VICI Properties Inc (VICI) — Q3 2018 Earnings Call Transcript

Thank you, Operator, and good morning. Everyone should have access to the Company’s third quarter 2018 earnings release and the supplemental information. The release and supplemental information can be found in the Investors Section of the VICI Properties website. Some of our comments today will be forward-looking statements within the meaning of the Federal Securities Laws. Forward-looking statements, which are usually identified by the use of words such as will, expect, should, guidance, intend, projects, or other similar phrases, are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. I refer you to the Company’s SEC filings for a more detailed discussion of the risks that could impact future operating results and financial condition. During the call, we will discuss non-GAAP measures, which we believe can be useful in evaluating the Company’s operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our third quarter 2018 earnings release and our supplemental information. Hosting the call today, we have Ed Pitoniak, Chief Executive Officer; John Payne, President and Chief Operating Officer; David Kieske, Chief Financial Officer; and Gabe Wasserman, Chief Accounting Officer. Ed and the team will provide some opening remarks, and then we’ll open the call to questions. With that, I turn the call over to Ed.

Thank you, Samantha and good morning everyone. We appreciate you taking the time to join VICI's third quarter earnings call this morning. We released our third quarter results last evening and it has been just over one year since we emerged from our spin-off. We now have a full year, four fiscal quarters of reported results under our belts. Here are a few of our key accomplishments in building our business over our first four quarters of operations. We’ve raised nearly $2.4 billion of equity through our Q4, 2017 equity private placement and our February 2018 IPO. We refinanced over $2 billion of debt and eliminated over $1 billion of debt. We’ve closed or announced a total of $2.1 billion in acquisitions and we’ve managed to de-lever from 8.4 times debt-to-EBITDA emergence to 5.0 times as of Q3, while growing our pro forma AFFO by about 46%. And might I add, we accomplished all of this within the governance framework that was established to serve our one and only class of shareholders: the common equity shareholders. We realize that our sector leadership is and always will be contingent on us making good decisions, taking the right actions and managing risk properly, day after day, so that every day our shareholders' interests are being relentlessly cared for and value is being steadily created. In this past quarter, regarding our growth pipeline, we closed on the acquisition of Octavius Tower for $507.5 million, adding $35 million of rent and rounding out our ownership of the iconic Caesars Palace, Las Vegas. We continue to move toward closing the Margaritaville, Harris Philadelphia and lease modification transactions. We hope to have all of those wrapped up during the fourth quarter. We continue to see a lot of activity in the sector, as John can attest, and we'll do so in a moment, and we don’t see ourselves slowing down as we intend to continue to pursue attractive growth opportunities. Not to be forgotten, we still have three call option properties in our back pocket, as well as any ROFO assets that become available. Needless to say, we feel very good about how our first year has progressed based on the three key elements of our business model: one, best-in-sector governance and high-energy management capability; two, high-quality portfolio income that is durable and transparent through all cycles; and three, best-in-sector growth prospects. With that, I’ll now turn the call over to John to discuss what we’re seeing in the market. John, over to you.

Thanks, Ed, and good morning everyone. The market environment for gaming transactions continues to be active, and the number of transactions announced by us and the gaming REIT sector more broadly over the past year is a testament to the growing confidence operators and investors have in the gaming REIT model. This quarter we closed on the Octavius Tower at Caesars Palace and we continue to make progress towards completing the acquisition of Harris Philadelphia with Caesars and Margaritaville, Boulder City with Penn National, which we hope to close during the fourth quarter. We have no intention of slowing down. And as you've seen from the transactions we’ve announced over the past year, there is no shortage of external growth opportunities currently in the marketplace. While we are the new player in the market, we have long-standing relationships within the industry that have allowed us to make progress towards our goals. Those goals have not changed. We continue to work on diversifying our tenant base, expanding geographically in attractive regional markets and growing our Las Vegas exposure, all while creating value for our shareholders. As we have said before, we continue to believe we can further build the portfolio by putting your capital to work. The principles key to our success have been our true independence, our depth of understanding of the tenants' underlying business and our focus on executing what we can consider fair deals, deals that are mutually beneficial to both the OpCo and VICI. We believe that the acquisitions we’ve completed and announced to date have demonstrated this, not only to our operating partners but to our shareholders who we’ve entrusted our capital with. With that, I’ll turn the call over to David who will discuss our financial results.

