Penn National Gaming – Workout or Worthless?
February 15, 2008 | Joe Ponzio | about: PENN
There had been a considerable amount of discussion about the acquisition of Penn National Gaming, both in these comments and in a few other comments around the site. As the deal stands right now, Wall Street appears to be leaving $18 a share – or 38% – on the table for today’s workout investors.
What will upset the applecart?
In any workout situation, we ignore the emotions of others (those who offer the premium and price) and start by looking at the proposed merger agreement filed with the SEC. Let’s answer some preliminary questions (assuming, of course, we already know the parties to the transaction):
When is the deal expected to close?
Section 2.1(c) 2.2(c): The companies are shooting for a June 15, 2008 closing date at $67 a share. If the deal is not done by that day, the price ticks up $0.0149 per day until it closes. That’s about 8% a year.
Where are the funds coming from?
Section 5.7: The financing for this transaction is two-fold. Debt financing: The parties have executed commitment letters from Deutsche Bank Securities Inc., Deutsche Bank AG New York Branch, Wachovia Capital Markets, LLC, Wachovia Bank, National Association and Wachovia Investment Holdings, LLC. Equity financing: The acquiring firms, Fortress Investment Group and Centerbridge Partners, have signed equity commitment letters. In short, the financing is in place.
But we have to look at this:
None of the Financing Commitments has been or will be amended or modified, except as consistent with Section 7.9(c), and the respective commitments contained in the Financing Commitments have not been withdrawn or rescinded in any respect as of the date hereof.
Section 7.9(c): Not as exciting as I thought it might be. Basically, no changes or modifications of the financing commitments may be made unless PENN agrees, except that debt financing on better terms may be accepted. In short, it says, “If we find better lenders, we’ll use them. If not, we’ll go with the ones we have.”
Backtracking to Section 7.9(b) – If the financing falls through
Most deals are generally on a “best efforts” basis whereby, if financing falls through, there is no back-up plan other than we’ll try to find money. In this deal, there is a back-up plan: bridge financing.
In this case, the lenders are offering (or have been asked to consider) bridge financing in lieu of the proposed debt financing. As such, the lenders would make a temporary loan, in whole or in part, to float a portion of the debt financing that could not be obtained. The newly private PENN would then be required to find alternative financing or take some other action to quickly pay back that loan (as opposed to paying back the traditional loan over longer periods).
The bridge financing is not guaranteed (is anything?), but it can be a safety net in the event that the banks were overly zealous in their terms when the deal was proposed early in 2007.
So, the terms look good and financing is more or less arranged. Let’s check out the bumps in the road.
The Reverse Termination Fee; Cash Involved
If the acquiring firms kill the deal, they are on the line for a $200 million reverse termination fee on a $9.4 billion deal (including the repayment of some $2.8 billion of PENN debt). The acquiring firms have to bring up to $3 billion of cash to the table to get the deal done. The banks are bringing $5.1 billion in secured loans and throwing in another $2 billion in unsecured loans.
The good news is that the acquiring firms are putting about 30% down when many leveraged buyouts close on 20% or less. The bad news? The termination fee is a drop in the bucket when compared to the size of the companies and the deal. Penn routinely reports having nearly $200 million in cash at the end of each quarter, so the termination fee would not be a major benefit to PENN or its shareholders.
Fortress and Centerbridge run private equity funds. Fortress reports that it manages roughly $40 billion in assets. I don’t know how big Centerbridge is, but I’d be willing to bet it has some dough considering it is partnering with a $40 billion company to acquire a string of casinos.
Something Smells Funny On The 13F-HR
Looking at Fortress’ 13F Quarterly Report of Holdings for December 31, 2007, Fortress reported a new holding – PENN – of 157,396, or $9.4 million. Is this a quiet acquisition of shares or a weak commitment to support an otherwise-ready-to-plummet stock price?
