Pinnacle Gambles on Aztar

In a bold move, riverboat casino operator Pinnacle Entertainment (NASDAQ:PNK) announced Monday that it will acquire casino operator Aztar (NYSE:AZR) in a $2.1 billion deal, including $38 per share, or $1.45 billion in cash -- a 24% premium to Aztar's price at Friday's close -- along with the assumption of $723 million in long-term debt. Aztar had $88 million in cash on its balance sheet at the end of 2005.

This represents a fairly significant adjustment in strategy for the company. Consider this paragraph from Pinnacle's 2004 annual report:

"We are building a great company at a time when merger and acquisition in our industry is at an all-time high. We prefer to build versus buy. At current prices, we think the returns are higher. We hope to achieve a minimum 15% cash-on-cash return on our new projects. That's a multiple of about 6.5 times on current anticipated cash flow (EBITDA). We estimate that most of the acquisitions have been at multiples of eight to 10 times EBITDA."

Indeed, Pinnacle has been building rapidly and aggressively. The company opened its largest property -- the $365 million L'Auberge du Lac resort in Lake Charles, La. -- in May 2005. The company is in the process of building a $400 million property in downtown St. Louis slated for a 2007 opening, and it broke ground in November on another $385 million project in St. Louis with an expected opening date in 2008. In addition, the company could choose to rebuild in Biloxi on the site of its former Casino Magic property destroyed by Hurricane Katrina, and it has also applied for one of the two available slot parlor licenses in Philadelphia for what would amount to a $250 million-to-$400 million project.

This time, Pinnacle has chosen the acquisition route, and its $2.1 billion price tag -- which might seem hefty at 10 times Aztar's $212 million in 2005 EBITDA -- is more reasonable than it might appear at first glance.

But Pinnacle is paying up for a reason: The centerpieces of the merger are Aztar's Tropicana-branded properties on the Las Vegas Strip and in Atlantic City, which will give Pinnacle an established presence and prime real estate in the two biggest gaming markets in the country. That, in turn, positions Pinnacle to be a prime-time player in the industry.

Aztar also brings the Ramada Express in Laughlin, Nev., and will expand Pinnacle's riverboat footprint in the Midwest with its Casino Aztar-branded riverboat casinos in Evansville, Ind., and Caruthersville, Mo.

Aztar

The keys: Tropicana Las Vegas and Atlantic City
Virtually all of the prime real estate on the Las Vegas Strip is owned by MGM Mirage (NYSE:MGM), Harrah's Entertainment (NYSE:HET), Las Vegas Sands, Wynn Resorts (NASDAQ:WYNN), and Boyd Gaming (NYSE:BYD). With the $370 million sale of the Imperial Palace at Center Strip to Harrah's last year (see "Harrah's Imperial Ambitions"), that left Riviera Holdings' Riviera and Aztar's Tropicana as the prime pieces of available real estate on the Strip for acquisition and redevelopment.

The Tropicana features 1,871 hotel rooms, as well as 1,333 slots and 35 table games, on 61,000 square feet of gaming space. But more important are the 34 acres of land the property sits on at the street corner opposite MGM Mirage's MGM Grand, New York New York, and Excalibur. But as my colleague Nathan Slaughter discussed back in January, the aging property is a prime candidate for redevelopment (see "Tropicana Feeling the Squeeze?"). Pinnacle said that the design phase for the project will take at least two years.

The other key piece is the Tropicana Atlantic City. Aztar completed an expansion in November 2004, adding a new 502-room hotel, a 200,000-square-foot dining, entertainment, and retail complex, a 2,400-space parking garage, and 20,000 square feet of meeting and conference space. The payoff is that the property saw revenues climb 27% to $490.1 million in 2005 and EBITDA jump 45% to $118.7 million. Tropicana Atlantic City accounted for more than half of Aztar's $915.4 million in revenues and roughly half of property-level EBITDA.

