Sizing Up Ameristar

It happens from time to time. And when it does, this is the time when you look long, look hard, decide that this is really the company you want to own, and dive in with both fists.

On July 28, shares of Ameristar Casinos (Nasdaq: ASCA  ) closed down 16% to $25.65 after the riverboat casino operator missed its second-quarter earnings forecast and offered a somewhat disappointing outlook for the third quarter. While Ameristar continued to maintain its market leadership in each of the four riverboat markets in which it competes, increased marketing costs due to intense competition in the key St. Louis and Kansas City markets caused the company's EBITDA (earnings before interest, taxes, depreciation, and amortization) margin in the second quarter to fall to 27.1% from 28.3% during the same period last year.

Overall, net revenues in the second quarter increased 7.8% to $210 million, helping consolidated EBITDA grow 2.3% to $56.9 million. Meanwhile, diluted earnings per share rose slightly to $0.54 per share.

The knock on Ameristar is that the bulk of its revenues come from two key properties in one state (Missouri), and that its business is susceptible to competition from further expansion in gaming near its properties. Because of those concerns, the stock appears dirt cheap -- particularly for a company of this quality. That said, recent activity in the industry significantly advances Ameristar's opportunities for acquisition and expansion, and it's possible that competitive fears are overblown.

A leader at a value-like price
Here's the thing: Ameristar had already been trading at a discount to peers, including Argosy Gaming (NYSE: AGY  ) and Penn National Gaming (Nasdaq: PENN  ) , not to mention archrival Harrah's Entertainment (NYSE: HET  ) . The company had also been trading at a discount to recent merger deals, such as Harrah's acquisition of Horseshoe Gaming (see Harrah's Gains, Gamers Lose) at 7.2 times EBITDA, and Boyd Gaming's (NYSE: BYD  ) acquisition of Coast Casinos (see Boyd Takes the Coast) at 7.4 times EBITDA.

As of Monday, August 2, Ameristar had rebounded slightly, closing the day at $26.50 and a market cap just over $700 million. With $89.7 million in cash and $685.4 million in long-term debt on its balance sheet, that gives Ameristar an enterprise value (EV) of about $1.3 billion, valuing the whole company at around 5.5 to 5.8 times 2004 EBITDA. Even accounting for the roughly $117.4 million needed to complete the acquisition of Mountain High Casino in Black Hawk (see Ameristar's Land Grab) at the end of this year, Ameristar's EV/EBITDA is still well under 6.

That is dirt cheap for a company with Ameristar's brand and market leadership. For reference, valuing Ameristar at a reasonable EV/EBITDA ratio around 7 would put the common stock back in the $35 to $40 range.

And value is hardly the end of the story.

Big industry mergers leave acquisition opportunities
During the second quarter, Ameristar prepaid $15 million in long-term debt, dropping its debt leverage ratio down to a relatively low 3.17:1. That leaves room to raise capital to pursue development opportunities, as well as further acquisition opportunities beyond Black Hawk.

This is where things get really interesting.

Between all the merger activity in the industry and the large-scale legalization of slot machines in Pennsylvania (see The Magnitude of Pennsylvania's Slots), an increasing number of attractive opportunities seems to be popping up for Ameristar to step in and do its thing. Basically, that means pouring capital into a property at an attractive location, developing the Ameristar brand, and attaining a leading market position.

The proposed merger between Harrah's and Caesars Entertainment (NYSE: CZR  ) (see No Quick Win in Casino Merger) in particular may give Ameristar a second crack at the Tunica, Miss., market, as well as the Indiana side of the Chicagoland market.

Let's take a look.

Sheraton Tunica
Tunica, Miss., is a $1 billion-plus gaming market about a half an hour south of Memphis, Tenn. There are currently nine properties in the market; Harrah's owns two, and Caesars owns three others. You can see where difficulties might arise if the proposed merger between the two giants were to happen.

To make this discussion easier, let me describe the market.

The property closest to Memphis is Grand Tunica (Caesars), a resort-style hotel and casino with a golf course and an RV park that sits alone. Just up the road in the strongest cluster is Mandalay Resort Group's (NYSE: MBG  ) Gold Strike -- another resort-style casino/hotel -- as well as a couple of locals' casinos in Horseshoe Tunica (Harrah's) and the Sheraton Tunica (Caesars).

Basically, the Horseshoe, the Gold Strike, and the Grand represent the top three players in the market. But beyond the Grand and the main cluster, it's tough to compete effectively in Tunica.

Bally's (Caesars) is a low-quality locals joint that sits off a side street towards that cluster. Further up and off the main road and by itself, Majestic Star's Fitzgerald's is another hotel casino that caters to locals. And at the far end of the market are three high-quality locals casinos, where Harrah's shares a cluster with Penn National's Hollywood Casino and Boyd Gaming's Sam's Town.

Last year at about this time, Ameristar made a bid for Jack Binion's Horseshoe Gaming, including Horseshoe Tunica. That offer got trumped by Harrah's (see Harrah's Gains, Gamers Lose again), which is why Harrah's now owns it.

But if Harrah's must sell, the Sheraton Tunica next door is an intriguing prospect.

To be honest, the Sheraton Tunica is nothing special in its current form. But the key is its location in the main cluster closest to Memphis, which is central to Ameristar's strategy. As it has done quite successfully in the past, Ameristar would pounce on the opportunity to snatch an underperforming asset in a key location at a reasonable price.

But would Harrah's sell it to Ameristar?

In a perfect world, Harrah's would dump its own property at the end of the market, dump Bally's Tunica, and re-develop and re-brand Sheraton to the Harrah's brand. While not out of the question (Harrah's current property, after all, isn't even its first shot at the market), that might prove too complicated and too cost-ineffective a solution.

You also might suggest attaching the Sheraton and redesigning it as an expansion of the Horseshoe. However, I believe that would simply kill the intimacy of the place.

Skeptics would also point out that Harrah's refused to sell its Shreveport property earlier this year to Ameristar to avoid having to compete with it, and thus wouldn't sell to it here. But as I recall, Ameristar CFO Tom Steinbauer said something interesting during the shareholder meeting a couple of weeks ago -- that despite the intense rivalry, Ameristar and Harrah's "respect each other" as competitors, and if a deal made sense for both parties, they would certainly consider it.

In this case, I believe that Harrah's would consider the probability that Ameristar's presence would increase the attraction to both the Tunica market and its main property in the strong cluster, in the same way that The Venetian or MGM Mirage's (NYSE: MGG  ) Bellagio on the Las Vegas Strip serve to make the Strip more powerful.

That said, there will almost certainly be many other interested parties, a list that may include Argosy Gaming, Isle of Capri (Nasdaq: ISLE  ) , or other private investors.

>>Next up,Part 2: Is It Time to Buy Ameristar?

Fool contributor Jeff Hwang owns shares of Ameristar Casinos and International Game Technology. The Motley Fool has a disclosure policy.


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