While the giants in the gaming industry focus their efforts on the fast-growing Macau market, some smaller players are finding their winnings back on our shores. Penn National Gaming (PENN 2.35%) may have missed analyst estimates in the most recent quarter, but there is evidence to suggest the company is headed for brighter days. The $4 billion casino and racetrack company is approaching a significant milestone on Nov. 1 when the company will split into two -- a real estate investment trust and an operating business. Let's take a look at the company's recent earnings and determine whether the corporate schism will indeed juice shareholder returns.
Quick recap
For the recently ended quarter, Penn National saw its top-line sales rise by about $7 million to $714.4 million -- roughly $300,000 ahead of internal guidance. Going further down the income statement, though, the company was unable to maintain the growth with a $5.8 million separation-related hit to EBITDA. As a result, the company saw diluted EPS fall $0.04 to $0.40 per share. Management had been expecting $0.43.
The regional gaming industry is not the super-hot business that companies such as Wynn Resorts and Las Vegas Sands are enjoying abroad. Gambling revenue growth remains unappealing, but it does create the potential for industry consolidation. As one of the strongest players in the space, and with a cash infusion from the business separation, Penn's REIT business and casino operating business can pick up struggling peers at attractive prices. One publicly traded player that has struggled lately, Dover Downs Entertainment, could be picked up on the cheap as the sub-$50 million business currently trades at under eight times forward earnings. Penn trades north of 24 times earnings.
How to make it work
The REIT and the casino operator will take on the roles of their respective businesses on the market -- trading at different multiples and attracting different investors.
The casino operator, obviously, may appeal to investors seeking strong operating cash flows and property EBITDA. Freed from the balance sheet associated with an asset-heavy company, the market may better recognize the cash-generating potential.
The REIT should attract the income seekers. By law, REITs pay out 90% of their earnings in a dividend. Upon completion of the separation, investors will already receive a $3.33 special dividend. The REIT will lease its properties, naturally, to the casino operator.
In a recent Barron's article, the author advocated the special situation, suggesting that buying shares prior to the spinoff would be the best way to generate promising returns. But investors not so sure that the two businesses will immediately flourish may want to wait until the separation is complete. Of course, waiting until the spinoff is completed potentially sacrifices the current value proposition.
