Gregg Carlson report sample Pinnacle Entertainment


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2009 Company model example of Pinnacle Entertainment (PNK)

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Gregg Carlson report sample Pinnacle Entertainment

  1. 1. Gregg Carlson carlson.requests@gmail.comGREGG CARLSON <br />July 8, 2009<br />Pinnacle Entertainment (PNK)<br />Buy<br />Since early June 2009, the stock has traded down from approximately $13 per share due the general equity market decline tied to economic and consumer issues, fear of a potential secondary offering tied to balance sheet restructuring issues and concerns regarding new competition in connection with the company’s Belterra facility in Southern Indiana. <br /><ul><li>At $8.50 - $9.00, the stock is trading at 5.1x – 5.2x our 2011 EBITDA estimate less net debt, which is below the low end of the company’s historic forward EV/EBITDA valuation range of 6x – 11x (2002 – 2008). Regional gaming markets and company results have generally held up despite declines in major gaming markets where PNK does not currently operate (i.e. Las Vegas and Atlantic City). The company continues to ramp Lumiere Place and is on track to open it’s River City project during the first half of 2010. As a result of River City and the continued ramp up of Lumiere Place, the company has one of the highest pro-forma EBITDA growth rates in the gaming industry. The company also has additional solid development opportunities in Louisiana, subject to credit cost/availability and general economic conditions. We also believe the company will successfully negotiate covenant relief as current credit metrics appear to be conservative. As a result, we recommend investors buy the stock at the current price/valuation.
  2. 2. Gaming Research / Company Model PNK is currently addressing issues in connection with it’s senior secured credit facility as the company is at risk for breaching leverage covenants during 2010, due to the timing of completion of it’s River City project in St. Louis. Availability of the facility is currently limited to $350 million due to sub-debt covenant’s that may be be waived subject to PNK achieving specific EBITDA performance metrics during the back half of 2009. Recently credit markets have re-opened some and allowed other operators such as Wynn, MGM and Ameristar (ASCA) to successfully amend and restructure debt. We believe this bodes well for PNK. Most recently, ASCA’s valuation/stock price increased due to it’s success in adjusting covenants and amending the terms of it’s senior credit facility. We believe the ASCA transaction may provide a roadmap for PNK’s effort here due the to general similarities of the business models and credit metrics of the two companies. The company has highlighted it’s liquidity position and based on our model, we believe PNK can fund completion of River City from current liquidity.
  3. 3. Risks to our estimates include new and enhanced competition for it’s Belterra facility, potential gaming expansion in Ohio and Texas, development/construction cost overruns and further slowing of the U.S. economy/gaming spend.
  4. 4. We have adjusted our forward EBITDA estimates to $188m 2009 EBITDA, $198m 2010 EBITDA and $254m 2011 EBITDA.</li></ul>Recent Trends and Estimates<br />Business trends have held up reasonably well in Riverboat markets compared to Las Vegas and Atlantic City in recent months and quarters. PNK delivered an upside surprise in Q109 as the company reported EBITDA at $53.4M that was above consensus of $45.2M. Lumiere Place, Belterra and Boomtown Bossier posted solid results. Lumiere Place delivered another quarter of sequential revenue and EBITDA margin improvement which is positive given the relative importance of the St. Louis market for PNK looking forward into 2010 and beyond. L’Auberge Du Lac also posted continued exceptional results. <br />Looking forward we have modeled a sequential decline in net revenue in New Orleans and Belterra due to new competition. We have also modeled flat lined revenue for Reno with a continued ramp for Lumiere Place during 2009 and into 2010 until the River City opening. For L’Auberge we have modeled flattish revenue trends based on the assumption that the property is currently operating near peak revenue levels given capacity constraints.<br />Penn National (Penn) recently opened it’s remodeled expanded Argosy riverboat that is located in Southern Indiana at a location closer to Cincinnati, a major feeder market. Various analysts have made positive comment’s regarding the property based on recent post remodeling opening visits. PNK has indicated that they believe their Tom Fazzio golf course and other amenities will help Belterra compete with Penn’s property. Nonetheless, we have assumed a sequential revenue decline for Q309 and Q409 with YOY declines of -2.9%, -8.9% and -8.6% for Q209, Q309 and Q409. We also assume a YOY decline of approximately -6% and 12% for 2009 and 2010.