High-Yielding VICI Properties Makes A Big Splash With Multi-Billion Acquisition

Summary

• VICI is a high-quality REIT with attractive fundamentals.
• The REIT performed very well in 2020, despite the pandemic.
• We like the Venetian acquisition and management's aptitude in finding ways to create value for shareholders.
• This idea was discussed in more depth with members of my private investing community, Cash Flow Kingdom. Learn More »

Article Thesis

VICI Properties (NYSE:VICI) is a solid REIT that is surprisingly resilient to the current crisis and that offers a sizeable dividend yield to its owners. We liked the company in the past, and despite solid gains since we first covered the stock, shares are not overly expensive. The recently-announced acquisition of the Venetian showcases that management is able to deploy capital in a profitable way and the acquisition also strengthens VICI's position as a premier player in Las Vegas real estate.

Source: unsplash.com

VICI Has Been Surprisingly Resilient In 2020

The pandemic has hit many industries hard, and travel and entertainment belong to the sectors that felt one of the largest impacts in 2020. Nevertheless, VICI's results remained quite solid in 2020, despite the fact that its real estate portfolio is centered around travel and entertainment assets.

The following slide from the company's Q4 earnings release showcases the underlying strength of the company's results in these unprecedented times:

Source: VICI presentation

VICI Properties continued to collect 100% of rent in cash, even during the pandemic, which wasn't expected by many during the peak of the crisis. After all, VICI's shares dropped by well above 50% peak-to-trough in 2020, as investors feared that the crisis would have a large impact on rent collection. The actual results, however, show that VICI's tenants remained in a position that didn't prevent them from making rent payments, despite hits to their businesses. VICI, as the provider of the assets, didn't feel a similar hit, which proves the excellent resilience of the company's business model.

VICI also was able to grow its business considerably, as revenues, its enterprise value, and EBITDA grew at a strong clip versus 2019. This does, however, include the impact of VICI's acquisitions, which are partially financed through the issuance of new shares. This is not necessarily accretive to investors, which is why investors shouldn't focus on overall company-wide EBITDA growth. Instead, growth should be evaluated on a per-share basis.

Even there, however, VICI did very well in 2020, as adjusted funds from operations rose by a very attractive 11% on a per-share basis in 2020. This would be a highly compelling AFFO-per-share growth rate for any REIT even in normal times, the fact that VICI delivered that kind of bottom-line growth during a pandemic makes it even more remarkable.

Last but not least, a third item that is noteworthy, is the fact that VICI continued to reward loyal shareholders through another huge dividend increase, as the gaming REIT hiked the dividend by another 11% in 2020. Once again, this would be a quite attractive dividend growth rate for a REIT even in normal times, which makes it look even better considering the pandemic and its impact on the economy.

VICI Strikes A Major Deal For The Venetian In Las Vegas

Very recently VICI announced that it made another major deal for real estate in Las Vegas. The company agreed to purchase the real estate of the Venetian, and some related assets, for a total of $4 billion. This is what the asset looks like:

Source: Venetian homepage

VICI offers some additional images of the property that it will acquire:

Source: VICI presentation

This is a leading entertainment/gaming resort at the Las Vegas Strip, with a renowned name and a history of about 20 years. The resort has a massive 7,000 rooms, dozens of restaurants and bars, retail space, several entertainment venues, etc. The property was acquired from Las Vegas Sands (LVS), which is one of the biggest casino companies in the world.

The deal was made with a quite attractive 6.25% cap rate, which means that the asset will generate about $250 million in net operating income for VICI going forward. The companies agreed to an ultra-long term lease, at 30 years, with two additional 10-year options on top of that. Investors can thus be quite sure that this asset will generate profits through at least 2050 for VICI.

Now, of course, with an asset purchase like this, several other things have to be considered - what are the rent escalators, how safe are the rent payments?

Things don't look bad in that regard, as the adjusted EBITDAR for the property in 2019 was $490 million, which means that the rent is covered at ~2.0 times in normal times. It has to be expected that the pandemic will have a lingering impact during the coming months, but once vaccinations have brought the pandemic to an end, a recovery in EBITDA to pre-crisis levels seems like a reasonable assumption. Considering massive stimulus spending and pent-up demand, even higher EBITDA generation wouldn't be a surprise, we believe.

At the time of selling the real estate, Las Vegas Sands also sold the property's operations to an affiliate of Apollo Global Management (APO), but Las Vegas Sands will guarantee the property's rent through 2023. With rents being backed by a $40+ billion behemoth like Las Vegas Sands for the coming years, there should be very little risk throughout this pandemic.

For a major asset like the Venetian, rent escalators matter - after all, inflation could have a huge impact over the coming thirty years. VICI has negotiated an annual rent escalation band of 2%-3%, linked to inflation. If inflation is 1.5% during a specific year, rents still rise by 2%, whereas rents rise by 2.5% if inflation is 2.5%. No matter what, rents can't climb by more than 3% during a single year, even if inflation is higher than 3% during that time.

We believe that this is a solid rent escalator, although it surely isn't perfect. With massive money printing and stimulus spending, it seems possible that inflation could run above 3%, at least for a while, which would then not be fully covered by the negotiated rent escalations. However, as the Fed agrees that inflation should be roughly 2% in the long run, it seems likely that the rent escalator will be sufficient in most scenarios.

Current inflation expectations for the next year and the next five years look like this:

Data by YCharts

An overshoot above 2% in the near term seems likely, due to the aforementioned monetary stimulus, but it is expected that inflation will be reined back in, and the rent escalator of at least 2% a year seems relatively appropriate for the long term. This would change if the Fed decided to increase the target inflation rate to more than 3% in the long run, although that is rather unlikely. This should still be kept in mind as a potential risk factor.

The acquisition was financed, in part, through the issuance of new equity. VICI decided to sell 60 million shares, which should result in net proceeds of about $1.6 billion, which will be enough to cover 40% of the purchase price. The rest will come from cash on the balance sheet and new debt financing.

Since VICI can access debt markets at attractive rates (according to its 10-K, VICI issued unsecured notes at an average rate of 3.8% in 2020), this deal should be accretive for shareholders immediately. Interest expenses for this asset should total about $90 million per year, or possibly even less if VICI uses secured debt that comes at lower rates.

VICI will add $250 million in net operating income once the property is taken over, which is way more than the additional interest expenses the company will have to pay. Even adjusting for the share count dilution, this deal should be immediately accretive on a per-share basis, as FFO should rise by 15%-20%, whereas VICI's share count will only grow by about 12%.

All in all, this acquisition thus looks attractive for VICI and its shareholders, as this will further improve the REIT's scale and position in the Las Vegas market, while also giving a boost to funds from operations on a per-share basis.

Takeaway

VICI looks like an attractive investment - it combines a yield of 4.6%, a strong market position, the company has a healthy balance sheet, and last but not least, VICI continued to generate great results during the pandemic.

The deal for the Venetian resort looks good as well, with the only potential issue being that rent escalations are capped at 3%, even if inflation should run higher than that for a while. Apart from that, however, there is much to like about this acquisition, and it seems likely that this deal will help create value for shareholders in the long run.

VICI trades for ~15 times this year's funds from operations, which isn't overly cheap, but which also doesn't seem like an extraordinarily high valuation for a low-risk quality REIT like VICI. Shares were a better buy a couple of months ago, but they still look solid as a long-term investment at the current price, especially for those investors that want a sleep-well-at-night income stock. We believe that VICI is a fairly-priced quality REIT at its current price in the high $20s.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.