On Pinnacle, MGM, and the Bidding War for Ameristar

"My best guess is that, 10 years from now, MGM Mirage (MGM -1.24%), Ameristar Casinos (ASCA.DL), and regional casino operator Pinnacle Entertainment (NYSE: PNK) will all be one company."
-- Jeff Hwang, "More Suitors for Ameristar Casinos?" July 17, 2008

Back in February, regional casino operator Ameristar Casinos and the since-renamed MGM Resorts International announced a strategic cross-marketing relationship that will allow MGM to tap into Ameristar's premier regional network while enhancing the value of Ameristar's Star Awards and Plateau Players Club (see "On Ameristar and MGM's New Strategic Marketing Alliance"). And last Friday, Pinnacle Entertainment announced that it would purchase Ameristar outright for $26.50 per share or $869 million in cash, while assuming Ameristar's $1.9 billion in debt and $119 million in cash on hand for a total of $2.8 billion.

On the announcement, Ameristar shares shot up 20% to $26.50 at Friday's close, while Pinnacle shares jumped 21% to $16.20.

So everybody's happy, and it would seem that we are about halfway to my "best guess" that MGM, Ameristar, and Pinnacle would all be one company in another five or six years or so. However, it also looks like the acquisition agreement may not be the end of the story, but potentially the beginning of a bidding war.

And ultimately, I don't necessarily see Pinnacle closing the acquisition of Ameristar at $26.50 per share -- or at any price, for that matter.

Forecasting a higher bid
For starters, Ameristar shares shot up 20% to $26.50 -- which just happens to be equal to the purchase price, and for a transaction not expected to close until the third quarter of 2013. Basically what this means is that the market is already forecasting another bidder -- if the market actually expected the transaction to close at $26.50, then Ameristar's stock would trade at some discount to $26.50 to reflect both the time value of money and the risk that the transaction would not take place.

Instead, Ameristar's stock is trading at 100% of the purchase price, which means that higher bid is not only implied, but expected. Meanwhile, that Pinnacle's stock also jumped 21% is another story in itself.

The purchase price and the value
According to Pinnacle, the $2.8 billion purchase price represents a multiple of about 7.6 times Ameristar's trailing-12-month adjusted EBITDA of $365 million. At first glance, this sounds like fair value -- and it's probably close -- but it also might not be the best price Ameristar can get.

Factor in two things:

1. In addition to Ameristar's current operations, Ameristar expects to open its $500-million-plus Lake Charles, La., project (targeting the Houston area) in 2014. This has value not accounted for in the trailing multiple. 
2. Caesars Entertainment (CZR) sold its Harrah's Maryland Heights property (in St. Louis) to Penn National Gaming (PENN -3.64%) earlier this year for 7.75 times EBITDA.

The Harrah's sale is a key reference point. Because while it's a nice property and a good fit for Penn, it's also a second-best player, and is probably fourth-best in the St. Louis gaming market in terms of quality behind Ameristar St. Charles and the two casinos on the east side of the market owned by Pinnacle. That said, I don't see Harrah's Maryland Heights being worth a premium to Ameristar's entire portfolio of premium assets, which has only one clear second-best property (East Chicago).

It's also important to note that Caesars sold the property at 7.75 times EBITDA while under duress, in an effort to solve its own debt issues. And though Ameristar has been exploring sale possibilities at times going back to October 2007 (see "Who's Buying Ameristar?: Part 1"), the company is not selling under duress.

In other words, at $2.8 billion and 7.6 times trailing EBITDA, the Ameristar acquisition would be a very good value for Pinnacle, especially while the company also forecasts $40 million in annual cost savings following the merger. Now that said, post-merger cost savings have no value to current Ameristar shareholders in an all-cash acquisition; meanwhile, a good value for Pinnacle means that there is plenty of upside in pricing should another bidder join the fray.

That value in itself might explain some of the jump in Pinnacle's share price, but there might also be another element at play.

At this point, it's worth pointing out that both Pinnacle and Ameristar have done this before.

PNK, ASCA, and the 2006 battle for Aztar
In March 2006, Pinnacle announced that it would acquire Aztar in a $2.1 billion deal that would net Pinnacle some regional assets, along with Tropicana Atlantic City and the big prize: the 34 acres of real estate that the Tropicana Las Vegas occupies on the Las Vegas Strip (see "Pinnacle Gambles on Aztar"). And then in April 2006, Ameristar launched a competing $2.25 billion bid for Aztar (see "Gauging Aztar's Value").

Aztar: 2006

Ultimately, they both lost. A third bidder -- privately held Columbia Sussex -- eventually swooped in with an absurd $2.75 billion bid, won Aztar, and has generally failed miserably since.

But Pinnacle, led by then-CEO Dan Lee, did not walk away with nothing -- for its part in securing the initial acquisition agreement, Columbia Sussex paid Pinnacle a $78 million merger termination fee. And ultimately, the Aztar sale had two winners: Aztar shareholders and Pinnacle Entertainment.

We could be looking at a similar situation in which Pinnacle wins if the acquisition closes at this price as announced, but still gets paid in the alternative scenario by serving as a catalyst for a bigger bidder.

Like MGM, for example.