<br />Despite the potential for incremental competitive pressure for Belterra and near term risks for sequential revenue declines, we believe the impact on overall company longer term estimates and valuation will be small based on 2011 estimates and a ramp up of the River City project in St. Louis which drives the changing composition of overall company revenue and EBITDA looking forward. In 2011, we estimate Belterra’s Revenue and EBITDA to be 11% and 7% of total property Revenue and EBITDA.<br />Figure 2: Property % of Total EBITDA      -863600                                                                                                                                  Source: Company data, Carlson Research estimates      <br /> <br />Figure 3: Property Revenue ($’s in billions)      -863608255                                                                                                                                  Source: Company data, Carlson Research estimates      <br />Figure 4: Property EBITDA ($'s in millions)      -137795-4445                                                                                                                                  Source: Company data, Carlson Research estimates      <br />While our company valuation is based on our 2009 – 2011 Belterra estimates, we stress tested our valuation model by arbitrarily assuming that Belterra’s revenue would decline by as much as 50% between Q309 – 2011. For this exercise we downward adjusted our earnings and free cash flow models resulting in an increased overall net debt level and decreased EBITDA estimates. Using a comparable multiple assumption in both our valuation models based on our estimates and our stress tested valuation assumptions, we found that the valuation impact to be approximately -11%. At an approximate current stock price of $9, the stock is trading at 5.2x modeled 2011 EV/EBITDA, 5.6x Belterra stress tested 2011 EV/EBITDA and 6.2x 2009 EV/EBITDA These multiples appear to be cheap relative to the company’s 2002 – 2008 forward EBITDA multiple range of 6x – 11x given the company’s forward significant EBITDA growth rate profile. As a result, assuming all other model factors are held constant, we would buy PNK at the current price as the stock is currently trading at a 30% discount to a one year target valuation that has been arbitrarily set low assuming that Belterra’s revenue were to significantly decline.<br />Company Balance Sheet <br />We believe PNK is currently in the process of working to restructure it’s senior secured credit facility. While we view PNK as an aggressive developer, the company has conservatively managed it’s balance sheet, long term debt, leverage and overall liquidity. As a result, PNK’s debt metrics were conservative relative to other gaming industry operators as the economy slumped into the current recession. As riverboat markets have held up reasonably well compared to other major gaming markets, PNK’s liquidity and credit metrics have remained favorable. Wynn Resorts, MGM and Ameristar (ASCA) have recently successfully restructured debt as conditions in the credit markets for the gaming industry have improved somewhat. Most recently, ASCA restructured it’s senior secured credit facility through a combination of covenant relief, facility pay down through the issuance of senior unsecured debt and fee payment/interest rate adjustment. While ASCA’s and PNK’s situation’s are somewhat unique, we believe PNK’s restructuring approach may be similar to ASCA’s due to relative similarities of the companies and need to deal with issues associated with the 2010 maturity and covenant relief in it’s senior credit facility.<br />In March 2009, ASCA successfully amended it’s senior secured credit facility as follows:<br /><ul><li>Obtained leverage covenant relief permitting an increase in the senior leverage ratio (senior debt divided by EBITDA for the trailing four quarters) beginning at March 31, 2009 through March 31, 2010 with gradual step down thereafter in order to accommodate the company proforma leverage/cash flow relationship between March 31, 2009 and the completion of their Colorado cap-ex in late 2009 with a subsequent deleveraging thereafter.
  5. 5. The interest rate add-on was increased by 125 bps, therefore the the facility now bears interest at LIBOR + 325 bps. The company also paid one time fees.
  6. 6. Increased the aggregate limit on capital expenditures.
  7. 7. The permitted incurrence of senior unsecured debt was set without limitation as to amount.
