There are few industries with as many barriers to entry as the gaming industry. This fact, coupled with recent pro-gaming legislation taking place within various states makes it particularly fertile for investors looking to cash in on this trend. Companies such as Penn National Gaming (Nasdaq: PENN), Caesars Entertainment Corporation (Nasdaq:CZR), and MGM Resorts International (NYSE: MGM) will benefit differently to the paradigm shift. Foolish investors able to find the aces within the deck will likely receive huge winnings.

Goodwill and intangibles
Goodwill and intangible assets are often viewed as watering down a company's balance sheet because they are not physical assets  and are subject to management's assumptions; deeming it's value very subjective. Intangible assets in the gaming industry regularly include state gaming licenses. Goodwill on the other hand is put on the balance sheet when a company acquires another company for a price higher than the carrying  value of the assets and liabilities acquired.

 

Goodwill

Intangibles

PPE

Total Asset

Penn National

$494 million

$379 million

$550 million

$2.2 billion

% of Assets

22%

17%

24%

100%
         

Caesars

$3 billion

$3.5 billion

$13.25 billion

$24.3 billion

% of Assets

13%

14%

54%

100%
         

MGM

$2.9 billion

$4.4 billion

$14 billion

25.35 billion

% of Assets

11%

18%

55%

100%

 Source: SEC 3/31/14 10Q

The above chart shows intangibles and goodwill as a percentage of total assets. Penn National's 17% of intangible assets/total assets is comparable to Caesars 14% and MGM's 18%. Penn National's 22% of goodwill assets/total assets stands out considerably above that of its peers. , which may cause anxiety to foolish investors; but the reason is twofold:

1. Penn National's recent real estate spinoff transferred the majority of its property to a independently traded REIT.

2. Penn National began transitioning from a horse racing company to a diversified gaming company in 1997. Since this time, its primarily growth has been through acquisitions. Since goodwill is created when acquisitions occur, Penn National logically has more goodwill as a percent of total assets than it's much older competitors.

 

Expanding & regulated industry
Intangible assets and goodwill hold significant value in the gaming industry because it is highly regulated with only a few participants. For those that took an economics class in college, such a market resembles an oligopoly, which is a market with a few competitors and a high barrier of entry. Beyond the capital requirements to start a casino, the necessary licenses are limited and granted on a state-by-state basis.

Many states have just begun to allow gaming, primarily due to the desire for higher tax revenue. This has severely hurt Caesars, which is overly concentrated in areas like Atlantic City, which was the city to gamble on the east coast before nearby states allowed gambling. But what may be bad for Caesars at the current moment is great news for the overall gaming industry. For instance, Pennsylvania's table game legislature in 2010 opens the market for customers not willing to take a weekend trip, but would rather gamble for a couple hours without the need to purchase a hotel room. This value migration catalyzed by the state politicians hunger for tax revenue has made Penn National a primary beneficiary.

Even as states liberalize on gambling, many states only grant a few licenses to operate. While this creates a ceiling to growth, it also creates a predictive competitive environment. Penn National's future growth strategy encompasses a three-prong strategy:

  • Acquisitions of gaming properties (such as Harrah's St. Louis gaming and lodging facility from Caesars Entertainment which closed on November 2, 2012)
  • Jurisdictional expansions (such as the February 2012 opening of a casino through a joint venture in Kansas, the May 2012 opening of Hollywood Casino Toledo, the October 2012 opening of Hollywood Casino Columbus)
  • Expansions of gaming in existing jurisdictions (such as the introduction of table games in July 2010 at Hollywood Casino at Charles Town Races and Hollywood Casino at Penn National Race Course, Hollywood Casino Bangor in March 2012, and more recently at Hollywood Casino Perryville in March 2013)


Massachusetts license
The Massachusetts Governor signed a bill in late 2011 that allows three casinos and one slot parlor. On February 28, 2014, the Massachusetts Gaming Commission awarded the only slots parlor gaming license to Penn National in connection with the proposed Plainridge Park Casino. On March 10, 2014, Penn National announced it's intention to begin construction and that the opening should be in 2015.

The $25 million license fee paid to Massachusetts was recorded as an intangible asset. The adage "price is what you pay, value is what you get" applies here. The $25 million provides a government issued monopoly. In such a scenario, the intangible assets true value has the potential to be worth far more than the books suggest.

Foolish Takeaway
Foolish investors should double down on Penn National because it will benefit from the gaming industry changes. The high barrier to entry from state license requirements and state legislature change provide a moat with upside potential. Those who prefer calculated bets should delve deeper into the goodwill and intangible assets, as there may be substantial intrinsic value hidden from clear site.