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Penn National Gaming, Inc. (PENN)

March 05, 2013 10:00 am ET

Executives

Hayes Croushore

Unknown Analyst

Okay, everyone, we're going to get started. I'm here with Hayes Croushore from Penn National. Hayes is the Director of Finance, Investor Relations. I appreciate Hayes, your being here. And everybody will kind of -- I'll start with some questions and if you have any questions in the interim just raise your hand, otherwise we'll kind of reserve the last 15 to 20 minutes for some -- some Q&A from the audience.

Question-and-Answer Session

Unknown Analyst

But, Hayes, thanks again. So let's get started obviously big picture of topical. We've seen regional gaming go through kind of the hits and starts on a monthly basis but if you look over the longer-term, it's been an industry that kind of bottomed and never really saw that recovery that other retail industries have. Fast forward to the present, we've certainly seen some sluggish months here. Obviously weather is a difficult comparison. You have constraints on the consumer, whether it's the payroll tax, gasoline prices going up, later tax returns this year, et cetera. When you guys look across the broader landscape and you speak to your customers, what's kind of vested tone that resonates, I guess, most loudly for you?

Hayes Croushore

Well, we're still trying to understand. There's, as you mentioned, there's a lot of factors that we'd like to know. Is the timing of tax returns -- clearly the weather is an issue. Last February was probably the best month on memory. So we knew this February would be a difficult comp for us.

March, is I think going to tell us a whole lot and if weather-related business, if tax return related business comes back in March, we have strong March then I think we'll feel better about the consumer. If March continues the trend that we've seen in January and February, then you have to wonder whether it's more related to the payroll tax. The Dow, I think this morning is hitting an all-time interday high. So there's consumer confidence somewhere. And I think we have confidence that, that business will flow through to us. It's a matter of patience and like I said, I think we're going to wait and see how March goes.

Unknown Analyst

Great. In terms of -- as you think about, obviously your outlook for this year and relative to the guidance that you guys set forth, have -- clearly it's been about a month since you guys have announced earnings, a little bit more. Has anything since then kind of surprised you guys one way or another with respect to the cadence of February albeit a shorter month and obviously not the greatest weather?

Hayes Croushore

Our guidance essentially anticipated a flat consumer in markets where we didn't have any competitive impact, there's only a few for us. But we contemplate essentially a flat consumer and we planned for normalized weather. So to the extent that weather is worse than we expected or to the extent that there is a consumer impact, a longer-term in our business, then those will be factors in our forward-looking guidance. And I don't think at this point, we have any interest in changing our guidance, I don't think we have any motivation for that. We're going to wait and see how this quarter rounds out. There's a reason we report quarterly, right? It's so that we can allow some of these short-term trends to work their way through and try to report on a more longer-term impact.

Unknown Analyst

So on a more Penn-specific topic, obviously, given your scope, as you mentioned, you're going to face some competition. And generally speaking, I mean, you guys seen more of it and have more experience in the competition than your peers just given your exposures. But in recent months, you've seen Louisiana, you've seen Indiana, you've seen properties -- your property in West Virginia all face pressures and maybe there's some incremental coming from different legislative changes too that will show up. I guess, how is the early experience at each of those places, on the aggregate, varied from your original expectations and what have you been doing to kind of minimize, not so much the top line impact more so the impact on the EBITDA line?

Hayes Croushore

Our expectations internally were actually relatively close on the whole. We did miss the timing in Lawrenceburg. Scioto opened earlier and had a little more of an impact than we expected. But with Columbus open now, a combination of Columbus and Scioto competing with Lawrenceburg, we've been relatively close. In Baton Rouge, we were relatively close, same thing in Charles Town. Maybe Charles Town might be a little bit better than our expectations. But I think that our internal forecasting was on the whole, okay. And that's -- the challenge that we've had for the last few years is that we've had all these moving parts, we've had a lot of competition and a lot of new facilities opening that in the finance department we've worked hard to forecast. And really, we do our best to make educated guesses. We saw, years ago, sort of the writing on the wall that all these new markets were opening up, and I think we've successfully positioned ourselves to take advantage of the new markets. We knew that in Ohio that we were going to have an impact to Lawrenceberg and we knew in Kansas City we will have an impact to Riverside. And so we've been able to position ourselves to also take advantage of positives of those new states opening up.

