Stressed Valuation of Entertainment Properties

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Includes: BJK, EPR
by: James Cullen

As was discussed in my opening write-up on Entertainment Properties (NYSE:EPR), completely writing off all non-core assets to leave only the theater business leaves assets and liabilities essentially equal; no equity remains. While writing about $1.3 billion in real assets down to zero might be useful for purposes of a stress test, it is not exactly realistic. Assessing the value of the collateral will be useful in showing what equity exists (beyond what the company can raise through dilutive common stock sales).

The major investments we’re concerned with here are mortgage notes on:

  • New York Casino, $134.2 million
  • Kansas Water Park Resort, $134.9 million
  • Toronto Retail Center, $103.3 million
  • Various Ski Resorts, $132.5 million

And other assets, which are:

  • Vineyards, $207.5 million
  • Public Charter Schools, $169.8 million

The casino project is a large commitment for Entertainment Properties, and it also carries the most uncertainty as to viability. As the Market Vectors Gaming ETF (NYSEARCA:BJK) suggests, gaming stocks have been under enormous pressure, and with the limited financing available, it is a tough time to be newly investing in the industry.

For sake of conservatism, I’m still assuming this winds up having no positive economic impact on Entertainment Properties’ results.

The water park loan has been modified to cross-collateralize the Kansas water park with others already operated under the Schlitterbahn name, as well as having a small portion of Entertainment Properties’ outstanding funding commitment replaced by equity capital from the operator of the water parks. Although this may reduce the upside somewhat should the new water park prove to be a well-drawing destination, the risk here has been reduced – a good thing for our purposes. The working assumption here is that an approximate annual return of 6.5% is realized on the total investment.

The Toronto property was on the selling block before a lack of bank financing dried up a potential bid. Original appraised in value at $325+ million, a newer and more conservative estimate is in the range of $275 million. Although the future of this is unclear, the amount is still in excess of Entertainment Properties’ investment (a first mortgage and second mortgage) totaling $248 million CAD. The second mortgage (in the amount of $129 million CAD) is the main one at issue, as its financing came due this month; the expected path here will have Entertainment Properties convert to becoming the equity holder in the project, with an initial return in the neighborhood of $15 million annually, increasing to $25 million. We’ll stick with the lower figure, however, which gives a total return of 6% on the investment.

Next up are the ski assets, which are spread out over a number of suburban areas. In total, the ski holdings comprise about 1400 skiable acres, with another 4600 acres of residual land. A recent pair of leasebacks valued a skiable acre of land from $65,000/acre upwards; this yields a value of $91 million with no price being given to the other land. Entertainment Properties’ investment here is upwards of $130 million, so while there is some potential for loss here, it seems less significant than the previously used complete write-off.

Next up are the vineyard assets, which include 1145 plantable acres of land. The majority of this is in California, with some in Washington state. An exact breakdown is hard to get, but at least half of the land is premium territory in California’s wine country. Using a price of $150,000/acre for that and giving a nominal value to the other plantable acres suggests the value here is at least $102 million (but could be much, much higher).

This leaves the charter school assets, totaling about $170 million. The operator of the schools, Imagine, is hoping to break even financially this year; since they are losing money overall, the working assumption here is to simply write-off the assets to zero. Charter schools may represent a new wave of education, but I prefer this for purposes of establishing a margin of safety.

Where does this leave us overall?

  • Casino: Total Write-off ($134.2 million loss)
  • Water Park: 6.5% Return on $134.9 million
  • Toronto: $15 million CAD annual return on $248 million CAD investment
  • Ski Areas: $91 million value ($41.5 million loss)
  • Vineyards: $102 million value ($105.5 million loss)
  • Charter Schools: Total Write-off ($169.8 million loss)

Remember from the previous example that only rental revenue from movie theaters was being included; all theater-anchored retail rental revenue is assumed to be zero. Using the inputs above renders income from continuing operations of $30.1 million, equal to the sum of the cumulative preferred stock dividends. Further, pro forma shareholder equity under this scenario is in excess of $500 million, well in excess of the $416 million in aggregate par value ($148 million market value) of preferred stock outstanding. This margin of safety will grow as Entertainment Properties raises cash by issuing additional common stock.

Although the purpose of this exercise is to establish the degree of safety inherent in the preferred stock, two classes of the preferred are convertible into common shares. While some of the value of the convertible preferred depends on the value of the common shares, my analysis is not currently focused on that – rather, I prefer to establish if a distressed obligation like these will be money good. I think that is a strong likelihood, and the option to convert into common shares that currently trade under 4x FFO is simply a bonus as the various preferreds trade essentially flat on a yield basis.

Disclosure: I own Entertainment Properties convertible preferred stock.