Thanks, John. We reported total AFFO of $132.2 million or $0.36 per share for the third quarter. Our earnings for the quarter reflect $232.7 million, which was comprised of $227.3 million from our real property business and $5.4 million from our golf business. Real property business revenue was comprised of $189.9 million of income from financing leases, $12.2 million of income from operating leases and $25.1 million of property taxes paid by our tenants. Our income from direct financing leases for the quarter includes a $13 million net change to our investments in direct financing leases, which is a non-cash item. After adjusting for the non-controlling interest attributable to Joliet, our portion with DFL that is deducted from net income should calculate AFFO to $12.9 million. On the cost side, our general and administrative costs were $5.7 million for the quarter. We're thrilled to report that we have completed the previously discussed transition from Las Vegas to New York and reached our steady state run rate for G&A. We continue to expect that costs will hover around $16 million per quarter with slight fluctuations possibly occurring quarter-to-quarter. During Q3, the Company recognized a $12.3 million non-cash loss on impairment on certain non-operating vacant land parcels. By way of background, it was part of our emergence and spinoff from CEOC, VICI inherited approximately 215 acres of non-operating land parcels scattered across the country. All of the land parcels are located outside of Las Vegas and none of the land parcels are components of the operations of our regional property portfolio. As part of our efforts to monetize certain parcels, it was determined the carrying value reported on our balance sheet at the time of emergence exceeded the fair market value. As a result, we recorded a one-time non-cash impairment and reclassified the remaining land value of approximately $22 million from investment in operating income to land on the balance sheets. On the acquisition side, on July 11th, we completed the acquisition of Octavius Tower for $530.5 million. The purchase was funded with cash on our balance sheet. Octavius Tower is operating pursuant to a standalone lease, which provides for annual rent of $35 million and has an initial term that expires on October 31, 2032, with four, five-year renewal options. In connection with the closing of Harrah's Philadelphia and the lease modifications, the details of the lease will be amended to include Octavius Tower. As has been mentioned, we hope to close Margaritaville and Harrah's Philadelphia and the lease modifications during the fourth quarter. We expect the total net cash outflow for these transactions, including the impact of the $159 million reduction of the Philadelphia purchase price in connection with the agreed-upon lease modifications, to be approximately $344 million. We expect both transactions to be funded using cash on the balance sheet. Turning to our balance sheet, we ended the quarter with approximately $466 million of cash and short-term investments. Our outstanding debt at quarter-end was $4.1 billion with a weighted average interest rate, including the impacts of our interest rate swaps, of 4.95% and a weighted average maturity of approximately 5.2 years. We have no debt maturing until 2022. Based on the annualized third quarter adjusted EBITDA, our net leverage is 5 times. With respect to our guidance for the remainder of 2018, the Company is updating its estimated net income per share guidance to reflect the non-cash loss on impairment which occurred in Q3. And we are reaffirming the AFFO per share guidance for the full year 2018. As a reminder, our guidance does not include pending acquisitions that have not yet closed. We estimate that net income attributable to common stockholders will be between $1.44 and $1.45 per share, and net AFFO per share will continue to be between $1.43 and $1.44 per diluted share for the year ending December 31, 2018. Finally, regarding the Company’s dividend policy; with the closing of our Octavius Tower, we raised our targeted annual dividend rates to 9.5%; on September 17th, we declared a quarterly dividend of $0.2875 per share of common stock for the third quarter, which reflected the increased annualized dividend rate of $1.15 per share. The dividend was paid on October 11th to stockholders of record as of the close of business on September 28th. In closing, we continue to make tremendous progress as we execute on our strategy. We believe we are well-positioned to keep growing our portfolio and driving our shareholder value. Operator, at this time we’d be happy to open the line for questions.

Can we talk about the M&A environment a little bit outside of the call right properties and other dropdowns from Caesars? What are you guys seeing in terms of new pipeline opportunities? And as a follow-up to that, are you seeing opportunities more with publicly traded operators or with both public and private casino owner-operators? Thanks.

I apologize if I sound repetitive, but over the past two quarters, we've observed continued strong activity in the market. We're actively engaging with operators to ensure they understand our business model and our true independence. In terms of the companies we’re interacting with, there's a mix of both public and private entities. We are committed to maintaining a strong presence in discussions regarding potential assets, and while we can't predict transaction outcomes, we are focused on ensuring that VICI is recognized in the space.

Dan, I might just add to that. What we’re benefiting from is the increasing understanding on the part of asset controllers and/or operators regarding the nature of the capital we convey to them if we do a sale-leaseback transaction. That is to say, we’re another form of permanent capital. We believe, in many cases, a cheaper form of permanent capital than they could access either through the public markets or other private channels.

This is Abhishek on for Smedes. There have been a lot of media stories about the state of Caesars from a perspective. Can you talk about what this change of control would mean, if anything, for your existing leases with Caesars, as well as your call options on the three Harrah’s Casinos?

