By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics”
Activist investor involvement
On April 21st, 2014, Orange Capital LLC disclosed a 4.5% stake in Pinnacle Entertainment, Inc (NYSE:PNK), an owner, operator and developer of casinos and related hospitality and entertainment facilities. In addition to an outright stock holding, Orange Capital LLC established an option position in shares of Pinnacle Entertainment, Inc (NYSE:PNK): the firm bought call options on 1.35 million shares with an exercise price of $25 per share and financed this purchase by selling put option contracts on a similar number of shares with an exercise price of $20 per share. Both call and put contracts have an expiration date of September 19th, 2014. As contract terms require a cash-based settlement, no stock will exchange hands in case the options will be in-the-money, but it can be said that Orange Capital LLC has an effective economic exposure to 1.35 million shares or 2.3% of total shares outstanding. Based on the SEC filing the firm spend $61.5 million to acquire the shares which means an average cost of $23.3 per share (attributing the total cost to an outright stock position).
Ameristar Casinos acquisition
During December 2012, Pinnacle Entertainment, Inc (NYSE:PNK) announced acquisition of Ameristar Casinos, Inc. (NASDAQ:ASCA), a casino operator of a similar size. The acquisition reflected an EBITDA multiple of x7.6 for Ameristar’s Adjusted EBITDA of $365 million for the trailing 12-month period ended September 30, 2012, excluding synergies Pinnacle expects to achieve. The combined enterprise would have generated net revenue of $2.4 billion and Combined Adjusted EBITDA of $649 million (excluding potential synergies), over the trailing 12-month period ended September 30, 2012. In August 2013, Pinnacle Entertainment completed the transaction, which was valued at $2.8 billion including assumed debt. Excluding discontinued operations, Pinnacle currently owns 14 gaming properties in Colorado, Indiana, Iowa, Louisiana, Missouri, Mississippi, and Nevada. The company also owns a racetrack in Ohio that is currently being re-developed into a new gaming entertainment facility and manages a racetrack in San Antonio, Texas.
REIT spin-off proposal
In its letter to management, Orange Capital LLC proposed to create a property company which will qualify as REIT and to spin-off its shares to Pinnacle Entertainment shareholders on a tax-free basis. Without going into much detail of the proposal as one can easily access it, it can be said that activist’s proposal is a standard financial engineering practice of creating a REIT that will provide interested investors with an attractive dividend yield and would therefore command a higher valuation multiple, unlocking value for current shareholders. Penn National Gaming executed such transaction during 2013 and listed its real estate owner, Gaming & Leisure Properties.
Based on a recent share price, Pinnacle Entertainment, Inc (NYSE:PNK) had a market capitalization of $1.4 billion. Net debt stood at about $4.2 billion. Adjusting for $293 million in net assets of discontinued operations held for sale, net debt was $3.9 and enterprise value equaled $5.3 billion. Using a FY 2015 EBITDA estimate provided in activist investor’s presentation of $630 million, company is currently valued at a x8.4 multiple. Assuming annual interest expenses of about $270 million, “remaining” equity part is definitely looking cheap. Taking current market cap and adjusting it for net assets of discontinued operations held for sale leaves one with a market value of equity of about $1.1 billion with an “associated” EBITDA of $360 million and a valuation multiple of x3.
Obviously “channeling” at least 20% of this amount or $70 million for example to yield hungry investors can help unlock a lot of value. With a yield requirement of 8% or a valuation multiple of x12.5 such transaction can help unlock $875 million which is 63% of current market cap or 80% of the adjusted market cap of $1.1 billion. Assuming profitability will not deteriorate and will be in-line with projections and estimates, it is only a question of management and company taking actual steps to optimize capital structure and unlock value for equity shareholders, either by creating a REIT and spinning it off to shareholders or by returning capital in other way.