MGM: The right fit at the right time?
We've been talking about Ameristar as a natural fit for MGM for at least five years now (see "Who's Buying Ameristar?: Part 1"). It's easy to see why: MGM has a dominant set of Las Vegas Strip assets covering the entire range of Strip patrons, while Ameristar has a customer set to match -- there aren't a lot of casino operators out there who have been able to dominate the mass market while still effectively catering to the high end.

Meanwhile, there is effectively zero overlap between these two companies in the regional markets. As such, a merger would create the kind of national network that right now only Caesars Entertainment has -- only better, with higher-quality components.

MGM and Ameristar's Regional Markets

But there's more evidence to suggest that an MGM-ASCA merger may be more likely to happen now than ever before:

1. As noted, earlier this year, MGM and Ameristar entered a cross-marketing agreement linking their player rewards systems (see "On Ameristar and MGM's New Strategic Marketing Alliance").
2. In November, Ameristar announced that it was withdrawing its bid to build a $910 million casino in Springfield, Mass., even though the company believed it had a superior proposal. Who were the other two bidders for the Springfield license? MGM and Penn National.
3. On Thursday -- the day before the announcement of the PNK-ASCA deal -- MGM announced that it had completed a substantial refinancing of its debt.

It could all be coincidence -- and it might be a little much to suggest that MGM finally got its debt situation settled just to pile on more debt in an acquisition -- but the pieces seem to be in place for an MGM-ASCA merger to happen. Moreover, MGM can easily justify a higher bid price for Ameristar (a) because the price of the original PNK-ASCA agreement is relatively low to begin with, and (b) simply because Ameristar is worth more to MGM than it is to Pinnacle due to potential cross-marketing synergies from a national network, as opposed to a PNK-ASCA regional network.

Meanwhile, MGM can also sweeten any bid with MGM stock, which may prove desirable to Ameristar shareholders.

PNK-ASCA: Full circle in Lake Charles
We've discussed the merits of a PNK-ASCA merger before (see "Who's Buying Ameristar?: Part 2), but this is a completely different scenario, in which Pinnacle is simply paying cash for Ameristar's premium assets, and perhaps Ameristar's operational expertise as well (which shows up in Ameristar's EBITDA margins). There are other interesting angles here as well, most notably Ameristar's Lake Charles project.

Earlier this year, Ameristar acquired the Lake Charles project from Dan Lee's Creative Casinos. Creative Casinos had won the license to build on that site after the license was vacated by Lee's previous employer, Pinnacle Entertainment. In 2006, Pinnacle -- with Lee at the helm -- had acquired the license (along with a second license it would use in Baton Rouge) in a swap with Caesars Entertainment (then called Harrah's) for Pinnacle's Biloxi property, which was damaged and closed due to Hurricane Katrina in 2005.

Pinnacle's plan at the time was to build a second resort on a site adjacent to its own L'Auberge du Lac property in Lake Charles, in order to create a larger, integrated resort. Pinnacle's chosen site for the resort is the same site that Ameristar's Lake Charles project sits on.

And so in addition to direct value and cost savings from acquiring Ameristar as a whole, Pinnacle may also achieve greater synergies in Lake Charles by reacquiring and completely reintegrating Ameristar's Lake Charles project.

A win-win for PNK, and a catalyst for an MGM and/or LVS bid
Regardless of the outcome, there's a lot of sense in the Ameristar acquisition for Pinnacle, particularly at this price. But a lot can happen between now and Q3 2013, and as I said earlier, I don't necessarily see Pinnacle acquiring Ameristar for $26.50 per share.

Nor do I see Pinnacle engaging in a bidding war as it did for Aztar.

Ultimately, I see MGM making an offer. Acquiring Ameristar makes a lot of sense for MGM, in that MGM can justify making a higher bid than Pinnacle to the point where Pinnacle simply walks away with a merger breakup fee (or a "bigger bid catalyst fee," which, if I read it correctly on pages 61-62 of the SEC filing, would be $38 million plus up to $12.5 million in transaction expenses) -- as it ultimately did with Aztar. And if it comes to it, I can also see MGM sweetening a deal with stock, which I think would prove desirable to Ameristar shareholders.

I can also see Las Vegas Sands (LVS -0.63%) kicking the tires, as Ameristar makes sense for LVS for all of the same reasons that it makes sense for MGM. Ameristar can similarly give LVS an instant national network with cross-marketing synergies to support LVS' Las Vegas Strip properties on one end and Ameristar's regional assets on the other, while solving all of the problems LVS doesn't have. Moreover, from a financial standpoint, LVS can make this happen with its eyes closed.

In my mind, a good opportunity is a good opportunity, and I think LVS wants Ameristar even if it doesn't know it yet.

As far as other potential bidders, I see both Penn National and Boyd Gaming (BYD -1.10%) as being interested, but I don't necessarily see them making material cash bids. This is simply because Ameristar is worth more to a casino operator with Las Vegas Strip assets than one without (Penn doesn't have one, and Boyd is at least several years away from building Echelon Place), and thus neither Penn nor Boyd would be able to justify paying the same price that MGM or LVS could.

I also don't see Penn or Boyd stock as attractive trading chips in this scenario, either: I think the game for Ameristar is to either sell into the Las Vegas Strip with stock or sell out completely.

For more gaming industry coverage, check out:

• What's Ameristar Worth?
• Sorry, Mr. Online Poker. Nobody Cares About You
• G2E: On Value Investing and Macau Casino Stocks

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