Expanded riverboat presence and cross-marketing
Pinnacle currently operates Boomtown-branded locals properties in the Shreveport-Bossier City, La., market, in New Orleans, and in Reno. The New Orleans property is Pinnacle's third-largest contributor, with $143 million in revenues. Its $51 million in EBITDA was tops among Pinnacle's properties.

The company is moving more toward the high end, with its Belterra Casino Resort -- located in Indiana about an hour away from both Cincinnati and Louisville -- and L'Auberge du Lac, which opened in Lake Charles last May. That effort continues with the company's projects in St. Louis. In addition to the $400 million property in downtown St. Louis in 2007 I mentioned earlier and a $375 million property with 3,000 slots and 60 tables games at a location 10 miles downriver in 2008, last month Pinnacle agreed to acquire the bankrupt President Casino in downtown St. Louis, with the intention of using the President's experienced employee base for its new operations.

Aztar's riverboat properties don't further that effort much, but they do expand Pinnacle's regional presence. Casino Aztar Evansville is a fairly modest property but a solid contributor, with $136.6 million in revenue and $41.3 million in EBITDA in 2005 -- the EBITDA figure outperforming that at Tropicana Las Vegas. Casino Aztar Caruthersville basically amounts to a truck stop located halfway between St. Louis and Memphis. That property delivered a paltry $27.8 million in revenue and $6.5 million in EBITDA in 2005.

Ultimately, the ability to scoot patrons from its riverboat properties to resorts in Las Vegas and Atlantic City will help improve Pinnacle's competitive positioning at its regional properties, as well as enhance the company's performance at the destination properties. Such cross-marketing capability has proven to be a boon to the performance of giant Harrah's Entertainment, and it's the reason why I think that regional casino operator and Motley Fool Hidden Gems selection Ameristar Casinos (NASDAQ:ASCA) -- a player with leading market share in every market in which it competes -- would fit a company like MGM Mirage like a glove.

Pinnacle Entertainment

A reasonable price
The $2.1 billion price tag -- or about 10 times EBITDA -- may look expensive at first glance, but it really depends on how you look at it.

Harrah's $370 million purchase of the Imperial Palace amounts to about $20 million per acre. At that price, the Tropicana Las Vegas' 34 acres would be worth about $680 million. And if you think that's expensive, consider that there aren't a whole lot of alternatives for a company wanting to enter the Strip market.

In addition, valuing Tropicana Atlantic City at a reasonable eight times EBITDA yields a value of about $950 million. Aztar's other three properties -- Casino Aztar Evansville, Casino Aztar Caruthersville, and the Ramada Express Laughlin -- combined to produce $75.1 million in EBITDA in 2005. At six times EBITDA, the three properties would be worth about $450 million.

Add it up, and at $2.1 billion the deal is spot-on.

Final thoughts
It was probably just a matter of time before a casino operator stepped in to pick up Aztar, if only for its Las Vegas property. Whether Aztar would have been able to come up with the financing on its own to build a billion-dollar-plus property is questionable, and combining operations with Pinnacle solves that problem. Meanwhile, Pinnacle gets access to both Las Vegas and Atlantic City, and the potential for cross-marketing capability is enticing.

Pinnacle is stretching its balance sheet a little thin. If the deal were to close today, Pinnacle would have about $2 billion in net debt on assets that generated $340 million in EBITDA in 2005. After that, the company is also building the two large projects in St. Louis (one of which will be substantially paid for from insurance proceeds related to the loss of the Biloxi property), with the potential for two other significant projects in Philadelphia and Biloxi.

That said, the merger makes sense for both companies. Aztar shareholders get a 24% premium and financing for a new Las Vegas property, and Pinnacle gets an opportunity to build a powerhouse casino company with a nationwide network at a reasonable price.

For more high-rolling commentary by Jeff Hwang:

• How Much Would You Pay for Aces?
• Vegas on the Mississippi
• IGT: Time to Buy?
• The New WMS Industries: Part I and Part II

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Fool contributor Jeff Hwang owns shares of Ameristar Casinos. The Fool has an ironclad disclosure policy.