Description

Investment Thesis

Tropicana Entertainment Inc. is a portfolio of profitable casinos trading at a large discount to peers due to low liquidity, understated profitability, misunderstood risk in the Atlantic City (“AC”) market and overlooked potential to unlock value from its real estate holdings. Even assuming continued declines in AC and Lumiere Place in St. Louis, the stock is worth $19-$20 per share. If the majority owner, Icahn Enterprises, monetizes hotels or real estate and Tropicana’s casinos stabilize, the company is worth in excess of $25 per share.

Business Overview

Tropicana Entertainment operates seven regional gaming properties in the United States and one casino in Aruba. The company was bought out of bankruptcy by Icahn Enterprises in March 2010 and IEP continues to own 68% of the equity. Their largest casinos are the Tropicana Atlantic City, Tropicana Evansville in Indiana (formerly known as the Aztar) and Lumiere Place in downtown St. Louis. The remaining casinos are smaller, consistent cash flow generating properties in Greenville, Mississippi; Baton Rouge, Louisiana; Laughlin, Nevada; and South Lake Tahoe, Nevada. The Aruba property generates negligible revenue and is set to reopen from renovations in 2015. The table below provides an overview of Tropicana’s properties:

Tropicana Entertainment Property Overview

Competitive Environment

The success of a regional gaming property is a function of the population, per capita income and number of competitors within a 50-200 mile radius. Over the last few years, regional gaming markets have become more competitive as state governments have granted more gaming licenses to stem the flow of disposable income to neighboring states, supplement state tax revenue and increase employment. Five of Tropicana’s U.S. casinos enjoy strong regional positioning: Evansville, Laughlin, Baton Rouge, Greenville and South Lake Tahoe. Two properties are under pressure from increased competition and declines in the regional economies in which they operate: Atlantic City and Lumiere Place in St. Louis. Fortunately, with extensive state level gaming revenue disclosures, we can see past the noise around problems in AC and consider each property on its own merits.

Central: Tropicana Evansville is particularly well situated from a competitive perspective owing to its location over 60 miles from the nearest competitor in an area addressing a population of over 700k people, near the borders of Indiana, Illinois and Kentucky (Kentucky has no commercial or tribal casinos, only racinos). Gaming revenue at the property grew by 5% in 2014, significantly outperforming an 8% decline in the Indiana market. Evansville has grown modestly over the last five years while Indiana gaming has declined 5% annually and the property has consistently generated 26%-29% EBITDA margins despite the addition of new racing machines at racinos nearby in Kentucky in 2012. It is a strong regional casino that deserves a full market multiple.

Tropicana acquired Lumiere Place from Pinnacle for $261m in April 2014. At the time of the acquisition, the property was generating $180m revenue and $30m EBITDA, but has since declined 8% to $166m revenue and $19m EBITDA. The decline was driven by two factors: (1) competitive pressure from Pinnacle transitioning existing customers to its River City casino (common following M&A in the space) and (2) a surge in crime and protests in downtown St. Louis following the events in Ferguson, Missouri. When the temporary post-divestiture customer poaching stops, Lumiere Place will be a premium facility with high-end lodging options, near the Gateway Arch, in a state that offers favorable competitive dynamics as the number of gaming licenses is limited to 13. Any recovery in Lumiere would significantly increase Tropicana’s earnings power.

South: Belle of Baton Rouge is one of three competitors in the 60 mile area serving one million people around Baton Rouge to New Orleans. The casino lost share to Pinnacle’s L’Auberge Baton Rouge property when it opened in September 2012, but has stabilized since Q4 2013 and grew gaming revenue by 5% in 2014. The Baton Rouge market is exposed to a downturn in local income due to energy-related unemployment, but much less so than Lake Charles, Louisiana, which serves the Houston market. The main shale formation near Baton Rouge, the Tuscaloosa, is in its infancy with 8 rigs drilling for oil and gas versus 163 in Eagle Ford. Baton Rouge is much more exposed to the downstream segment, which benefits from low oil prices. Nonetheless, I have assumed the Baton Rouge market declines in 2015 and 2016. Tropicana Greenville in Mississippi is a smaller casino that shares the central Mississippi/Arkansas region with one competitor, in a thinly populated 90 mile radius. Trop Greenville grew slightly in 2014 and is approximately one-third of the revenue of the “South” segment (Mississippi does not report gaming revenue by property). Both of the South casinos are healthy, cash generative businesses with limited near-term exposure to new competitors and improving hotel occupancy rates (49% in 2011 to 71% in 2014) and gaming revenue.