To start, I want to provide some context about our relationship with Caesars. We are in the midst of a long-term partnership that has at least 34 years remaining, and by 2052, we expect that this relationship will still be ongoing. Regarding the change of control, I want to emphasize that Caesars has made no announcements about any potential changes. They are currently searching for a new CEO, as they shared yesterday, but for any technical details on a change of control, I will pass it over to David and John.

Yes, in terms of the call properties, those are essentially obligations of Caesars and the entity, and those would carry forward if there were any change of control. And then the leases are obligations of the entity as well and we don't have any concern that those leases would be impacted if there were a change of control. Regarding Caesars as our tenant, we're only speculating on what is rumored in the press as you are. But we feel good about our tenant relationship.

And I think, obviously, you know this well, Smedes, that we're in a triple net space and you have to look past just quarter-by-quarter. But if you do look at the underlying business at Caesars, you look at their Q2 results, EBITDAR was up 13%. This quarter was a little down, but they're forecasting for the fourth quarter the outlook looks really strong, between I think it was 6% and 16%. Those are healthy growth metrics for the underlying tenant's business.

And would it change the way you think about the timing of the call options? Would you opt to be more in front to exercise them sooner rather than later, or is it a little different?

No, not necessarily. Our timing on the call properties will always be based upon our belief in a very opportune time to exercise a call or multiple calls at any given time over the remaining four years that we have to call them. We are not concerned about anything that may happen and how it may impact timing. We’ll always do it when we believe it's the best time on behalf of our shareholders to take them down.

I guess one clarification just on the impairment. Can you just provide a little more detail on where some of that land is, maybe why there was deterioration or maybe it fell under your expectations or maybe that's even the cost of the land? And then also what you plan to do with the rest of the land?

So this is land that has been on Caesars' balance sheet for years, and John can speak to how long it's been around. This is land that Caesars accumulated over a period of time when there were potential opportunities to expand gaming and jurisdictions, representing a likelihood that we're going to grant it. So this is really non-de minimis, non-operating land. It is not associated with any casino operations. And as we went to start to monetize some of this, because it has no intrinsic value to us going forward, we realized the value on our balance sheet at the time of emergence was simply different from the fair market value. We took a $12 million non-cash write-down. There was $34 million in aggregate. We wrote that down to $12 million, but the one-time cleaning up some accounting that was done at the time of emergence.

And then maybe turning to just the overall M&A environment and you alluded to this a little bit. But have you seen any shift at all in property pricing expectations, either due to the rising interest rates or even just gaming sector performance in general?

We have not seen any difference in activity or pricing at this time. Maybe it’s a little earlier; we’ll just have to continue to watch that. But the activity has been as robust as it has been in the previous quarters as I've communicated. So, again, we'll continue to monitor and listen to what’s out in the market, but we have not seen a decline in the number of activities.

The question is for Ed or David or John. In terms of potential accretion from transactions, I mean a lot of gaming deals over the past few years have been done with 5% to 8% accretion to AFFO per share. Where do you think that settles down over time? And do you think it settles down at some level below that?

I think historically, Cam, part of the explanation for that magnitude of accretion is that until recently most of the big trades or big portfolio trades were capable of generating that kind of block accretion. I think when you get down to single assets, it’s unlikely you’re going to see that magnitude of accretion. At that point, you’d be more rightly focused on the cash-on-cash return of the transaction itself as opposed to an EPS accretion per share. Because obviously, as each of us, as each of the three of us get bigger, the accretion per share will become mathematically somewhat harder to achieve. I would evaluate single, especially single asset transactions, not only on an accretion per share basis, which we will always ensure is positive but also on a cash-on-cash return of the acquisition in relation to the cost of capital required to execute that transaction.

And then, David, in terms of funding M&A, if you were to issue seven to ten-year paper today, where do you think that might price?

I mean with our rating at Ba3, BB rating, it's in the mid to high 5s, is what the bankers continue to tell us as the rates are moving around, 10 years move around the books. But the overall debt markets are being liquid and fluid still and pricing that would make sense to achieve the accretion that Ed talked about.

And then one last one for John, if I can. John, you’ve been in the gaming industry a long time. What’s your interpretation of what we saw in the third quarter in Vegas?

I think people were prepared for numbers that were going to be quite weaker than that, Cam. The numbers that have come out had some weakness compared to the prior year, but they seem to have exceeded the expectation, which was nice to see. It's funny, we’re looking at less about the third quarter, Cam, and onto the fourth and the first, and the operators have talked a lot about the strength that they’re seeing in the fourth and into 2019, which is great to hear.