  8. 8. Other affirmative and negative covenants were set, such as fixed charge coverage ratio and and increase in EBITDA to maximum total permitted and senior leverage ratios.</li></ul>In May 2009, ASCA paid down approximately ½ of it’s senior secured credit facility through the issuance of $650 million of 9.25% senior unsecured notes at 97.09. As a result of this transaction ASCA’s senior secured debt was reduced to approximately 2:1 TTM EBITDA. As a result of the credit facility amendment transaction and a better than expected Q109 results, ASCA’s valuation/stock price increased as the liquidity issue was removed.<br />PNK will be required to manage through a similar issue as the company is currently at risk for a potential covenant violation during 2010 in connection with the River City build-out, as debt to EBITDA peaks in connection with this development. In addition, PNK is limited to $350M of senior facility debt capacity as part of it’s sub-debt covenants, which may be waived/partially waived subject to achieving 2:1 EBITDA to total interest (which may occur during the 3rd quarter 2009) subject to overall maximum permitted indebtedness covenants. We believe PNK is currently working on restructuring it’s debt to address these issues.<br />We have compared PNK’s key credit metrics to ASCA’s and found that they are roughly comparable, with PNK comparing favorably re: senior secured debt to EBITDA at 1:1 vs. ASCA’s restructured 2:1 ratio. As a result, PNK may obtain a more favorable interest rate than ASCA in a restructured facility. The companies also share some similarities (in terms of markets where they operate) and differences, as ASCA will de-lever post 2009, subsequent to their Colorado room build-out later in 2009, while PNK will as well but would like to pursue additional incremental development projects post River City such as Sugarcane Bay. Because of this, timing of a potential PNK restructuring transaction, credit market conditions and other factors, we have not attempted to predict the precise terms of a potential amendment for PNK. We do note however that WYNN, MGM and ASCA’s stock prices adjusted upward in connection with similar debt restructuring events. As a result, we believe resolution of this issue could be a positive catalyst for the stock. <br />Our model includes development costs and capital expenditure assumptions for and through the completion of River City during the first half of 2010. Based on our assumptions, we believe PNK has adequate liquidity to complete this development without the issuance of additional equity. We also believe that PNK would be willing to commence the Sugarcane Bay project subject to credit availability/costs and other factors as PNK views this project positively given the significant positive return on investment on it’s L'Auberge facility and current excess demand. Currently PNK maintains a dominant market share in Lake Charles, LA, a market where historic demand has typically grown as supply has been added. While we have not included this project or others in our company model, we view this project as attractive and believe PNK would be willing to commence the project if capital is available in the low to mid 9% range. It is our understanding that PNK will look to sequence the project from a balance sheet vantage point in order to avoid an equity issue.<br /> <br />Figure 6: Debt/EBITDA (4Q08 - 2011E) Through River City Build-out-67310-4445                                                                                Source: Company filings, Carlson Research estimates  <br />Figure 7: Capex & Free Cash Flow ($ in millions) Through River City Build-out-58420-4445                                                                      Source: Company filings, Carlson Research estimates  <br />Figure 8: PNK/ASCA Senior Debt to EBITDA Figure 8a: PNK/ASCA EBITDA to Interest -205105-4445       -58420-4445                                                                                                                                        Source: Wall Street estimates, Carlson Research estimate Source: Wall Street estimates, Carlson Research estimate<br />Figure 8b: PNK/ASCA Gross Debt to EBITDA Figure 8c: PNK/ASCA Net Debt to EBITDA -1206504445      11430013335                                                                                           Source: Wall Street estimates, Carlson Research estimate Source: Wall Street estimates, Carlson Research estimate<br /> <br />Valuation<br />At $9, the stock is trading at 6.0x, 7.2x and 5.2x our 2009 – 2011 EV/EBITDA estimate. Recently PNK’s major competitors traded at 7x – 8x 2009 EBITDA. Our 12 month target price is $14 based on 7x 2011 EBITDA less debt, discounted 1 period at 15%. PNK has traded at 6x – 11x forward EV/EBITDA between 2002 – 2008.<br />With completion of River City in St. Louis, PNK’s cash flow composition will significantly change with the majority of valuation support coming from St. Louis and Louisiana as we estimate 37% and 53% of total property EBITDA will be derived from these two markets during 2011.