Interview With VICI Properties (Strong Buy Reaffirmed)
Important Note
Before going into today's article, I wanted to let you know that we will soon conduct interviews with the management teams of the following REITs:
Farmland Partners (FPI)
Easterly Government Properties (DEA)
H&R REIT (HR.UN:CA)
Safehold (SAFE)
Cibus Nordic (CIBUS)
Canadian Net REIT (NET.UN:CA)
Let me know if you have any questions for them and I will make sure to ask them for you. You can put your questions in the comment section below.
Thanks!
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Interview With VICI Properties (Strong Buy Reaffirmed)
VICI Properties (VICI) is the biggest casino REIT in the world.
We first invested in VICI in July 2019, and for several years, it was our top holding, sometimes accounting for up to 10% of our Core Portfolio. Our substantial investment was driven by our belief that its distinctive approach to net lease investing could offer above-average returns with reduced risk over the long term.
Unlike conventional net lease REITs that focus on properties like Dollar General stores or Walgreens pharmacies, VICI's model targets casino net lease properties and here is how they compare:
Picture of the Caesars Palace - One of VICI's most prized possessions:
Today, exactly 5 years later, we are pleased to note that our decision to invest in the company contributed significant alpha to our portfolio.
Despite the unlucky timing of our investment, which was shortly before the pandemic, it still nearly doubled our money and vastly outperformed the rest of the REIT market and its net lease peer group:
It also grew its dividend at the fastest pace in its peer group, growing nearly 3x faster than Realty Income (O) as an example:
Even with the pandemic—a crisis that was arguably the worst possible scenario for a casino net lease REIT—its tenants continued to pay their rent even when they were unable to operate their properties.
In fact, VICI is the only net lease REIT to have managed to collect 100% of its rents during the pandemic. In comparison, other net lease REITs saw their rent collection rates temporarily dip in to the 70s or 80s at the onset of the pandemic.
This experience validated our original thesis that VICI's distinctive business model has the potential to provide superior returns with lower risk.
But what about its future?
Is VICI still a compelling investment opportunity?
Or are its best days now behind?
I reached out to Edward Pitoniak, the CEO of VICI Properties, to discuss their future growth plans and potential risks to our investment thesis.
Below, I first share my main takeaways from the conversation and I then share the transcript of the interview as well.
My Takeaways From The Interview:
It appears that VICI has a clear goal of lowering its exposure to Caesars Entertainment (CZR), which is today its biggest tenant, representing 39% of its rental income. Although Caesars is performing well, this heavy concentration with a single tenant is likely keeping some investors away from the stock, or at the very least, leading them to demand a larger risk premium. By reducing this exposure, VICI could potentially achieve a higher valuation multiple and a lower cost of capital. This is not just a wild theory as VICI's valuation multiple has already greatly expanded from the days when it generated 100% of its rental income from Caesars, and that's despite today's higher interest rates. Sometimes, shareholders are better off with slightly slower FFO per share growth, but an improving portfolio quality that would eventually justify a higher valuation multiple.
VICI has a call option to buy some assets from Caesars at a 7.7% cap rate, and Caesars has a put option to sell those same assets to VICI at an 8% cap rate. VICI has made it clear that it has no intention of buying these assets, and Caesars has publicly said that it won't put the assets to VICI. While I think that VICI has a good rationale for not buying the assets (wanting to diversify away from Caesars), I think that Caesars might be just bluffing to encourage VICI to exercise the call option at the lower cap rate. It wouldn't surprise me if Caesars still uses their put option later this year, resulting in VICI acquiring about $2 billion worth of additional assets from them at an 8% cap rate. This would further increase the exposure to Caesars, but VICI would be well compensated for taking this risk. I like how they are approaching these call options given their current portfolio structure and cost of capital.
The fact that VICI isn't planning to exercise its call options, despite offering a strong 7.7% cap rate on good assets, tells us that VICI likely has a good pipeline of other acquisition opportunities. If their pipeline was empty, they would likely be more prone to exercising these options to secure some easy wins.
It sounds like it will take another year or two before VICI will start to acquire casinos outside of North America. They are doing due diligence and learning more about foreign markets, but it sounds as if they are not quite ready for it yet. Over the long run, these foreign markets could serve as a strong tailwind for the company because they could grow their acquisition pipeline, potentially offer even stronger spreads, and allow them to further diversify their tenant roaster, which would justify a higher valuation multiple.
A common misconception is that digital gaming will kill casinos, but in reality, it could even benefit them. Companies like Caesars have both, digital and physical businesses, and they are embracing a hybrid approach so that one benefits from the other. As an example, Caesars has a very big loyalty program and as people gamble on the app, they then gain Caesar Reward Points based on the size of their bet, which can then be redeemed for free drinks, meals, hotel rooms, and shows at Caesars’ properties. As a result, there are significant synergies between the two businesses, physical and digital, as users of the app are highly incentivized to then visit a property, where they are likely to also play further.