The other thing I would add is that, as John previously mentioned, we are a triple net REIT, which means we will collect the same rent regardless of what happens at the operator level from quarter to quarter. Nevertheless, we believe that our strategy of having exposure to both regional markets and Las Vegas is the right approach for us as a REIT. This strategy allows us to distribute cash confidently throughout all cycles. As you may have seen in their reports, Caesars, which reported yesterday, had a commendable performance for Q3 that was very strong. Approximately 50% of our portfolio is in the regions and 40% is in Las Vegas. We appreciate that balance. While we don’t focus on a quarter-to-quarter basis, we value having tenants with portfolio disclosure and geographic diversity.

David, just wanted to circle back to the comment that earlier in terms of the $344 million of financing net for the two transactions, including the lease modification. You mentioned largely cash. I think you guys have about $145 million of cash on the balance sheet as of Q3. And what's the comfortable balance there you guys are willing to keep at the corporate level?

So the one thing we want to point out is that we also have $320 million of short-term investments. Those are just simply, from an accounting classification, highly liquid investment-grade commercial paper with maturities of 91 to 120 days. So, to the extent that the two together, that's the $466 million that was referenced in my remarks. We have plenty of cash on the balance sheet to fund the two pending transactions. As we think about our cash needs on a go-forward basis, probably in the $75 million to $100 million range. We want to ensure we get enough cash to cover the next quarter's dividends. We have very little working capital needs, but we want to make sure we're able to continue to fund our dividend, and with the free cash flow that we generate from our low payout ratio also allows us to be well covered.

And then just if I may one follow-up. As it pertains to some of the changes that are taking place at Caesars. When you think about the potential for them to be doing M&A on the buy side going forward, does any of the decision-making there or anything you could potentially be partnering on, do you believe there might be a little bit of a lag in that right now until things are more settled?

Only time will tell, Carlo. Again, we have a lot of confidence in the Caesars' board, a lot of confidence in the Caesars' management team. What you heard yesterday was a continuing commitment to growth over time and very good results. One thing I just want to highlight that Caesars reported yesterday that probably didn't get the attention it deserves is the continuing guest satisfaction improvement that Caesars continues to generate in terms of net promoter scores and customer service scores. As real estate and hospitality people with hospitality backgrounds, I put a lot of stock in how happy a tenant's customers are, and whenever you have improving happiness, you have a company that has improving prospects. I think that has implications on how they grow in the future.

This is Ally on for Sean. I know you guys in your prepared remarks mentioned interest is growing in Vegas. Just wondering if there are any other regional markets that you think seem appealing right now or ones that maybe you're currently in, and would be interested in expanding in?

We continue to look at all opportunities. We’ve talked about expanding our footprint in Vegas, not only on the strip but there are opportunities to get into the local market there. We like that business. That business continues to grow. We like what we’re seeing in the Reno market, which we already have an asset there as well, and then there are some other regional markets that continue to show great strength and growth in some regional markets that we just aren’t in that we think would continue to diversify our portfolio. If those assets came up for sale, we would be very interested in those assets as well. So that’s a short answer, but hitting all the markets we think there are still opportunities for us to look at.

And maybe just add onto John's comment on a day when we obviously saw very positive jobs support and moreover very positive wage growth. So much of that increased economic vitality is taking place out in the regions, and we feel it is going to mean good things for regional operators in the years to come here.

Just a couple of quick follow-ups. What’s your appetite on taking on larger transactions or potentially multiple properties at once, especially considering the pace of M&A so far has been fairly measured?

Ken, I think because a lot of that, obviously has to do I think the underlying question really hinges on our confidence in our ability to effectively fund larger transactions. I will turn it over to David.

As a basis of any acquisition, it has to be accretive day one for us. We would not shy away from larger portfolios, just because they are larger. We feel that we have good access to both the debt markets and the equity markets as needed to potentially acquire larger acquisitions if they are accretive, if they make sense for our portfolio diversification and our tenant diversification. So, as John has alluded to, there is a lot going on out there, and we’re not shying away from anything just frankly given the size.

Yes, that was actually the direction I was going in, so as a follow-up. Is there a level of leverage that you think could be just too high and that would contribute to you guys considering using equity for a transaction? Is it something in the six range, 6.5 range, something higher than that, that could frame how you think about these potential transactions?