<br />The valuation model does not include value for unused assets (Colorado and Atlantic City land for example) or for potential development projects in Lake Charles (Sugarcane Bay) and Baton Rouge Louisiana or Colorado. The model also does not include any assumptions for potential management contracts or other transactions.<br />While we are not implying that this will occur, we have stress tested our model for a significant decrease in revenue for PNK’s Belterra property in Southern Indiana and have found that the impact on the 2011 valuation is negligible. We have also made assumptions for Reno that include negative cash flow assumptions for 2009 – 2010 and zero cash flow for 2011. These assumptions may be conservative assuming that PNK will continue to evaluate it’s operational, development and potential sale options for all or part of this property, therefore neutralizing our negative assumptions.<br />We view the current multiple as cheap but recognize the risks tied to the current overall financial crises/consumer recession. A continuing overall crises and challenging issues in the credit markets will likely continue to depress industry and company valuation metrics. At the same time, a current stock price of $9 provides a current potential return to our 1 year target of approximately 70% and two year target of 83%. As a result of the above, combined with PNK’s high rate of overall EBITDA growth relative to the industry, we recommend the stock at $9 for investors with a horizon.<br />Additional Comment’s<br />River City project, St. Louis – We expect that more will be said and written about the project over the next several quarters as the calendar moves toward a first half 2010 property opening. This project is the “carrot” in the St. Louis licensing combination PNK acquired a few years ago. It is our understanding that the property design, business model and marketing strategy will primarily focus on the immediate surrounding locals market. We believe locals market properties can deliver optimal EBITDA margins and ROIC compared to destination type properties in destination markets. In the Las Vegas locals market for example, operators have generally delivered better margin and return performance than LV Strip operators, owing to the smaller capital requirements of these projects and recurring revenue stream nature of a customer base that tends to make frequent repeat visits.<br />The property may very well exhibit a pattern of sequential and steady improvement over a period of years as it develops the local surrounding market, which may be currently under served. This longer term sequential ramp pattern may not be reflected in current street estimates that only address the initial ramp up phase to a combined St. Louis mid teens return. While we have not assigned a higher multiple to our SOTP company valuation, this may be possible in the future given the potential superior return and risk profile of this type of property.<br />Sugarcane Bay project, LA – We like the return potential of this project and believe PNK will pursue development here subject to credit availability and costs. PNK has indicated that it’s existing property is operating near capacity. PNK’s existing property, L’Auberge has delivered consistently exceptional results with current EBITDA ROIC at approximately 25% ($90m ish TTM EBITDA/ approx. $360M cap-ex). The property continues to perform exceptionally well owing to a number of factors including positive energy based economic factors in the region. While there is some level of ongoing risk that Texas may ultimately legalize gaming, we believe potential demand in the market would support PNK’s development effort. As this project is not currently included in our model, we view it as potential upside to our company estimates and valuation.<br />Risks and disclosures<br />The thesis and opinions expressed in this report reflect my personal view. No part of my compensation was directly or indirectly related to specific recommendations or views expresses in this research report. Readers should consider this report as only a single factor in making investment, business and/or economic decisions. As we are not your advisor we do not take responsibility for any action you take based on this report. This publication is provided to you for information purposes only. The views in this publication are those of the author and are subject to change, and the author has no obligation to update the opinion or information in this publication. The author does not accept liability for any direct or indirect losses arising from use of this publication or it’s contents. The author recommends that readers of this report consult with any personal advisor’s they deem necessary before taking any actions based on this report. Actual results may and are likely to be materially different than those indicated in this report. We have received no compensation from the companies mentioned in this report and do not have an economic and/or advisory relationship with PNK and/or other companies mentioned in this report. We currently own shares in PNK. Finally the author does not provide tax or financial advice and nothing contained herein should be construed to be tax or financial advice.<br />