The reality is, in the consumer -- in the regional gaming market, consumers are motivated by proximity. And so it doesn't do us a whole lot of good to try to fight that. Now we have some benefits, in Charles Town and in Lawrenceburg for example, we have smoking, which we think offsets to some degree the impact of proximity. But we try to manage our business in a very thoughtful manner and so to the extent that we will pursue new marketing opportunities. It will be focused on geographies, on particular ZIP codes, battle zones and also on a higher fee of [ph] customer that if they take up their offer and they come to our business, that they will still be profitable for us. So don't expect to see from us an across-the-board panic marketing philosophy.

Unknown Analyst

With respect to obviously Ohio and I know you guys have done your work and you talk about kind of demographics and the radius around the properties. And I've heard Tim and Bill both say many times, with respect to Ohio, if it gets to where we thought it was going to be, it would be demographics number lied [ph] before. Earlier this morning, speaking with gentlemen from Caesars, their view is more or less that the slot stuff was a little slower to come around. There were some behavioral changes that needed to take place in Cleveland but also that some of these internet cafés, internet parlors were hampering some of that slot business or I should say pulling some demand from there. Do you feel like that market -- and I'll speak more specifically to just Toledo right now, Columbus obviously a little bit too early to make any firm judgment. But do you think those internet cafés and those kind of gray market, if not illegal, machine have really taken that big of chunk out of your slot product?

Hayes Croushore

I think there's a little bit of a chicken and egg to debate you can have. There's a lot of logical that these internet cafés also introduced new customers to a new gaming experience which they would then choose to bring to our facilities. And then the opposite is true that this is maybe a more convenient alternative for them. I think, if you ask Tim, he's pretty convinced that there is a significant impact there. And I know that our operators told us that we had customers who came in and got their players card and they asked how they could put a balance on it. And that's how it works in the internet cafés, is they get debit cards. And so customers came to our facility and expected to get debit cards because that's their experience. I know there's a lot of them. I know that we've had operations folks that have visited them and have said that the experience is very similar to a slot machine. So I think we're working towards legislation to at least minimize the impact there. And I think that Caesars is probably on the same page with us in that goal. So we'll see where that goes.

Unknown Analyst

In terms of in the near-term, I know you guys did some tweaks to your slot floor at Columbus and are there other things that you guys are kind of doing to maximize, I guess, the efficiency of the Ohio assets and how are you thinking about, more or less, the promotional behavior that's currently in the market?

Hayes Croushore

You know, we work every day to maximize the efficiency of our properties. And where we've had cannibalization, we've pulled slot machines off the floor. We've reduced headcounts. We've done what we can to deal with that. In Columbus, we're in the process of pulling about 500 machines off the floor. It probably means we just started out with too many in the first place. There's basically a dump of 5,000 slot machines in that market and that's a lot for any market to sustain, even Columbus that has 1.7 million people. There's a lot of adults there. And so, we work, we work every day to run our businesses as efficiently as possible. That includes reducing slots if we need to.

Unknown Analyst

If we were to -- I just have a feeling a lot of your questions are going to be non-regional gaming based. But if we were to put regional gaming on the side and let's talk a little bit about the REIT restructure, can you talk a bit about the financing discussions and maybe lay out your expectation for us of the timeline from here with respect to the financing as well as the state approval process. And correct me if I'm wrong, but the states basically need to see a balance sheet in place, correct, with each of the entities before they could effectively sign off?

