Shares of Penn National (PENN -1.24%) have been on fire over the past year, primarily because of the casino and racetrack operator's moves to get into online gambling. The company is still in the early days of its expansions into offering sports betting and other casino games online, but its growth prospects in this business have made the stock too tempting for some  investors to pass up. 

For investors considering opening a position in the gambling company now, the question that needs to be answered is: Does the potential of online betting make Penn National a great buy today, or is all of the upside already priced into the stock?

Person betting on a soccer game on a mobile device.

Image source: Getty Images.

Online gambling is still tiny

I can see why investors are excited about Penn National's online gambling prospects, but keep in mind that the business is tiny today. Between the launch of the Barstool Sportsbook app in Pennsylvania in September and the end of 2020, the app generated under $300 million of handle. Handle is the amount of total bets, and the revenue made by the casino is generally around 10% to 15% of the handle figure. So, we can expect that $300 million in wagers would result in between $30 million and $45 million of revenue.

That tracks with the $37.8 million increase in Penn National's "other" revenue category (where it reports its online gambling results) from $15.6 million in Q4 2019 to $53.4 million in Q4 2020. For perspective, "other" sources accounted for 5.2% of Penn National's revenue in the quarter. And I'll also note that the "other" category generated a negative adjusted EBITDAR of $1.3 million, so this is a money-losing business today

This isn't to say that online gambling won't grow significantly or become highly profitable eventually. But keep in mind that the company has a long way to go to make this a sustainable business. 

Regional gambling has been solid, but not impressive

The pandemic severely impacted most entertainment businesses in 2020, but regional gambling wasn't hit as hard as most. That's in part because at smaller regional casinos, locals contribute a significantly larger share of the handle than they do in places like Las Vegas. Further, many of Penn National's operations are located in places where governments did not impose stringent restrictions on businesses.

As a result, the company's revenue last year fell by just 32.5% to $3.6 billion, and adjusted EBITDAR dropped 31.8% to $1.1 billion. That's a solid performance amid the pandemic. 

But let's take a step back and look at EBITDA generation over the last decade (pre-pandemic). You can see from the chart below that EBITDA rose 48% between the end of 2011 and 2019. That's less than 6% annualized EBITDA growth, which isn't exactly high for a company with an enterprise-value-to-EBITDA ratio of 17.8 in 2019.

PENN EBITDA (TTM) Chart

Data by YCharts.

The market is clearly expecting online gambling to turn this into a growth stock, but keep in mind that there could also be some cannibalization of regional gambling revenue if people who otherwise would have visited casinos start betting from home instead. And Penn National hasn't proven that it'll make a lot of money in online gambling. 

Is Penn National a buy? 

Penn National's share price is riding a wave of optimism about the future of online gambling, but I think there may be better ways to play this niche of the industry. DraftKings is a pure-play in online gambling, but MGM Resorts (MGM -5.01%) may be a better bet for investors who want some physical casino presence with their online betting. And MGM has already staked out a large market share in about a dozen states, putting Penn National about a year behind. And based on price-to-sales ratio -- which I think is the best metric to use for the unprofitable online gambling business -- MGM is a cheaper stock today. 

PENN PS Ratio Chart
Data by YCharts.

Until Penn National proves it can be a dominant force in online gambling, I would make a safer bet on a stock like MGM Resorts. There could be upside in Penn National's shares, but after the past year, I see too much risk if the company doesn't perform flawlessly.