Previously seen as little more than as an annoyance to corporate boards, activist investors have stepped up the heat in recent years. Backed by hedge funds and the ultra-rich investors, they are making a strong push to force companies to unlock shareholder value.

#-ad_banner-#So far, these activists have been most vocal about higher cash returns to shareholders. Carl Icahn launched his historic fight with Apple, Inc. (Nasdaq: AAPL) in October 2013, calling for a $150 billion buyback. Reluctant at first, Apple has since instituted a dividend and bought back $68 billion in shares.

Beyond higher cash returns, activist investors have also increased their calls for spinoffs, management changes or an outright sale of the company.

But a recent ruling by the Internal Revenue Service may spark a new wave of activist demands. The IRS’ moves could have a strong impact on one industry in particular, has already drawn the interest of a major activist investor.

Do You Really Want To Be A Real Estate Company?

The IRS ruling in question regards document storage firm Iron Mountain, Inc. (NYSE: IRM). The company was given the greenlight to convert into a real estate investment trust (REIT). Shares soon rose higher, and other firms are now pondering a REIT conversion as well.

Over the last few years, the tax authority has scrutinized the conversion of real estate assets outside the traditional commercial property market. The uncertain regulatory environment has limited calls by investors for spinoffs of real estate assets, but the new ruling sets a positive precedent.

The ruling represents an expanded willingness at the IRS to consider non-traditional assets for REIT conversion. The idea is an intuitive one. Large companies in retail, restaurants and gaming have massive real estate holdings on their balance sheets. Owning the property saves the cost of rent, but includes property management hassles and assets exposed to the real estate cycle.

Many companies are realizing that real estate management is not a core competency, and by spinning off the assets, they can  unlock investor value through the cash flows.

Investors love when companies make these moves. Shares of Sears Holdings Corp. (Nasdaq: SHLD) surged 31% in November of last year when the company announced its plans to convert some assets. More recently, McDonald’s Corp.’s (NYSE: MCD) stock increased more than 2% following a suggestion by hedge fund manager Larry Robbins that the company should convert to a REIT, which could unlock $20 billion in value.

Ripe For REIT Conversion

One industry in particular is perfectly suited for REIT conversions. Casino operators sit on some of the most developed and sought after land on the planet. Property values in Las Vegas have rebounded since the recession and many casino operators are ready to book the first profits in years, which would mean paying taxes. Besides holdings in Sin City, casino operators have expanded internationally with prized assets throughout Asia.

One possible impediment: Rules on REIT conversions state that no more than 50% of the shares may be owned by five or fewer people. Some casino moguls own a large block of company stock. High levels of institutional ownership or the potential for management change are important factors to look for when assessing potential targets.

Shares of MGM Resorts International (NYSE: MGM) jumped 10% on March 17 when a hedge fund controlling 0.8% of shares recommended that the gaming company spinoff its land assets to a REIT. Land and Buildings, run by Jonathan Litt, believes the shares could surge 150% to $55 if MGM converted to a REIT. During the fourth quarter call, CEO James Murren said that a conversion was discussed before the recession, but eventually scrapped.

Shares of MGM Resorts trade for an enterprise value of 10.8 times EBITDA. Litt thinks the multiple would expand to 18.4 times if MGM makes the change.

Wynn Resorts Ltd (Nasdaq: WYNN) owns one of only six licenses to operate in Macau and should generate strong revenue from the region. Macau operations generated 70% of sales last year, even as a late entrant to Macau’s Cotai Strip.

Wynn’s  focus on the high-end luxury segment means its properties could bring top dollar in a conversion. The company owns 238 acres of land on or near the Las Vegas Strip and holds a 25-year lease for 67 acres in Macau.

Steve Wynn and former wife Elaine own 20% of the shares, while another 76% of shares are held by hedge funds and institutional firms. Shares trade for an enterprise value of 11.3 times EBITDA.

Las Vegas Sands Corp. (NYSE: LVS) was one of the first to target Macau and Asian operations.  The company’s Sands China complex accounts for more than 50% of the tables in Macau’s Cotai Strip, and LVS plans to open another casino in Macau in 2016. The company also holds a dominant position in Singapore, with the Marina Bay Sands and the Venetian on the Las Vegas Strip.

Along with his wife, Sheldon Adelson controls more than 50% of the company. Another 40% of shares are held by hedge funds and institutional firms. For now, that creates an impediment to REIT conversion.

While Adelson is in relatively good health, the 81-year old casino tycoon will eventually need to look at options for estate planning. The shares trade for an enterprise value of 9.9 times earnings before interest, taxes, depreciation and amortization, well below the 14.6 multiple that Land & Buildings assessed as fair value on assets in a 2012 report.

Risks To Consider: While companies typically see a pop in the share price on rumors or announcements of a REIT conversion, longer-term returns are mixed. Investors may want to take profits on an announcement and wait for a better entry for a long-term position.

Action To Take –> Take advantage of the potential for REIT conversions within gaming stocks along with low valuations and tailwinds from Macau growth.

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