By Alex Gavrish, Etalon Investment Research; author of “Story Investing”
Developing story
In my recently published book Story Investing I discuss how to be creative in the investment research process and come up with great investment ideas. One of the highlights of the approach is the proposal to identify important turning points. Just as any good story or movie there are important turning points, there are such inflection points in company’s history. After such turning point is identified, one can develop both a historical perspective as well as future narrative around this event. A major turning points can be a spin-off, sale of a division, a merger, etc. One should not be carried away into fantasy with this storytelling: the story should be combined with analytical thinking and should be supported by fundamental valuation.
Penn National Gaming
Company profile
Penn National Gaming, Inc is a diversified, multi-jurisdictional owner and manager of gaming and racing facilities and video gaming terminal operations with a focus on slot machine entertainment.
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Company’s story
During Novermber of 2013, company completed the separation of its gaming operations from its real estate assets by creating a publicly traded real estate investment trust (REIT) called Gaming and Leisure Properties, Inc through a tax free spin-off of its shares to Penn shareholders. Over a more than three years period since then, company’s shares did not move much and currently trade at a price similar to when the spin-off was completed in November of 2013.
Despite this neutral stock price action, the “real” company made a number of interesting initiatives since then: in 2015 completed the acquisition of a Tropicana Hotel and Casino in Las Vegas, Nevada and Prairie State Gaming, one of the largest video gaming terminal route operators in Illinois. In addition, in 2016 company completed developement of a Hollywood Casino branded gaming facility on the Jamul Indian Village near San Diego, California. Company also established a new business line to implement its interactive gaming strategy through a new subsidiary, Penn Interactive Ventures, which included building out a new interactive team, launching Hollywood Casino branded Play4Fun social gaming partnership with Scientific Games and establishing other partnerships.
Valuation narrative
Penn National Gaming Inc currently has a market cap of $1,148 million, net debt of $1,789 million (own net debt, without GLPI lease obligations), and enterprise value of $2,936 million. For the first nine months of 2016, EBITDA was $629 million. On an annualized basis, EBITDA can be estimated to equal $839 million, while company’s own EBITDA (after GLPI lease payments) can be estimated to be $396 million. This values the company at an EV/EBITDA multiple of x7.41. Free cash flow (cash flow from operations minus maintenance and investment capex) during nine months of 2016 equaled $246 million, and can be estimated to equal $327 million for the full year, which would value the company at a P/FCF multiple x3.5 or a FCF Yield of 29%.
If Penn National Gaming Inc will continue to generate a similar annual free cash flow over next three years, it will generate a total free cash flow of $982 million over next three years. Applying a x8 EV/EBITDA valuation multiple to company’s own EBITDA and adding own net debt would value company’s equity at $2,366 million or $28.32 per share. This target price provides a potential upside of 106% from current share price.
We believe Penn National Gaming Inc’s story provides an attractive investment opportunity for long-term, value-oriented investors.
By Alex Gavrish, Etalon Investment Research; author of “Story Investing”