James Packer must have a smile on his face. Crown Resorts’ share price has jumped 13% following the announcement of ‘major initiatives to enhance shareholder value’, boosting his fortune by $568m – the equivalent of 56 Mariah Carey engagement rings.
The price jump isn’t too surprising as the proposals are clearly designed to boost the share price, but the question is whether they also create long-term value. On balance, we think they do.
Spin off of international businesses
IPO of hotel properties
Raising dividend payout ratio
The company has outlined a three-point plan. The first proposal is to spin off its international investments into a separate holding company, including its 27% stake in Melco Crown Entertainment (currently worth $2.7bn), as well as other international holdings, such as its stakes in Nobu, Apsers and Caesars. This would leave Crown Resorts to focus on its wholly owned local casino operations, including Crown Melbourne, Perth and (eventually) Sydney. Investors will then be able to choose whether they want exposure to Melco Crown and any recovery in the Macau market, or prefer to stick to the stable Australian assets.
We're less convinced, though, about part two of the plan – to "explore a potential IPO of a 49% interest in a property trust which would own Crown Resorts' Australian hotels (excluding Crown Towers Melbourne)".
On the one hand, it makes sense for the company to take advantage of high property prices. The sale would also improve the company’s balance sheet and reduce the risk of a dilutive capital raising (a point surely not lost on Packer). The move will give the company ample cash to fund its significant capital expenditure requirements over the next few years (see Betting on Crown – part I).
Selling negotiating power
However, as with retailers and residential property, the value of a hotel is ultimately down to its location. By selling the hotels’ main properties to someone else and then leasing them back, Crown is selling some of its competitive advantage. We trust that it will get a good price. At least Crown will still own 51% of the new property trust, but leasing terms will need to be set at market rates for the board to fulfil its requirement to be fair to all shareholders.
The final change is to increase the dividend payout ratio to 100% of normalised net profit, up from 65% previously. That makes sense: the Australian casino assets are steady earners, which reduces the need to retain earnings to cope with swings in profitability. But raising the payout ratio also undermines the rationale to sell the hotels. If the company needs to raise capital, why not hold onto the properties and reduce the dividend payout?
Of course, there’s one glaring reason to sell the hotels and increase dividends – investors are starving for yield, and giving them what they want is one way to increase the share price. Whether the proposed changes add long-term value for shareholders is yet to be seen, but we continue to believe that Crown is undervalued. At the very least, the changes outlined above should go some way to closing the gap between the current share price and our estimate of intrinsic value. BUY
Disclosure: The author owns shares in Crown Resorts.