Great combinations don’t happen often. Reese’s Peanut Butter Cups were created in 1928. Also in the 1920s, a Milford, Connecticut restaurant brought lobster to the masses by sticking the meat in a hot dog roll and presto, the lobster roll was born. Nobody knows exactly when, but at some point a Frenchman decided to pair up Bordeaux and Ribeye. So good. I’ve got to stop writing these posts on an empty stomach. Maybe I’ll go grocery shopping instead.

I’m not quite ready to put a PENN/PNK combination up there with those classics, but boy if there was ever a time for PENN to ignite its dry powder, now would be it. I’m thinking bear hug, a la PENN/AGY, not that long ago. PNK management may not want to sell at $10 but who cares what they think. Those guys own an immaterial amount of stock. You live by an option based executive compensation structure, you die by one.

So why is this a good combination?

• Very accretive to free cash flow – even assuming a $10 per share bid (75% premium), the deal could be accretive to PENN Free Cash Flow by 20-30% in 2010. PENN is underleveraged, maintains significant borrowing power on the credit facility, and should preserve a cost of capital significantly below the rest of the industry and certainly lower than PNK.
• Calculated accretion does NOT include likely cost savings and debt refinancing.
• Better management – PENN are better operators, pure and simple. Look for higher EBITDA margins under PENN ownership
• Better stewards of capital – no gaming company has created a larger % increase in shareholder value over the last 5 (except Wynn), 10, and 15 years than PENN and Peter Carlino.
• Asset sales – PNK won’t sell its boardwalk land. PENN would. Boardwalk property values are going lower. Bader field and the Marina district is where the value is. Look for a quick sale even with the tax bite. AC costs PNK $1m a month and the equity markets give ascribe no value to the development opportunity nor the land value itself. Sell it.
• Development opportunities – Investors are also not ascribing any value to PNK’s potential growth projects in Lake Charles and Baton Rouge. Nor should they. PNK’s management is not as ROI focused as PENN. PENN’s management would downscale the cost of these projects and drive a much better ROI. The option value is much higher under PENN’s stewardship.
• Bigger is better – Not always, but in this case bigger is better. Significant purchasing leverage could be generated along with cross marketing benefits, particularly if PENN were also able to secure a Las Vegas property (MGM?).
• Diversify market exposure – PENN is underexposed to the stronger regional markets servicing the east Texas population.
• Big step up in Baton Rouge – Baton Rouge is a growing and attractive market but PENN’s product is weak. A PNK acquisition gives them the opportunity to develop the right product for the market and jettison its existing assets.

At $10 per share, the acquisition price would be about $1.6bn, including 2009 capex and the assumption of debt. Following the receipt of the remaining $775 million from Fortress two weeks ago, PENN maintains about $1bn in cash and is net leveraged only 2.75x. A cash buyout of PNK would raise leverage to just under 4.0x, still well below industry average, and barely putting a dent in PENN’s liquidity situation.

Investors, don’t miss this one. I’m pretty sure PENN won’t.

Financial metrics of a PNK acquisition are compelling