As we’ve talked about, Komal, and as Ed alluded to in some of his opening remarks, at emergence we were at 8.4 times debt to EBITDA; we are at 5.0 times on a net basis today. We are going to be very disciplined in keeping our leverage in the low fives, around 5 to 5.5 times. There may be times when it picks up slightly north of 5.5 times, but we would be hard pressed to ever get in the 6 times debt to EBITDA range. We want to be measured and disciplined to ensure we can grow the portfolio accretively and we want to work to acquire assets or portfolios on a leverage-neutral basis.

And then just one last one for me, in an effort to be more aggressive on M&A deals given the landscape. Would you consider using the TRS structure for operating rights if an attractive property comes up, something like one of your public peers recently did? Or do you think that doesn't quite align with your risk appetite?

I don't think we ever rule it out if it made sense at a given time to do so. I would say generally though, again, we take very seriously as we obviously have to the fact that we're a REIT. We believe that equity capital invested in us as a REIT in order to receive the distributions it does in the most tax-effective way possible from the source of income. We wouldn’t rule it out, but we would always look to see the degree to which we can take any dollar of income that our Company generates and turn it over to our investors in the most tax-effective way possible.

I think you've touched on pretty much all of my questions, but maybe just a housekeeping item if I missed it in the prepared remarks. Do you have updated timing or time range on the acquisitions of Harrah's and Margaritaville?

We aim to complete everything by the end of the year, as Penn indicated, with a similar timeline for Margaritaville, based on their call. We are currently finalizing some regulatory and loan consent processes for both transactions.

And then just to say high-level. We've talked a little bit about the M&A environment and your appetite in different parts, but maybe to ask a question a little differently other than ensuring that the next deal that you do is economic and value accretive, are there other strategic priorities in terms of tenant diversity or things that you might be looking for as you scale the M&A environment?

We’re obviously always going to value tenant diversity. And tenant diversity is not necessarily just an end unto itself. Tenant diversity is a means of getting more exposure to more markets, more operating practices, more end-user end-customer relationships. So again, that will always be a significant part of what we're doing. But again, it will have more to do at the end of the day with the quality of the market we're buying into, the quality of the asset in that market and the operator's relationship to its end customers. If that yields us more and more tenants, we’ll obviously be very happy to have achieved that.

Most of my questions have been asked. I'm curious though as you're having increased discussions for the smaller portfolios or single assets. Is there any change in what sellers are expecting in terms of economics or where you're selling the rents? Just curious how those negotiations have changed possibly from larger deals to smaller deals?

There hasn't really been a shift from larger to smaller portfolios. It really depends on the operator we are discussing. As you can imagine, different goals and objectives exist depending on the operator and the property, but there hasn't been any change recently. The situation has remained quite stable. We will keep observing. There has been considerable activity, as we've mentioned, but ultimately it comes down to what the seller aims to achieve with a potential deal.

And R.J., to elaborate on that, the major gaming operators, particularly the public ones, have experienced quite a tumultuous period recently. Following the Q2 earnings announcements, many of their stocks faced significant declines. The situation unfolded so rapidly and unpredictably that it was challenging for anyone to assess and recalibrate their expectations. The prevailing sentiment seemed to be confusion over what was happening. Only time will reveal whether this was a temporary setback that everyone will rebound from quickly or if it reflects a more enduring trend. We believe that the Q3 results being reported by nearly all operators indicate a severe overreaction in the performance of gaming stocks over the past couple of months. It will soon become evident that, based on the robust fundamental performance they are all demonstrating, stability will be restored.

And when we do hit that equilibrium, which we would anticipate, do you expect greater velocity in terms of M&A and/or the selling of real estate?

I don’t know if the velocity is necessarily going to pick up. But I think there will be a commitment, obviously, or very much flow to the conversations around these potential transactions and a recognition that these transactions do take time.

Just one quick follow-up. Can you remind us what the expected AFFO per share accretion is from Harrah's Philadelphia and Margaritaville? And do you intend to update Q4 and 2018 guidance once those deals close? Thanks.

Dan, our follow-through would be to update guidance once those deals do close. And just as a reminder, Harrah's Philadelphia would generate $21 million of annual rents, and Margaritaville will generate about $23 million of annual rents. So you can do the math on what that adds to really a full year in 2019 in terms of AFFO per share growth, which we think once we get these closed, our shareholders will benefit from a full year of having those acquisitions in our portfolio. We’re excited about what 2019 brings.

And maybe just to restate the obvious, because they are being paid for with the cash on hand, the $400 million-plus of cash that David referred to earlier. Obviously, that rent turns into NOI and turns into AFFO with 100% flow through just about.

Thank you, everyone, for your time today. We look forward to providing an update on our continued progress when we report our fourth quarter and year-end results. Thanks again.