An important difference between VICI and its casino net lease peer, Gaming and Leisure Properties (GLPI), is that VICI has much greater exposure to Las Vegas and its higher quality assets. This warrants a higher valuation multiple because the Las Vegas properties have a greater moat and enjoy better long-term growth prospects. Moreover, the Las Vegas properties also enjoy stronger reinvestment opportunities. Despite that, VICI is today priced at roughly the same AFFO multiple as GLPI at the moment.
We maintain our Strong Buy rating. VICI is not as cheap as it once was but it is today safer, bigger, and better diversified than it has ever been. Despite its proven track record, VICI shares are still trading at a discount compared to most of its net lease peers. As VICI continues to diversify its tenant base, we believe the market will eventually reward it with a higher valuation multiple. Additionally, anticipated interest rate cuts should provide further support. With a 5% dividend yield, expected annual growth of 3-5%, and 15-20% potential upside from multiple expansion, investors can look forward to strong total returns. You can read our full investment thesis by clicking here.
Interview Transcript:
1) Carl Icahn recently invested in Caesars, your largest tenant, and it's rumored he may push for selling more real estate to fund share buybacks. You hold rights of first refusal (ROFR) on several key assets, including Planet Hollywood, Flamingo, Paris, Horseshoe Las Vegas, and The Linq on the Las Vegas Strip. How do these ROFRs work, and how likely do you think it is that you'll eventually acquire these properties?
In 2018 and 2019 Carl Icahn took a significant position in CZR stock (about 25%) and at that time did activate for significant change. According to recent filings, his current position is less than $100 million and represents about 1% of shares outstanding. He has indicated that he has bought CZR shares as an investment, believing the company under-valued but well-managed. CZR leadership hasn’t indicated any intention to sell the real estate of its Las Vegas Strip casino holdings, so, for the time being, we don’t see those assets as key components of our growth pipeline.
2) Tom Reeg from Caesars has indicated they won’t use their put option to sell Harrah’s Hoosier Park in Horseshoe, Indianapolis, to you at an 8% cap rate, implying they think that these properties deserve a lower cap rate. You've also stated that you won’t exercise your call option at a 7.7% cap rate, even though you've funded other investments at lower cap rates. Is this a matter of not wanting to increase exposure to Caesars, which already accounts for 39% of your rental income, or do you believe better assets can be found at similar cap rates?
We believe we have sufficient exposure to CZR regional gaming within our current portfolio, and do believe that we have in front of us growth opportunities that can better serve our diversification goals, meaning diversity both by tenant and geography.
3) Your peer, Gaming and Leisure Properties, has made quite a few acquisitions of regional casinos at around an 8% cap rate this year, while you haven't announced new casino acquisitions for a while. Have you simply not found properties that met your criteria for accretion and quality?
While we haven’t recently acquired incremental casino properties, we did recently announce an incremental investment of up to $700 million in our Venetian property, in return for incremental rent. We continue to have high conviction in higher-quality gaming properties and are especially excited about Las Vegas’ secular trends. We believe Las Vegas is the experiential capital of the world, with innovation generating new demand drivers (examples: Sphere and professional sports) that promise to keep Las Vegas globally relevant for decades.
4) I was intrigued to learn that your COO, John Payne, recently traveled to Australia, New Zealand, and Europe to explore potential casino investment opportunities. While the gaming property sector is well-established in the U.S., it seems foreign markets might still be a decade behind, offering a significant opportunity for VICI as a first-mover. Do you see this as a chance to acquire quality assets at attractive cap rates while diversifying your portfolio, potentially justifying a higher valuation multiple?
We are willing to take the time and do the work to get smarter on the real estate aspects of the global gaming industry. What we’re learning is that the gaming sector in certain international markets does have U.S.-like real estate intensity, while other markets tend to offer their gaming experiences in either smaller real estate formats or within regulatory frameworks that likely wouldn’t support or allow for REIT ownership of the real estate. At VICI we’re in it for the long term in all respects, and that also involves conducting field and fact-finding work that may pay off for us in years to come. We did expand into Canada in the last couple of years, and we’re very happy we did. To your point, international expansion does expand a REIT’s investment aperture, and that expanded aperture can be a factor in valuation.
5) Some investors express concern about VICI's tenant concentration, with 39% of income derived from Caesars. Additionally, Caesars’ share price has dropped 65% from its peak, and the company went bankrupt less than a decade ago. What gives you confidence in maintaining such high exposure to a single tenant?
Both VICI and our investors benefit from the fact that, as a public company, Caesars makes its financial results and condition fully transparent, and its results in recent years should give all stakeholders comfort that the corporate guarantee backing our rent is very strong. You can also see, by means of our growth track record, that we have significantly decreased our exposure to Caesars in recent years to the 39% you cite. Remember, at IPO in February of 2018 our rent roll was 100% CZR. Our recent decision not to call the CZR Centaur assets in Indiana is another example of our commitment to continuing diversification.
6) Caesars expects significant growth from its digital gaming segment, which has some investors worried that gambling could be shifting online. However, similar to how e-commerce hasn’t replaced class A malls or Zoom hasn’t replaced offices, could you explain how digital and physical gaming might complement each other and potentially benefit your business?
