Gauging Aztar's Value

Ameristar Casinos (NASDAQ:ASCA) has launched a $2.25 billion buyout offer for Aztar (NYSE:AZR), owners of the Tropicana Las Vegas and other casino properties. Is it a smart bid, or a sure bust?

Ameristar's offered price amounts to about 9.5 times Aztar's $236 million in property-level EBITDA in 2005. Keep in mind: That evaluation doesn't fully account for the value of the 34 acres of land that Tropicana Las Vegas occupies. In addition, Ameristar's willingness to pay up stems partly from the company's belief that Aztar's assets outside of Las Vegas would be more valuable in its hands.

In its investor presentation, Ameristar pointed out that it boasts some of the industry's highest property-level EBITDA margins. Among comparable companies in 2005, only Station Casinos (NYSE:STN) and Las Vegas Sands (NYSE:LVS) had higher EBITDA margins -- and both companies primarily do business in the state of Nevada. In contrast, more than half of Ameristar's EBITDA comes from Missouri, a state with a relatively high gaming tax rate.

2005 Industry Property-Level EBITDA Margins

*Source: Ameristar Casinos investor presentation

With a bit of investment, Ameristar can close the EBITDA margin gap between itself (31.3%) and Aztar (25.8%) and effectively lower the EBITDA multiple implied by the purchase price. As we've discussed on a number of occasions, the simple act of upgrading the slot floor -- as Ameristar has done so effectively at its own properties -- would both drive revenue growth and improve efficiency at Aztar's properties.

But before we gauge the effect of that, let's assign Aztar a baseline valuation.

Baseline valuation: $2.13 billion plus
Last year, Harrah's Entertainment purchased the Imperial Palace on the Las Vegas Strip for $370 million, or about $20 million per acre for the 18.5 acres of land the property sits on. That's not a cheap valuation by any means; at that price, Tropicana Las Vegas' 34 acres of land would be worth $680 million.

Tropicana Atlantic City is not the region's best property, but Ameristar could certainly do worse. Aztar completed an expansion in November 2004, adding a new 502-room hotel, a 200,000-square-foot dining, retail, and entertainment complex, a 2,400-space parking garage, and 20,000 square feet of meeting and conference space. As a result, the property saw revenues climb 27% to $490.1 million in 2005, while EBITDA climbed 45% to $118.7 million. Excluding $3.4 million in construction-related disruption, that EBITDA figure comes in at the $122 million shown in the table below. At a reasonable eight times EBITDA, the property would be worth about $1 billion.

Aztar's other three properties -- Casino Aztar Evansville, Casino Aztar Caruthersville, and the Ramada Express Laughlin -- combined to produce $75 million in EBITDA on $262 million in net revenue in 2005. At a very modest six times EBITDA, the value of the three properties comes to $450 million.

If you look at it that way, the baseline value for Aztar would be about $2.13 billion, or roughly what Pinnacle bid for the company, and a discount to Ameristar's initial $2.25 billion bid.

In addition, the company has outstanding insurance claims of about $150 million related to an Oct. 30, 2003 construction accident related to the expansion project at Tropicana Atlantic City, which was completed in November 2004. The amount that the company stands to actually recover is questionable, but I'm guessing they'll get something back.

Investment upside
Note the disparity between the EBITDA margins at Ameristar's properties and those at Aztar's. As we noted earlier, Ameristar showed a property-level EBITDA margin of 31.2%, compared to Aztar's 25.8%:

Aztar 2005 Property-Level EBITDA

*Excludes $3.4 million in construction-related disruption

Ameristar 2005 Property-Level EBITDA

The key properties in question are the Tropicana Atlantic City, Casino Aztar Evansville, Ramada Express, and Casino Aztar Caruthersville. Those four properties generated $197 million in EBITDA on $752 million in net revenue. Applying Ameristar's 31.2% margin would improve EBITDA by 19% -- almost $38 million -- to a total $235 million.

Here's what that means. Our baseline valuation assumes that Ameristar is paying $1.45 billion for these assets, or 7.4 times EBITDA. Ameristar's target EBITDA return on investment exceeds 20%. If Ameristar invests $200 million to obtain that $38 million gain, it would bring the effective purchase price to $1.65 billion. That's down to about seven times $235 million in EBITDA -- and that's assuming zero revenue growth.

Property specifics
The first area of improvement is the slot floor. Converting Tropicana's 4,318 slot machines to coinless slot technology -- a staple of Ameristar's successful strategy over the past few years -- would not only reduce costs, but also drive revenue growth. This move was already on Aztar's agenda prior to its merger agreement with Pinnacle.

The two riverboat casinos -- Casino Aztar Evansville and Casino Aztar Caruthersville -- are also in need of slot upgrades. And the riverboats at both properties are candidates to be replaced.

But there's more. Ameristar Council Bluffs is in need of an expansion. One possible solution is to float Ameristar Council Bluffs to Evansville, and send Casino Aztar Evansville down to Caruthersville, effectively expanding that property as well. Then Ameristar would simply replace the Council Bluffs boat with a larger facility.

In addition to that possible move, Aztar is already adding a 100-room boutique hotel and a multi-venue dining and entertainment complex to the Evansville property. Set to open later this year, it should yield further revenue gains.

I have no personal gauge on the Ramada Express in Laughlin, but Ameristar management said on the conference call that it sees room for improvement there as well. Given the unpolished state of Aztar's other properties, I fully believe that.

Remember the intangibles
Assuming Ameristar puts in the winning bid, it may pay full price for Aztar. However, Ameristar's ability to invest effectively should help to lower the purchase price on an EBITDA basis. Having a boat to send to Council Bluffs to Evansville, and possibly another to go from Evansville down to Caruthersville, is an intangible plus that would certainly improve the value of both Aztar properties; both have little or no direct competition in many respects. And once Ameristar has a multibillion-dollar property in place Las Vegas, the ability to ship patrons at its riverboat properties to Las Vegas will further enhance the value of those properties.

If it plays its cards right, I think Ameristar could unlock some serious value here.

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