Pinnacle: The Battle for Baton Rouge

Pinnacle wants to build a new casino in Baton Rouge, using one of two Louisiana state riverboat gambling licenses the company acquired from Harrah's. If approved, the casino would be a favorite to dominate the Baton Rouge market. However, local detractors say the Baton Rouge market can't support a third casino, and the two casino operators already in the market aren't going down without a fight.

Back in October, emerging casino operator Pinnacle Entertainment (NYSE:PNK) filed a formal petition seeking state approval to build a $250 million resort hotel and casino in Baton Rouge, La. The proposed project would be located near a residential area along the Mississippi River just south of Louisiana State University, and would use one of the two Louisiana state riverboat gaming licenses acquired from Harrah's Entertainment (NYSE:HET) in November. If built, Pinnacle would be an instant favorite to dominate the Baton Rouge gaming market, as well as the only casino operator with a hand in every major gaming market in the state of Louisiana.

There's one problem, though: Even if approved by state gaming regulators, the project would still require approval from East Baton Rouge residents in a March 31 vote. And it seems that not everyone in Baton Rouge wants the casino, least of all the two casino companies already operating in the market -- Columbia Sussex and Penn National Gaming (NASDAQ:PENN), owners of the Belle of Baton Rouge and Hollywood Casino, respectively.

A few weeks ago, Columbia Sussex commissioned a public opinion poll showing that 66% of residents oppose the project. Meanwhile, Penn National has taken to TV ads attacking the project, citing a projected increase of traffic in the residential area near the proposed casino. The ads also criticize the secretive details of the project -- including the proposed berth of the riverboat and the company's projected economic impact on Baton Rouge, as well as other information that Pinnacle has held close to the vest thus far -- calling it a project "with a lot of promises but no answers."

Of course, that's about what you'd expect the casino operators to say when their territory is under attack. But behind some of the more frivolous complaints is a very legitimate concern:

What if Baton Rouge can't support a third casino?

The opposition case
Detractors say that not only would a third casino chop up the Baton Rouge market -- easily the smallest in the state -- but it could wind up putting one of the two existing casino operations out of business. They say that 93% of the people who visit the casinos in the market are locals, and that before Hurricane Katrina, the market was mostly stagnant -- and maxed out -- as it was.

Somewhere in there is a point.

Since Hurricane Katrina hit New Orleans and the Gulf Coast in August 2005, the Baton Rouge gaming market has been on a tear, thanks largely to an influx of transplanted residents from New Orleans. After several years of marginal growth, total market gaming revenues soared from $188.9 million in 2004 to $238.8 million in 2005, and $260.3 million in 2006. And at its 12-month peak -- from September 2005 thru August 2006 -- the market brought in $281.9 million.

But the market has been in regression since. Coinciding with the return of MGM Mirage's (NYSE:MGM) Beau Rivage to the nearby Mississippi Gulf Coast in August, the Baton Rouge gaming take dropped 30% in October, 24% in November, 23% in December, and 20% in January. So while the Baton Rouge market is probably bigger than it was in 2004, it is definitely not a $280 million market based on the current casino product, and probably not a $260 million market, either.

Baton Rouge Gaming Market Revenues

But let's assume -- for the sake of discussion -- that the Baton Rouge gaming market is in fact now a $250 million market as is. Assuming Pinnacle requires a 15% EBITDA return on its $250 million investment, the company would be projecting $37.5 million in EBITDA. And based on a 25% EBITDA margin -- in line with Pinnacle's L'Auberge du Lac property in Lake Charles, and within the range of the company's other two Louisiana casinos -- the company would be projecting about $150 million in annual gaming revenues.

The point is this: If the market is maxed out at $250 million in revenue -- as the detractors suggest -- and Pinnacle is saying it will get $150 million of it, that would leave about $100 million for Penn's Hollywood Casino (which Penn's property has made every year since 2002) and nothing for Columbia's Belle. This scenario would be unacceptable to state gaming regulators, much less local voters; somehow, Pinnacle would have to grow the market.

