 Q2, 10-Q financial reports. VICI is complicated by the late-quarter completion of the mammoth MGM Growth Properties acquisition and it’s use of sale leases in its portfolio (makes VICI appear less profitable on a net income basis).
GLPI, however, allows us a more apples to apples view through Adjusted Funds From Operations (AFFO) reporting (sales lease revenues are still missing from VICI which somewhat overstates VICI’s AFFO margin), which we will use as our cash flow marker for margins and coverage analysis:
| Ticker |
Revenues (millions) |
Adjusted Funds From Operations (millions) |
AFFO Margin |
AFFO per Fully Diluted Share |
Interest Expense (millions) |
AFFO/Interest Expense Coverage |
L-T Debt/ Total Capital |
| GLPI | 326.5 | 231.6 | 70.93% | 0.91 | 78.26 | 2.96 | 66% |
| VICI | 662.6 | 430.1 | 64.91^ | 0.48* | 133.128 | 3.23* | 40% |
^Somewhat overstated because sale lease revenues run through the balance sheet.
*would be materially higher if the full quarter contribution from the MGM portfolio had be added.
Debt leverage is materially different between these companies with GLPI at about 66% leverage versus about 40% for VICI. Importantly though, GLPI has the cash flow to support its debt at almost 3 times interest coverage while we expect VICI’s balance sheet to be in flux after the two large mergers.
Right now, VICI has a lot less long term debt with apparent room to leverage. However, new borrowings will carry much higher interest rates than a year ago and VICI has a less profitable business as measured by AFFO margin. VICI has running room to enhance equity returns, but not as efficiently as GLPI.
Important Note: Late-quarter merger completions skew the numbers. While real estate is much easier to digest and report than an integrated manufacturer, we may be missing more than just MGM’s full quarter’s AFFO contribution to make the comparison more even-handed.
In the end, both these companies squeeze similar cash flows from related assets. VICI appears more conservative because its debt load is much lighter but its AFFO margin is materially lower, adding back risk.
The coming economic environment will impact each company’s performance. Most GLPI leases have no performance component for extra rent, only pre-negotiated rent escalators. A chunk of VICI leases have an extra rent component tied to revenues which will struggle during downturns.
Conclusions
In person casino gambling has evolved from seedy distraction to legitimate experiential leisure. Gambling is legal in most states and sports gambling via app is now legal in many states since the Federal Government reversed its national ban in 2018.
There are two ways to invest in the publicly-traded, underlying casino real estate with well covered dividends – VICI, which is mostly Las Vegas Strip oriented and GLPI, which is mostly regional.
With a looming recession and continued rising interest rates into 2023 we prefer GLPI for being (1) fairly valued, (2) having better near term growth prospects as a percentage of its portfolio and (3) having a more recession resistant economic model. We rate VICI a weak hold until we see several quarters’ AFFO in the much larger casino/waterpark/golf company to prove it can digest and operate these increasingly diverse assets efficiently.
Be the first to comment