In keeping with the proud legacy of the late Kirk Kerkorian, MGM seems to be structuring a REIT that looks to use the “Other People’s Money” principal to lighten its debt load yet retain controlling interest over the proposed REIT.
As announced last week MGM is forming a Real Estate Investment Trust (REIT) and will be contributing seven of its Las Vegas Strip assets: Mandalay Bay, Mirage, Luxor, Excalibur, Monte Carlo, New York-New York and The Park; along with three of its out-of-state properties: MGM Grand Detroit, Beau Rivage and Gold Strike Tunica; and $4 billion in debt.
According to MGM’s press release, MGM plans on retaining 51% of the new company holding the REIT and is looking to see the contributed $4 billion in debt restructured with new debt and equity.
Though MGM is placing the selected real estate into a REIT, it will lease the facilities back from the new company to operate their business as usual and pay a set rent with an initial ten-year term and four five-year extension periods for essentially a 30-year lease. This basically means: for the employees, customers and vendors nothing really changes at all. For the investors, accountants, lawyers and the IRS though, lots of things will change.
Usually when a casino chooses to go the REIT route, the company essentially splits in two with one side being the operating company and the other the landlord; existing shareholders then have a share in each company.
Though the full details of the MGM plan have not been released, the nature of the MGM REIT, based on what has been release so far, seems to be shaping up not to issue any shares in the new REIT to existing shareholders but to sell shares through an initial offering next year in the open market. Depending on market conditions and valuations, this could have the benefit of taking somewhere between $2 billion and $4 billion dollars of debt off of the over $12 billion the company currently shows on its balance sheet, and fundamentally pay for it with money that would normally go to the IRS.
In a REIT, the company does not pay Federal income tax unless they do not distribute at least 90% of the company’s income to its investors. In MGM’s case the Federal tax rate is 35%. The 2014 Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) on the properties MGM is putting into the REIT was over $846 million dollars. So let’s assume MGM rents the properties from the REIT for $500 million a year. The $175 million that would normally go to the Federal government as taxes on the $500 million would then be kept by the company and the new investors.
Going one step further, remember above that MGM has indicated it would retain 51% of the REIT. Therefore in this example if the rent is $500 million and it is fully distributed, then MGM would send $255 million to itself and the outside investors of the REIT would get $245 million. If the outside investors are willing to get a 6 percent return on their money then that $245 million has, in this example, a worth of a little over $4 billion in principal to the outside investors.
Note that we showed in this example that the Federal income taxes would be reduced by $175 million and the outside investors would get $245 million so the difference of $70 million a year would be the out-of-pocket cost to the company to get rid of $4 billion in debt, or an effective interest rate of 1.75%.
The upside for MGM is it could potentially, depending on market conditions and financing rates at the time the REIT is funded, get rid of about a third of its long term debt rather cheaply. The upside for the new investors in the REIT is a steady and predictable income stream from the rents, which in today’s interest rate market is very desirable.
With the limited information provided by the company so far, the only downside to this structure seems to be that any near-term sales with material gains from the properties placed into the REIT as those gains would be shared with the new investors.
I suspect if Kerkorian were around he would be very pleased with this plan, its tax advantages and the use of “Other People’s Money!”
The Analyst is an experienced gaming industry executive who offers insight each week on events and issues affecting the industry. Contact The Analyst at [email protected].