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Here are some thoughts on the PENN deal to acquire the Harrah’s property in St. Louis

We are moderately positive on the transaction:

  • Accretive:  With goodwill accounting and low borrowing rates, EPS accretion ain’t what it used to be.  However, we calculate about $0.20 in annual EPS accretion from the deal.
  • Deferred Capex:  This situation could be worse considering it is a Caesar’s property.  We think they will need to spend about $50MM over the first few quarters on new slots, renovating the casino, rebranding, and a new IT system.  Rooms and restaurants are in pretty good shape.
  • Multiple looks ok:  The EBITDA multiple looks to be 7.4x – not a steal but not bad.
  • Is it better than buying stock? – Not right away since PENN’s multiple is lower (after Ohio opens) but probably over the long term.  PENN still needs to add a Strip property to get the cross marketing benefits of a big regional property like this.  Given the cash accretion, either option is a positive relative to status quo.
  • Total Rewards:  This is a big wildcard.  It is unclear how much the most effective loyalty program out there has contributed to EBITDA and how much goes away without it.  History is on the side of a huge impact but there are a few mitigating factors:  the closest CZR property is 120 miles away, there are marketing restrictions put in place, and the St. Louis market is well-established.  An additional negative:  would existing St. Louis customers prefer to cash in rewards benefits at Wynn (from PNK), MGM’s Strip properties (from ASCA), or PENN (M Resort)?
  • Cost Savings?  Not really a lot here although we would expect to see less promotional activity.  With rational competitors ASCA and PNK in the market, there could be some savings.

OTHER NOTES:

Stock vs. Asset acquisition

  • The acquisition is structured as a purchase of all the stock in the Harrah's St. Louis subsidiary.  Contrary to an asset acquisition, this allows them to step into their shoes on day one.  However, since both parties agreed, the IRS allows Penn to treat the acquisition as an asset sale, which means that they can depreciate roughly $428MM of the purchase price over 15 years, which results in a $10MM/ annual tax shield.  Penn estimates that the present value of this tax shield is worth $79MM.

Slots

  • In terms of slots, the 300 slots that are leased at the property will be replaced immediately since those are costly and then roughly 200 more will get replaced in short order
  • Penn will also reduce the number of games on participation
  • After replacing 500 slots off the bat, PENN will likely replace about 1/7th of the slots annually on a go-forward basis, which is in-line with their normal replacement cycle of 7-8 years

Margins

  • The Maryland Heights property’s margins are in the 29% range.  PENN believes that there is an opportunity to improve margins by a few hundred basis points over the course of a few years by removing costly slot leases,  lowering the participation percentage, hiring cheaper on-site property management in the fields of accounting, marketing, etc where Harrah’s used a centralized system and then allocated costs to the property, and optimizing marketing spend. 
  • Margin improvement will take some time to materialize since they need to get their new systems, marketing tools, and people in place.  PENN pointed to ASCA’s 37% property margin as an example of being able to achieve better than 29% margins.  However, comparisons to ASCA’s 37% are not apples to apples, since ASCA allocates less overhead to the property level than most companies.

Deal Closing

  • PENN hasn’t even gotten in front of the regulators yet.  They are already licensed in the state so that should make it faster.  Late 3Q/early 4Q is probably doable.