The stock price of Pinnacle Entertainment (NYSE: PNK) has increased significantly since the depths of the "Great Recession", but many shareholders are unsatisfied and think it is undervalued relative to Caesars Entertainment Corporation (Nasdaq: CZR) and MGM Resorts International (NYSE: MGM). The discount to peers has caused one hedge fund to take an activist role to increase shareholder value. Further shareholder activism is likely to take place if the stock remains at current levels, creating a buy opportunity for Foolish investors.
Hedge fund proposition
On April 16, the hedge fund Orange Capital filed an SEC form 13D, and effectively outlined a proposal for Pinnacle to spin-off it's real estate assets. In the proposal, Orange Capital contends that Pinnacle should take advantage of the recent IRS ruling allowing gaming companies to spin-off real estate into an independent publicly listed real estate investment trust (REIT). Their analysis shows that the spinoff could create a 77% increase in Pinnacle's stock price.
Source: SEC 13D
The table above compares the current 2015 estimated enterprise multiple with the expected spinoff enterprise multiple. The key point is that Pinnacle's real estate, which is represented above as "PropCo", is significantly undervalued. The Orange Capital proposal was a solution to Pinnacle shareholder frustration for the low enterprise multiple.
Casino enterprise multiple comparison
As I've discussed in previous gaming industry articles, the enterprise multiple essentially displays the length of time for a company to earn it's entire value. Pinnacle's 7.9 enterprise multiple means that in approximately 7.9 years, it could earn (EBITDA) its value, which is very low compared to other gaming companies.
|
Caesars |
Pinnacle |
MGM | |
|---|---|---|---|
|
Enterprise value |
$23.5 billion |
$4.9 billion |
$24.9 billion |
|
EBITDA |
$1.7 billion |
$630 million |
$2.1 billion |
|
Enterprise Multiple |
13.4 |
7.9 |
12.2 |
Source: SEC 13D and Yahoo Finance
MGM and Caesars' have enterprise multiples of 12.2 and 13.4, respectively. MGM's multiple is understandable given the company's international diversity and scope with MGM China; which consist of MGM Macao and the development of another resort in Cotai Macao. However, Pinnacle's large discount relative to Caesars is puzzling because Caesars is facing major solvency issues, which I've discussed here. With Caesars junior bonds trading near 50 cents on the dollar, there is a real possibility that Caesars could file for chapter 11 bankruptcy. With this is mind, it seems likely that Pinnacle is being undervalued based on enterprise multiple relative to peers.
Management's response
The CEO of Pinnacle addressed shareholder concerns briefly in the most recent conference call by saying:
"I want to address some recent public feedback that we received from a shareholder relating to the possibility of us forming a REIT with our real estate assets.Currently, we're focused on the integration of the Ameristar transaction and de-levering our balance sheet. We've made tremendous progress to both of these goals, as we've just discussed with you. We have a lot more work to get done. We are focused this whole year on the successful integration of all of our businesses.We're going to continue to evaluate ways to enhance shareholder value. We'll continue to talk with all shareholders and receive input. We'll evaluate whether or not a REIT today or long term in the future makes sense, but rest assured, our focus always is we are going to do what's in the best interest of the shareholders of Pinnacle Entertainment."
Win-win-win
With the Orange Capital proposal in mind, there are three likely scenarios for Pinnacle's stock, all of which are positive for Foolish investors.
1. The market notices the discount and the stock price increases.
2. The stock remains at similar levels, management implements further shareholder-friendly actions such as a spinoff, and the stock price increases.
3. The stock remains at similar levels, management defers on shareholder-friendly action, causing more activist investors to take action, and the stock price increases.
Foolish takeaway
Pinnacles current stock price provides a solid opportunity for Foolish investor's, as it is undervalued relative to peers. The situation seem to have multiple ways of working out in favor of long-term Foolish investors. If needed, further shareholder activism will likely catalyze the stock price to increase. Regardless of the outcome, Pinnacle Entertainment seems to represent a situation worthy of further consideration by Foolish investors.