Investing for locals growth
Pinnacle, naturally, will say that there is more growth to be had. I agree.

For one thing, the problem with the Baton Rouge gaming market isn't that it had maxed out -- it only maxed out because the gaming product currently in Baton Rouge isn't any good. And the reason it isn't any good is because nobody has bothered to really invest in it.

Columbia Sussex acquired the Belle from Argosy Gaming in October 2005 for $150 million upon Argosy's merger with Penn National. Both Penn and Argosy were second-tier players in general to begin with, and Columbia Sussex in general is more interested in cutting costs than trying to compete. And since Columbia Sussex doesn't particularly care about competing for market share, Penn National has done little more than give its property a facelift and a name change (the Hollywood Casino was called Casino Rouge until a few weeks ago). It's a nice arrangement for Penn.

However, by today's standards, both properties are lacking much in the way of non-gaming amenities. Meanwhile, the Belle is a cramped two-deck riverboat that's about a half-mile walk from the parking garage, and the Hollywood Casino is a three-deck riverboat without escalators. And Louisiana's law restricting gaming space to 30,000 square feet is probably a deterrent to most companies considering replacing their riverboat.

Frankly, the locals are getting gypped.

Pinnacle would fix that. Right now, Pinnacle's L'Auberge du Lac is the only casino on a single-level gaming barge in the state of Louisiana. Pinnacle's Boomtown New Orleans expansion will be the second, with the company's $300 million Sugarcane Bay project in Lake Charles and the Baton Rouge project being the third and (potentially) fourth.

Going back to our discussions on Ameristar Casinos (NASDAQ:ASCA) and the St. Louis and Kansas City markets, it's clear that the reason those markets have grown is because its players have invested in them -- namely, the new barge-based gaming facilities and non-gaming amenities. Pinnacle's own plans for the St. Louis market include a bowling alley, a movie theater, and an ice rink -- the kind of amenities that have become mostly standard for the Las Vegas locals market competitors Station Casinos (NYSE:STN) and Boyd Gaming (NYSE:BYD) -- suggesting that the company knows what it takes to bring the Baton Rouge locals market to another level.

Pinnacle's vision
It's not just about dominating the locals market, either. The Baton Rouge casino would also serve well as a regional destination to both further grow the market and establish Pinnacle's own regional network.

Detractors might say that a Baton Rouge destination resort could never compete with the Lake Charles market for business from Texas, given that you'd have to drive past Lake Charles and another 3 hours or so to get to Baton Rouge. They'd also say that Baton Rouge wouldn't effectively compete with the Mississippi Gulf Coast casinos -- or even Harrah's New Orleans -- for destination business. They would be right about Texas but missing the bigger picture.

Pinnacle would substantially control the Lake Charles market and the Baton Rouge market with two legitimate destination properties. Boomtown New Orleans works well as a locals property, though its remote location precludes it from competing with Harrah's for destination traffic in that market. Boomtown Bossier City also gives the company a platform in the Shreveport-Bossier City.

Pinnacle could then scoot its New Orleans patrons over to Baton Rouge for weekend trips (for example), and its Baton Rouge patrons to Lake Charles, and vice versa. Trips to Baton Rouge to catch LSU Tigers games could involve overnight stays at Pinnacle's property, where few might even consider staying at the Sheraton attached to Columbia Sussex's Belle of Baton Rouge.

Conclusion
I think if you consider what Baton Rouge is missing, there's no question that Pinnacle would grow the market. A Pinnacle property would be a boon to the company, and I think of benefit to Baton Rouge as well. The problem is that none of the other casino players would benefit from it. Pinnacle's entry would be a bad thing for Penn National's Hollywood Casino and could very well drive Columbia Sussex from the market, particularly given that state gaming rules require Columbia to keep 800 employees regardless of revenues.

That said, knowing that Columbia Sussex has little interest in investing in its property, I think the local voters would accept that risk. Ultimately, my guess is that Baton Rouge will warm to the benefits of Pinnacle's offering come March 31.

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