PENN: THIS RUMOR MIGHT NOT BE A MIRAGE

I’ve thought the two most compelling acquisitions for PENN were buying PNK or an MGM Strip asset. The pendulum appears to be swinging west all the way to Vegas.

The deal absolutely makes sense strategically. PENN would gain a high quality, well maintained, upper mid property in the premier gaming destination in the country. The Mirage brand is powerful and would bring a destination property into PENN’s portfolio. The cross marketing benefits are potentially huge. PENN’s current properties are widely dispersed with millions of customers in its database. Many of these players are already going to Las Vegas anyway and now they can be incentivized to stay at The Mirage. Harrah’s Entertainment has been very successful with this strategy and is the only company with the geographic diversity to pursue it, until now (maybe).

While we don’t know the price, an acquisition of The Mirage probably works economically. How many gaming companies can borrow over a billion dollars at 1.25% above LIBOR right now? None. We believe PENN would pay between 7.5x and 9x forward EBITDA for The Mirage. Of course, forward EBITDA is a very depressed number so the timing is probably right. We calculate The Mirage will generate $155 million in 2009. At those multiples the deal could be accretive to EPS by 20-25% to a run rate EPS number of $1.50. More importantly, the acquisition would add over 10% to free cash flow.

The previous assumptions assume PENN borrows the full purchase price from its credit facility. There is another, potentially more value added approach PENN could take. As we wrote about in our 7/25/08 post, “PENN: ‘BASSET’ SWAPS AND VALUE CREATION”, PENN may have bought/buying MGM bonds at a steep discount in order to trade them back to MGM in exchange for The Mirage. The transaction would be a “win-win” because PENN takes ownership of the property for less than 7.5x-9x discussed above while MGM retires debt at par. In effect, PENN pays a lower price than MGM is receiving. Thanks to a very lenient credit facility that allows MGM to use proceeds from asset sales to retire subordinated debt, this transaction is feasible.

Either way, the purchase of The Mirage for 9x EBITDA or below looks attractive for PENN shareholders.

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