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Gene Marcial's Stock Picks

Marcial: Penn National's Winning Hand

Back in the summer of 2007, Penn National Gaming (PENN) welcomed a buyout offer of $8.9 billion, or 67 a share, from a group of private equity investors led by Fortress Investment (FIG) and Centerbridge Partners, only to see the deal capsize a year later in the wake of the financial crisis.

This time, however, Penn National, a major regional gaming operator that doesn't have operations in Las Vegas, is the one looking to do some buying. The company is scouting around to buy assets of troubled companies that have either filed for Chapter 11 protection or are in dire financial straits.

Some analysts believe Penn's next property acquisition could be in Las Vegas. They say that Penn's "trim, modest but efficient" way of managing gaming operations would serve it well in Las Vegas, where flamboyance and extravagance are part of the reasons why gaming companies on the Strip haven't fared well during the recession.

Penn Chairman and CEO Peter M. Carlino has recently told analysts on separate occasions that he is, indeed, on the prowl, looking to acquire distressed properties everywhere, including Las Vegas, at the right price. Analysts say Carlino has always acted in a "prudent fashion" in acquiring assets. And unlike other Vegas operators, he isn't looking to build pyramids, or replicas of major cities—he would more likely be acquiring assets or properties on the cheap from distressed gaming companies.

The pickings are plenty, according to analysts who have become more bullish on Penn, whose balance sheet and stable operating performance are getting good marks on Wall Street. Of the 16 Street analysts who track Penn, 13 recommend buying the stock and three recommend holding it, according to Bloomberg. Not one analyst tags the stock a sell.

healthy stock bouncePenn's strong balance sheet "gives it the ammunition to take advantage of opportunities in this recessionary environment that others are not able to," says analyst Dennis Forst of KeyBanc Capital Markets (KEY), who rates the stock a buy. He notes that the economic downturn, which he says is already reflected in Penn's stock price, isn't materially affecting the company's results. (KeyBanc has done banking for Penn.) Forst says Penn deserves credit for its strong balance sheet, liquidity, and able management. Recent action in the shares may indicate that investors are taking notice of those factors. The stock, which tumbled to a 52-week low of 11.82 a share on Oct. 24, 2008, has since bounced, climbing to 31 a share by Aug. 14.

Analyst Brian McGill of investment firm Janney Montgomery Scott, who rates the stock a buy, agrees that Penn's strong balance sheet puts it in an enviable position to search for acquisitions from distressed sellers. Penn is apt to find properties at prices near the bottom of the current cycle, including some in Las Vegas, according to McGill. (Janney expects to do banking for Penn.)

"We do think Penn would be willing to consider a Las Vegas Strip acquisition at the right price," says McGill. A purchase would enable Penn's EBITDA (earnings before interest, taxes, depreciation, and amortization) to grow to more than $1 billion, which he figures would make Penn one of the largest and most diversified gaming companies.

Penn is one of the leading U.S. regional gaming operators and owns and operates 19 facilities in 15 jurisdictions, including horse racing tracks in Charles Town in West Virginia, which also features slot machines; casinos in Mississippi; and riverboat gaming in Louisiana. Penn also owns racetracks and off-track wagering facilities in Pennsylvania, and manages a gaming facility in Ontario, Canada. Other states in which Penn also operates include Colorado, Illinois, Indiana, Iowa, Maine, Missouri, New Jersey, New Mexico, and Ohio.

expansion strategy?Despite the collapse in 2008 of the proposed Penn buyout, the company "has never been better-positioned to grow in its history," argues analyst Joel Simkins of Macquarie Capital (USA), who also pegs the stock a buy, with a price target of 40 a share. With an underleveraged balance sheet and with roughly $1 billion in cash, "we believe Penn will continue to pursue a strategy of [same-store] expansion and competitor consolidation," says Simkins. Penn didn't come out empty-handed from the collapse of the buyout deal. The company received $1.47 billion in settlement and breakup fees.

"Penn's capital position and cash flow generation are compelling," says analyst David Katz of Oppenheimer (OPY), who is another bull on Penn, rating it outperform. Penn should generate approximately $385 million in free cash in both 2009 and 2010, even if volume trends remain uneven, figures Katz.

Penn's second-quarter sales and earnings results, which it reported on July 29, reflected soft trends in several of its markets, says Katz, but they were "consistent with our expectation that results will be choppy through the rest of 2009." He recommends that investors buy the stock on weakness.

Analyst Justin T. Sebastiano of investment outfit Morgan Joseph (it has done banking for Penn) upgraded Penn to a buy after its stock declined following the release of the second-quarter results. The relatively feeble numbers, he says, were a function of "property-specific variances," or weakness in some of its facilities, rather than an overall company problem.

strong competitive positionHe recommends buying Penn shares based on what he expects will be better results in some of its other markets. In sum, Sebastiano forecasts earnings of $1.33 a share in 2009, on revenues of $2.46 billion, and $1.60 a share in 2010, on $2.60 billion. Last year, Penn earned $1.34 a share on sales of $2.43 billion.

Another believer in Penn is analyst Joseph Greff of JPMorgan Chase (JPM), who lauds its strong competitive position in certain relatively healthy regional markets. Greff, who rates Penn's stock overweight, sees the company generating free cash flow of $2.85 a share in 2010 and $3.06 in 2011.

What distinguishes Penn from most of the Las Vegas gaming companies, he notes, is that it continues to perform well in a difficult environment. One reason: Apart from its strong balance sheet and ample cash, Penn has a "history of responsible capital allocation," says Greff.

Fortified by a solid balance sheet, efficiently managed operations, plus growth opportunities in markets it has yet to conquer, including Las Vegas, Penn is a standout in the beleaguered gaming industry. Imagine the upside potential for tightly run Penn when the economic recovery kicks in and casino fans return to their favorite games.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.
Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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