The announcement that MGM is buying out Boyd Gaming’s interest in the Borgata for $900 million was an immediate head scratcher, particularly as there has not been a lot of good news out of Atlantic City in recent times. Then when MGM announced they were selling the property to MGM Growth Properties (MGP) for $1.175 billion the deal became crystal clear.
On Boyd’s side the deal is a clear no brainer: Sell for $900M, get rid of $300M in debt associated with the property and net $600M to use on projects or debt reduction. As the Borgata was a 50/50 deal, the $200 million a year it generally cleared, with $100M each to Boyd and MGM, was like selling their interest for nine times their earnings, a good deal on its own. But it also allowed them to exit a struggling market and provide cash to focus on their strong suit (regional locals-based gaming). So the sell part makes total sense, but why would MGM pay such a price?
It was the REIT.
Earlier this year, MGP was approved as a REIT, via a private letter ruling from the IRS. This effectively makes the company a tax free entity as long as it maintains REIT status and distributes the required percentage of profits. As such it became the perfect vehicle to own the Borgata.
Here is why: MGM, in flipping the property to MGM Growth Properties for $1.175 billion, will pocket $275 million immediately. Then, in leasing the property back, it will generally pay MGP $100 million a year in rent. Since MGM is getting $275M it is almost getting the first three years rent free, from a cash flow perspective.
When MGM was a partner it was getting about $100M a year from Borgata, and as it is going to pay about $100M a year in rent, that does not change. However, the $100M that was going to Boyd is now going to MGP tax free, saving in theory about $35 million dollars a year in federal taxes. As MGM is the controlling majority shareholder to the REIT, when the dust settles they bought out Boyd for a 35% discount courtesy of Federal Tax Code, so the transaction is a win/win situation for everyone other than the IRS.
However, Atlantic City has not been a stellar performer, so what about the business risk?
Borgata has been the best-in-class performer in AC for some time, and while the city is struggling in many ways, the Borgata is likely to hold that No. 1 position for a long time to come. Accordingly, even if the city continued a slow death, it is likely Borgata would retain its profitability for the foreseeable future and be the “last man standing” against the rest of the market place, even if the city should “crap out.”
Though Atlantic City continues to suffer from other regional competition, it has its own niche, still has a fair amount of life left in it, and with other permitted activities like online gaming, has other supportive alternatives for its casinos’ bottom line performances.
The online gaming opportunity could be the hidden gem for MGM. While it is a given MGM will be able to take advantage of Borgata’s database to feed its emerging East Coast developments as well as its existing Las Vegas properties, online gaming permits access to the entire state of New Jersey with its roughly 9 million people.
Though online gaming has been growing in use, preference and acceptability to the citizens of New Jersey, it has not come close to reaching its peak performance or potential, and it could give MGM a much needed laboratory to learn and gain expertise in the field. It is an area MGM had to give up on before and it is likely to grow in other gaming jurisdictions; accordingly, the online aspect can certainly be an area of opportunity for MGM and potentially make it a competitor to Caesars’ online business both nationally and internationally.
MGM’s REIT is clearly shaping up to be a great move, the only thing suspect so far has been the lack of distributing REIT shares to shareholders of MGM. Arguably MGM shareholders are getting the benefit as MGM is the majority controlling party of the REIT, but if certain MGM executives are granted shares in the REIT for simply moving assets around and getting a tax ruling, why not the MGM shareholders as well.
The Analyst is an experienced gaming industry executive who offers insight each week on events and issues affecting the industry. Email: [email protected]