Hayes Croushore

Each of the states is going to ask for different parameters, they have different rules. And one of the primary concerns of the states is the health of the balance sheet. They want to make sure that taxpayers in their state have healthy businesses. And so, adult -- I don't think that the states are going to need to see a detailed signed-off balance sheet. We're not going to have that for a period of time, but I do think that some commitments from lenders, a proposed debt structure, some potential interest rate guidance, I just think that each of the states will want to see that. As for timelines, there's not a whole lot I can really talk about. The reality is that this is a really complicated process. And internally, we have an accounting department that's working really hard on the S11. We have a legal department that's working to set up -- that's working to set up all of the maneuvering of the legal entities that need to happen. Our compliance department is dealing everyday with various states. So exactly what the timeline is, is unclear. We expect at this point for the spend to happen likely sometime in the fourth quarter. And so between now and then, we expect incremental progress. The first part of your question, the financing, is going well. And we have our lead arranger group almost established. And so we've had no lack of interest in providing financing. And as Bill had mentioned, so far rates are coming in slightly better than maybe what we had expected. Remember, our guidance is essentially based off of interest rates that are maybe 6 months old. And so to the extent that in the next 6 months, interest rates are better or worse than where they were last 6 months, that's where we wind up.

Unknown Analyst

And I think if you look at some of the deals that have gotten done both in the space and around the space relative to probably what your implied rate was, I think there was probably some savings in there.

Hayes Croushore

That's the general consensus right now, but the crystal ball doesn't tell us what the rates are going to look like in 6 to 9 months, unfortunately.

Unknown Analyst

So if we think about the 2 entities on a stand-alone basis and you kind of think about the capital structures, I guess, how do you think about the debt ratings for each and do you expect that there can be any restrictions on share repurchase activity for either of the 2 entities?

Hayes Croushore

The goal we've mentioned is for PropCo to obtain an investment-grade rating. Whether that happens out the gate or whether that takes us a little while, we're not really sure at this point. But that's a goal that we've set. As for OpCo, it's likely to be similar to Penn National. And I know that we're levering up somewhat on that side of the business but at 3% on an absolute basis and at about 5.5% on capitalized rent basis, we're still well below our peers. And so we would expect our rates and our ratings on OpCo to come in somewhat similar to where Penn National is today.

Unknown Analyst

With respect to the management teams, as both of the entities obviously, the CFOs or the CEO roles are in place. Bill, I believe, it's widely known is going on the PropCo side. The OpCo side is still kind of TBD. Do you have any sense of when that process wraps up?

Hayes Croushore

I think, the general thought, plan right now is that Bill will go to PropCo. And we're working through a process. We've interviewed internal and external candidates for an OpCo CFO. It could always be that our search winds up with someone who's more suited for PropCo and that the plan changes. But timing, I don't know. This is one of those things that you never know when you're going to find that right candidate. I'm told that there's not a huge rush at this point. So I wouldn't expect anything, at least not early in the second quarter, maybe late second quarter. But again, any sort of timeline here is all up in the air on almost all these issues.

Unknown Analyst

Okay. You've obviously had investors who've had several months to digest this transaction. And I'm sure you fielded many calls over that period of time. Where more recently do you think investor education still has more -- a couple more incremental legs to grow? And I guess, where are you getting the bulk of your questions at this point in time in the learning curve?

Hayes Croushore

I think that the REIT industry hasn't taken it seriously yet. And I don't know if it's because there still a time period between now and the time they can actually own us. And so they're -- we just haven't met their horizon yet. Or if it has to do with the fact that we're gaming and we're new and there's an intimidation associated with gaming. But I expect that over the long-term, that'll change. We're out in the road a lot. Bill is out on the road today, he will be out on the road later this week. We continue to travel and we posted groups in our office who will explain as much as we can, as often as we can and will continue with that through the transaction. I would expect that as we get closer to consummating the deal that we will get more REIT interest and we'll be spending more and more time with those investors.

Unknown Analyst

And do you feel at this point people have a firm grasp? I mean, you guys internally have a firm grasp in knowing that this will be fluid and all these opportunities are likely to be unique. But when you think about diversifying the PropCo base, post-spin, do you think there's a level of understanding as to how the template for deals like that would look?