The Regulatory Hurdles
There still remain some regulatory hurdles to the transaction. Personally, I don’t understand the hurdles nor do I know if this transaction will breeze through the regulators or if it will get squashed. Worse yet, we don’t know when the regulators will approve the deal, so out timeframe is not fixed.
I’ll Wait…For Now
Admittedly, the transaction looks appealing, though I attribute that appeal largely to the price. Is this a virtually risk-less workout? Not in my view.
Today’s buyers are expecting a 38+% return by or shortly after the end of the second quarter, about five or six months from now. During that time, a lot can upset the applecart:
- regulators can squash the deal;
- there can be a “material” adverse change in the business of any of the parties;
- the price can drop so much that the buyers no longer see $9 billion of value in a then-priced $3 or $4 billion company (PENN is now trading at $4.1 billion);
- the acquiring companies can find better value for their $3 billion, even at the expense of a $200 million termination fee.
Let’s Define A Workout
A workout is a virtually risk-less transaction where the timeframe and potential profit are fixed and consummation of the workout depends on corporate action or events, the occurrence of which is highly probable.
At this point, the potential return on PENN is extremely attractive assuming everything falls into place. What I don’t see is the “virtually risk-less” part, the fixed timeframe, or a highly probable close.
To clarify my mindset (which may be skewed and way off base), revisit the arbitrage discussions in 1950s Buffett. I’m looking for “no-brainers” that are mispriced. With the remaining hurdles and variables in the PENN transaction, I can’t say with near-absolute confidence and competence that it is either a no-brainer or mispriced. Of course, there are a lot of smart people out there that can.
If, upon thorough analysis, you see safety of principal and a satisfactory return, and this is one of your best ideas, don’t let my apprehension slow you down.
Filed under: Workouts, Arbitrage, & Hedges
Related Stocks: PENN
Every day I come to your blog I gain one more nugget of knowledge. It was great to open the AGREEMENT AND PLAN OF MERGER and follow along. Thank you.
Just wanted to correct your web page. “When is the deal expected to close” is in section 2.2(c), not 2.1(c). Just in case others wanted to “follow along”.
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I see. Thanks for pointing out the unknowns that I didn’t realize.
I’d like to know more details on what sort of regulators need to be done with, though. Is this information that you’d have to be a bit of an industry insider to know? From what I’ve interpreted they’ve passed the major regulation (“Hart-Scott-Rodino Antitrust Improvements Act of 1976″), and the rest of the regulators are small-fry. Is there a way to figure this out from the outside looking in?
The weak position FIG has in the company is curious. But from June 5th 07-December the stock was mostly trading at 50-60/share–might they of been biding their time since they had a full year to pick up shares (June07-June08)? Now that it is so low, could they be building their position now? What of the other major holders? I suppose we have to wait until the next quarterly report to find out.
Whats your take on the CEO’s support of the transaction? He personally invested $50million and seemed confident about the merger in an interview. Would this be filed under noise?
Is it likely that the company will drop below the 4billion range when they were trading in the 3.8-4.1billion range before the merger announcement? They’ve had mostly good news since then and recently opened a new casino. Also, upon the next piece of good news is it not realistic that the price of the company could jump to something closer to the closing price? Would that squash hurdles 3 & 4?
Finally, I am still looking at it as an opportunity. I am not even sure why local regulators would have a problem with them going private, when it has no effect on how they run the business (as far as I know?).
Sorry for the barrage of “?”s but I am trying to straighten out all of the information in my head haha.
Thank you for the entry.
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So helpful thanks again. Had a few questions.
You mentioned regulatory approval might not happen. Is there anything (SEC filing for example) that you can reseach to get insight on the probablility of an approval?
Do the terms “specific performance” in the SEC filing agreement regarding obtainging financing mean the aquirer has to do everything and anything to try and finance the deal?
On a long ago post side note, Sharp has drop well below break up value, just wondering if your looking at it anymore?
Any update on the book?
