Pinnacle Entertainment (NYSE:PNK) announced December 21 that it was acquiring Ameristar Casinos (Nasdaq:ASCA) for $26.50 per share, a 45% premium over the average closing price of Ameristar shares for the 90 days ending December 20. The total purchase price of $2.8 billion includes the assumption of $1.9 billion in debt. Pinnacle calls it a "transformative transaction." Shareholders of both companies should consider it an early Christmas present.
Should you invest in a combined Pinnacle/Ameristar? That's what I'll determine.
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Pinnacle goes from six markets to 12 reducing its exposure to any single market. Prior to the acquisition, its Lake Charles and St. Louis operations accounted for 66.8% of its total revenue. Assuming the deal gets done, its two biggest markets will represent just 44.3% of its overall revenues. That's a far more balanced portfolio. Pinnacle operates in six states: Ohio, Indiana, Missouri, Louisiana, Nevada and Texas. Ameristar brings operations in Nevada, Colorado, Mississippi, Iowa as well as Indiana, Louisiana and Missouri. They'll now have 17 properties in 13 distinct geographical regions. More importantly, it will have a combined $2.4 billion in revenue, an adjusted EBITDA of $689 million, 23,500 slot machines, 640 table games and just less than 16,000 employees. In the nine states mentioned previously, this is an entirely big deal.
Ameristar brings to the table adjusted EBITDA margins that are higher than any of its peers including Pinnacle. Together, the two operations expect to deliver $40 million in annual synergies. Its combined revenue puts it third and within a stone's throw of Boyd Gaming (NYSE:BYD) and Penn National Gaming (Nasdaq:PENN). Thanks to Ameristar's adjusted EBITDA margin that's 600 basis points (BPS) higher than Pinnacle's, it moves into the second spot behind only Penn when it comes to profitability. Once the deal is done, Pinnacle will have an annual free cash flow (FCF) of $285 million or $4.84 per share. Even with the big 20% jump in Pinnacle's stock on the news, we're talking about a FCF yield of 30%. That's huge compared to the big boys. Assuming it can grow its free cash by 5% per year, it should be able to reduce its combined $4.5 billion debt by at least one-third in the next five years. Pinnacle definitely hasn't bitten off more than it can chew.
SEE: Analyzing An Acquisition Announcement
Penn National Gaming announced November 15 that it was pursuing the separation of its real estate assets from its operating assets creating a real estate investment trust (REIT) that will own 17 gaming properties, leasing them back to the operating company. The estimated rent it will be charged by the REIT is half the operating company's EBITDA. As of September that was approximately $368 million. In addition, the REIT will receive 4% of the operating company's revenue for the first five years whereupon the rate will be renegotiated. Penn argues that in order to deliver greater value to shareholders it needs to unbundle the real estate and go "asset light" just like Marriott (NYSE:MAR) and the rest of the major hotel chains. In the separation, PENN shareholders will receive a taxable dividend of $15.40 for every PENN share held with 35% in cash and the rest in newly created REIT shares. Moving forward, REIT shareholders would receive ordinary dividends on a pro forma basis of approximately $2.36 in 2013. Given the enterprise value for triple-net REITs it's currently a multiple of 13.3 times the next 12 months EBITDA, or almost double Penn's, it makes a whole lot of sense to separate the assets. Prior to Pinnacle combining with Ameristar it wouldn't have been possible for either company to pull off something similar given the lack of assets. However, together, the prospects become far more realistic. It won't happen tomorrow mind you, because they first have to successfully integrate the two businesses but 12 to 24 months from now I'm sure the subject will come up.
SEE: How To Assess A Real Estate Investment Trust (REIT)
The Bottom Line
Unless I'm missing something, this acquisition/merger seems like a consolidation play of the most straightforward kind. Instead of competing against one another in several markets, now they're on the same side. Synergies aside, one less competitor is always a good thing, especially when competing in such a cutthroat business. The ambulance chasing class-action lawyers can rumble all they want about fiduciary negligence, but the reality is Ameristar shareholders had no guarantee the business would remain strong. In fact, the third quarter saw Ameristar's revenues and operating income decline year over year. Joining forces with the competition provides it with the economies of scale necessary to maintain its best-of-class margins no matter the competitive landscape. As deals go, this one makes total sense.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.