Hayes Croushore

I think internally, there is. That's certainly one of the big questions I get externally. At this point we're not allowed to work directly on any deals. We've certainly built models for theoretical opportunities and how that would impact PropCo if PropCo works with OpCo, how that would impact OpCo. And so we've worked through that and we certainly have a general concept for what we may be looking for.

Unknown Analyst

If anyone does have any questions, just throw a hand up and we'll start taking questions.

Unknown Analyst

[indiscernible]

Hayes Croushore

In terms of -- the question was -- we're asked to repeat the questions, was about the acquisition in St. Louis and how their player program impacts the business and impacts our acquisition. I assume you're referring to the fact that they send their customers to Vegas. We do have the M. We can offer to send our customers to the M, and we have done that. It's obviously not a strip asset, we know that. And some customers would prefer to be on the strip. But the previous acquisitions of Harrah's assets that posed a challenge to the acquirers had another competing asset, Harrah's asset in the market. And so all that Harrah's was doing was taking all of that business, sliding it to their other asset and then selling off the building at the original location. And so in the St. Louis market, the Harrah's doesn't have another asset. And we also, in the deal, we negotiated protections in the database where we got 2 years of player history. We got restrictions on exactly what customers in that database Harrah's was allowed to market to, was not allowed to market to. So we worked a better deal there than previous acquirers have.

Unknown Analyst

[indiscernible] with the portfolio company and how you [indiscernible]

Hayes Croushore

The question was about Western Massachusetts.

Right now we understand obviously the mayor of Springfield is running a process where they're deciding between us and the MGM proposal. They're telling us they're only going to endorse one. We'll see whether ultimately they choose to endorse one or both. But we're in a competitive process [Audio Gap] occasion is a little bit stronger. Both deals involve significant amounts of community spend, [Audio Gap] sweeten the pot, and whether or not we're selected by the city of Springfield maybe it's a coin flip. I don't know how to best to quantify that. If MGM was to choose to spend a whole bunch more, I don't know that we would choose to follow. I think that we've met sort of an investment limit that we're pretty happy with. After that, whether it's us or MGM that's chosen, then there's a Western region selection process that the state will run and there's another handful of competitors. General consensus is that the Springfield licenses maybe are a little more appealing to the state. Maybe the political power of the city of Springfield will help that license. But again if another competitor just, outside the city of Springfield in the western region chooses to come with some blow-out proposal then -- I mean, it's been a slow, deliberate process and it's something that's going to continue to play out over the next year or 2.

Unknown Analyst

Just when you think about the value of that license given the demographics, given that you have to make some assumptions for what you might be able to take, to draw your circles around Springfield and make assumptions as to whether or not you'll impact some of the travel facilities. At what level of investment do you think that project becomes very difficult to make any kind of reasonable return?

Hayes Croushore

I think right now, we've put our best foot forward and we'll see how the negotiations go with the city and I wouldn't expect us to go much higher. I think that the market there, depending on exactly how much business you think you can take from Foxwoods [Audio Gap] case scenarios about the size of the Columbus market. And so at $800 million, we're already significantly more than we've spent on either of those properties. And now there's a beneficial tax rate in Massachusetts that makes up some of that difference.

Unknown Analyst

And then obviously as we move down, you guys are active in Pennsylvania. How do you kind of see that from a [Audio Gap] the timeline and the competitive proposals that are out there?

Hayes Croushore

Wynn has proposed I think $900 million. We're about half of that. Now our proposal, because we already own a license in Pennsylvania, we're only allowed to own 1/3 of another license. So our proposal would involve a charity that would be affiliated with the city. And we would basically make the investment and the charity would get an annual minimum payment until our investment is paid back. And then once our investment is paid back, then it would be split, 2/3, 1/3. So Wynn has the biggest budget, and we have we think the best deal for the city. So we'll see where the appetite of the selection process goes.

Unknown Analyst

And in terms of just the timeline on that, have you kind of given any dates, quarters?

Hayes Croushore

I think it's a Q4 decision issue.