Just want to rant a bit of praise for the site. It is so helpful and I have learned so much from it. Me being new I am not quite confident in workouts yet but here I am getting info that is building my confidence everytime I enter and am starting to feel confident about them. I love that you keep reinforcing the principles that the workouts are meant to be riskless and dont jump in if your not comfortable.
On the new site just PLEASE make sure everything (Blog and Comments) from the past are still accessible
Thanks Joe!
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I am not too concerned about the regulatory approvals. It took harrahs about a year to get them all, it is just a matter of time.
there is a filing out that seems to allow the buyers to purchase PENN on the open market, thereby decreasing their total cost. what do you make of that and the fact that PENN has remained weak in light of their ability to buy it.
from the latest cc the buyers seem very committed to this deal. I like this arb in the mid 40’s.
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Stephan – thanks for the info. So it seems FIG has the go-ahead to purchase shares, however it doesn’t mean they have the cash to actually do it. If they did, why wouldn’t they simple lower their cost basis by purchasing heavily discounted PENN shares on the open market?
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Answer to the previous post:
In the filing
[ link ]
it says ” Following the limited waiver of the Standstill in December 2007, the Board of Directors of the Company approved in January 2008 a general waiver to the Standstill that would permit the Sponsors or their respective affiliates to purchase the Company%u2019s securities. Notably, this waiver does not require the Sponsors to purchase any Company securities or to purchase such securities by any particular time. In addition, the Company expressly reserved the right to revoke this waiver for any reason at any time. Therefore, no assurance can be given as to whether, in what amount, or at what prices, the Sponsors may purchase any of the Company’s securities.”
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Another thing I don’t understand is – why would the banks walk and risk getting sued? They are in the business to lend money, right? Sure, they aren’t making money at the moment, but it seems risky to alienate the business community by screwing these LBOs. Don’t they have reputations to protect?
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Look at mortgage rates right now – on the rise with all other rates dropping. Banks need to clean up their balance sheets, so they will only lend money to A-level homeowners/buyers, and do so at higher rates than they can.
Part of that “clean-up” will come from backing out of these LBO deals which is why you need to make sure that financing and other terms are locked up tight, and that there is a back-up plan. You need done deals, or a big enough premium (on an annualized basis) that the risk of the applecart turning is outweighed by the potential profits.
To evaluate that, you need to estimate the odds of the deal falling apart, the odds that you’ll find many deals like this in the future, and the premium. Then, ask yourself: If I saw this situation 1,000 times, would I be a long-term winner or a long-term loser, regardless of the outcome of this particular opportunity?
Not sure? Then get the hell out of there.
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Now that PENN is near it’s 52 week low, I’m wondering if it would be a good investment *regardless* of the workout opportunity. The reason I ask – it appears this stock is getting punished based on the merger, and not based on an adverse change to the business itself. If the downside risk of a failed workout is already built into the current price, why not get in now and treat this as a normal investment? If FIG walks I suspect the stock will get punished further, probably unfairly.
Of course we would need to calculate PENN’s intrinsic value and apply a MOS discount on it to really know all of this. I’ll try to do that this week…anyone else care to try so we can compare notes?
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Great write up, as usual.
What I still don’t understand is – why would FIG back out of this deal based on price alone, assuming PENN’s instrinsic value hasn’t significantly changed since their original analysis? The financing isn’t tied to it, and we all know that price doesn’t always reflect fair value. Are you saying they might nix the deal, pay the $200m, and aquire PENN shares on the open market instead? Why wouldn’t they do that anyway as your 13F comment seems to insinuate?
Regardless, doesn’t the current PENN price volatility have more do do with arb trading rather than something insidious occurring within the business itself? Many of the long time PENN investors on the Yahoo forums are hoping the deal falls through, as they see the company’s prospects (value) driving price past $67 in a few years. I’m assuming FIG came to the same conclusion when they made the offer to begin with.
I’m not trying to be argumentative, rather I’m trying to learn how these things work!
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