Both Caesars and MGM, our other major tenant, have committed to an “omni-channel” strategy, using sports betting and on-line gaming to expand and engage their customer bases, with the greatest value per customer being realized when they are able to turn an on-line initiated customer into a customer for the brick-and-mortar casino property. Penn has also similarly committed to this sort of omni-channel strategy. Class A Malls have regained relevance because great mall placemakers and operators like Simon have created experiences that compel visitation. This is a competency that the best gaming operators share as well.
7) If interest rates are cut substantially and your stock surges before year-end, would you still consider exercising your call option to acquire Harrah’s Hoosier Park in Horseshoe, Indianapolis, to capitalize on the spread?
We have made a strategic decision, based on portfolio management principles and priorities, not to call the Indiana assets. Cost of capital was not the deciding factor.
8) Gaming and Leisure Properties recently raised some debt at an interest rate in the mid-5% range. Is that in line with your expectations for the current environment?
That was a good result for GLPI and credit market trends since that raise have stayed pretty steady, but if we’ve seen anything over the last 18 months or so it’s that the credit market can be every bit as volatile as the equity market, so we’ll need to be watchful and agile as the time approaches when we need to deal with our 2025 refinancings.
9) You generate about 45% of your rental income from Las Vegas. While this is advantageous given the city's strong performance and the desirability of its casinos, some investors are concerned about geographic concentration. How do you view your exposure to Las Vegas, and do you plan to maintain this level in the future?
We have geographic concentration in Las Vegas, but we see the depth, breadth and diversity of the experiential offerings in Las Vegas as a concentration mitigant. Visitors, now and in the future, go to Las Vegas for ALL kinds of leisure and business reasons. There are multiple demand drivers that we believe will endure, cycle in and cycle out, for decades to come, and at this point there is no other free-world destination that can rival the experiential depth, breadth and diversity of Las Vegas.
10) In our first interview a few years ago, you compared your casinos to traditional net lease properties like dollar stores and pharmacies, arguing that casinos were safer despite perceptions to the contrary. Today, Walgreens, Family Dollar, and Dollar Tree are closing stores, and Rite Aid and 99 Cents Only Stores are in bankruptcy. Some of your peers may have better diversified tenant roasters, but that doesn't help much if they are heavily invested in riskier categories that are facing secular threats. Could you elaborate on what sets casinos apart?
Casinos are about giving social experiences that can’t be put into a box or sent through a wire or wavelength to your home. We believe they are less vulnerable to the obsolescence factors that threaten many real estate asset categories today. I would never use the world “invulnerable.” We must be watchful for social and cultural trends that could impact the relevance of our operators’ offerings, and thus the relevance of our real estate. For the time being, we are confident that our operators’ businesses and our real estate face a lower threat of being “Amazoned.”
11) In recent years, you've expanded into other non-commodity experiential real estate categories. Arenas and stadiums seem like a natural addition to your portfolio given their large investment scale, low secular threats, significant barriers to entry, and proven longevity. Yet, these assets don’t seem to have been a target for you in the past. Is there a specific reason for this? Is it a matter of pricing?
Arenas and stadiums are intriguing to us, but we are mindful of two issues when it comes to arenas and stadiums: 1) Asset utilization, meaning is the use of the asset sufficient to produce revenues and cash flows that would support a sale-leaseback model, and 2) What’s the obsolescence or abandonment risk of a stadium or arena, especially in the U.S., where we tend to see a higher risk of teams leaving a stadium or a locale for newer, greener pastures after only two decades or so. Training centers are more intriguing to us, because, even in the case of a team relocating, you have an asset adaptable into a commercially viable training and recreation center.
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Analyst's Disclosure: I/we have a beneficial long position in the shares of all companies held in the CORE PORTFOLIO, RETIREMENT PORTFOLIO, and INTERNATIONAL PORTFOLIO either through stock ownership, options, or other derivatives. High Yield Landlord® ('HYL') is managed by Leonberg Research, a subsidiary of Leonberg Capital. All rights are reserved. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The newsletter is impersonal and subscribers/readers should not make any investment decision without conducting their own due diligence, and consulting their financial advisor about their specific situation. The information is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The opinions expressed are those of the publisher and are subject to change without notice. We are a team of five analysts, each contributing distinct perspectives. Nonetheless, Jussi Askola, the leader of the service, is responsible for making the final investment decisions and overseeing the portfolio. We do not always agree with each other and an investment by Jussi should not be taken as an endorsement by other authors. Past performance is no guarantee of future results. Our portfolio performance data is provided by Interactive Brokers and believed to be accurate but its accuracy has not been audited and cannot be guaranteed. Our portfolio may not be perfectly comparable to the relevant index. It is more concentrated and may at times use margin and/or invest in companies that are not typically included in REIT indexes. Finally, High Yield Landlord is not a licensed securities dealer, broker, US investment adviser, or investment bank. We simply share research on the REIT sector.