Unknown Analyst

And then obviously down in Maryland with the National Harbor stuff, and Rosecroft in terms of that entire scenario, what, in terms of -- how, if at all, have your expectations changed about the way that process runs from here?

Hayes Croushore

I don't think our expectations have changed. I expect the plan right now is that we'll be applying and we'll see where that goes.

Unknown Analyst

Anyone -- any questions from the audience? So just in terms of getting back to the REIT structures, and obviously a lot can change and quite honestly a lot has changed from the time of your REIT announcement. Over the next year and then once you guys do complete the structure, what other types of assets do you see being both attractive and accretive to the PropCo and what types of deals would you guys be a little bit more hesitant about or would try and shy away from?

Hayes Croushore

I think that you could see the PropCo will be focused on gaming. Diversification into other asset classes is something that's probably down the road and I don't know exactly when, but it's not an immediate thing. We'll be focused on what we know best. And the types of assets -- we've sort of put into 2 classes. There's the distressed assets. I would imagine that if Harrah's could go back and could sell St. Louis to PropCo, there would be certainly benefits to them selling to PropCo rather than Penn National. And I think that there will be other operators that would see that. The other thing is the one-offs, the family-owned or the smaller facilities where you have a group of owners and maybe some want to cash out and some like the idea of owning and the prestige that comes with running a casino. And so working with PropCo, they could do a sale lease back, they could keep their license, but they could also cash out for owners that are interested there.

Unknown Analyst

Then in terms of -- when you think about the pool of potential, obviously, potential deals, and you think about the geographic kind of SKU of what the PropCo is going to look like on a pro forma basis, you can clearly see where there's holes. Do you think that guys will be a little bit more apt to look at those opportunities in advance of maybe the other ones where you already have a presence? Or do you think it will be more just financially motivated rather than just breadth of product motivated?

Hayes Croushore

I mean, if this is a company that's run by Peter and Bill, I think you can expect it to be financially motivated. If we get the sense that there is financial value in geographical diversification, then that may be something we consider. But the reality is as Penn National Gaming and as PropCo, they're already going to be significantly diversified. There's not too many markets other than the AC in Vegas that they're not in, and so -- Vegas strip, obviously, that they're not in. So I don't know that diversity is necessarily easy to achieve.

Unknown Analyst

[indiscernible]

Hayes Croushore

As a land and building owner, I don't think that PropCo will be allowed to own tribal land. OpCo however, could work a management agreement or something along those lines. But for PropCo, I think we'd have to be really careful with restrictions on tribal land.

Unknown Analyst

Along those lines, when you think about the OpCo and you think about the new structure of OpCo, one of the questions that we'll get asked somewhat often is, OpCo growth is now more reliant on kind of either the PropCo doing deals and using the OpCo and/or the regional market turning around. When you think about, I guess, the profile of the OpCo, you guys will likely be generating close to $200 million in annual free cash flow from those assets. The balance sheet obviously will be in a position to be very sturdy in a hurry to the extent that it isn't when you spend out [ph]. Could you talk a little about uses of capital and the ideal structure you think about from a debt perspective, from an equity perspective, et cetera?

Hayes Croushore

No, I would expect for OpCo to function very similar to how Penn National does today. I think that the first goal for free cash will be growth. I think we've talked about Massachusetts, and we've talked about Pennsylvania, if one of them pans out, then OpCo certainly has a use for its cash flow there. We know that there's possibilities in Florida and Texas and other states that have considered. So that would certainly be the first choice for OpCo as it is today. If we were in a scenario where there is no other alternative, where we've missed out on those opportunities and no future states legalized, then deleveraging, certainly appealing. Peter comments frequently on his hatred of debt, so deleverage is appealing. And if we see value in share repurchases, that certainly is possible too. Much how we are today, we will look at those 2 scenarios side-by-side and see which creates more value.

Unknown Analyst

Anyone else? Hayes, thank you very much for your time.

Hayes Croushore

Absolutely. Thanks for having me.

Unknown Analyst

Thanks.

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