West: MontBleu and Laughlin operate in markets with a few competitors in small areas that serve tourists from northern California and Los Angeles, respectively. MontBleu sits on the shore of Lake Tahoe on the Nevada side and serves a higher end customer and corporate clients. Laughlin serves as a low-priced, low-key alternative to Las Vegas and is equidistant from Los Angeles. These are both steady, profitable properties that have had improving occupancy, increasing room rates and growing gaming revenue over the last couple of years.

Atlantic City is Not as Bad as It Seems for Surviving Casinos

The Atlantic City market has been in decline since 2006 and a number of recent, high profile bankruptcies have raised concerns about the longevity of the remaining casinos. While competitive pressures will grow with three casinos opening in the Catskills in the next few years and a new MGM casino in Maryland opening in 2016, Atlantic City will remain a regional gambling destination, albeit at lower revenue levels. Closures of Atlantic Club, Revel, Showboat and Trump Plaza in 2014 represent the competitive reality of an oversupplied, evolving market. The few remaining casinos have carved-up the city and control turf in different areas: Tropicana controls the south boardwalk, Caesar’s controls the central boardwalk (as Bally’s fades), Resorts controls the north (as Trump Taj fades) and Borgata/Harrah’s/Golden Nugget split the marina. While total market revenue is down, the remaining casinos have grown, improving their prospects of managing a controlled descent to AC's normalized revenue potential. Additionally, New Jersey has a relatively low gaming tax rate of 10.5% which means AC casinos have significantly higher earnings potential than their neighbors in Pennsylvania, where gaming revenue is taxed at 55%; this is an overlooked benefit of operating in AC.

Atlantic City Y/Y Growth in Gaming Revenue

1. Excludes internet gaming revenue

Casino closures make for compelling headlines about the death of AC, but they have been a boon for the survivors. The four casinos that closed last year lost about $300m of gaming revenue in 2014, while the top six surviving  players gained $140m (with the majority of gains going to Tropicana, Borgata and Golden Nugget). As Bally’s and Trump Taj continue to struggle and potentially close over the next couple of years, another $440m of gaming revenue will be up for grabs, which could translate into a $30-$50m revenue gain for Tropicana to counter volume declines in AC.

It is difficult to estimate the ultimate size of the AC market, but New Jersey’s relatively large population (8.9m people) and high per capita income ($53k) suggest it should survive as a sizeable market. Even if the surviving operators shrunk 20%, making AC a $1.9 Bn market, Tropicana AC would still be an EBITDA positive resort on 14 acres of beachfront property. Tropicana AC also has a growing online gaming business that generates $31m in run-rate revenue.

Valuation

From a simple multiple rerating perspective and under a range of growth scenarios, Tropicana is worth considerably more than the current price of $16.45.

1. See Financial Overview for an overview of scenario assumptions.

2. Includes $15.7m of restricted cash to collateralize letter of credit and satisfy predecessor professional service fees.

3. Comps for median 2016E EBITDA multiple include BYD, CHDN, PNK, ISLE and MCRI. As of 3/18/15.

A sum-of-the-parts valuation that ascribes different multiples to the properties based on their performance and prospects also shows considerable upside from current levels. This valuation assumes that (1) Lumiere Place EBITDA remains well below the $30-$35m levels generated in 2011-2013 and (2) Tropicana AC is worth less than the $200m value for which Icahn acquired it in 2009 (for 4.6x EBITDA).

1. See Financial Overview for an overview of the scenario assumptions.

Additional Sources of Value: the above valuations do not take into account a few sources of additional value, notably Tropicana’s real estate.

• Real Estate Optionality: Tropicana cannot pursue a REIT spin-off along the lines of Penn National’s spin of GLPI, because IEP’s 68% ownership would violate IRS rules that limit the number of shares a REIT shareholder can own to 10%. However, IEP could still monetize the real estate of Tropicana’s five land-based casinos and the hotels surrounding its two riverboat casinos. While the casino at Lumiere Place has underperformed, the property includes the Four Seasons St. Louis, which could be worth $60-$150m based on precedent transactions that value Four Seasons properties for $300k-750k per room (Lumiere Place has 200 rooms). In the current market, with cap rates at 6-7% for similar real estate transactions, Tropicana’s hotels are worth significantly more than the 6x-8x EBITDA at which regional casinos currently trade. Tropicana also owns undeveloped acreage around the MontBleu and Laughlin casinos and 14 acres of property near Eagle Beach in Aruba.

• Any recovery in Lumiere’s topline and profitability would considerably increase Tropicana’s value. Note that Lumiere was acquired for $261m last April and is only valued for $80-$140m in the above framework (a $120-$180m difference in value or $4 to $7 per share).

• $162m NOL subject to Section 382 limitations and $33m of investment assets earmarked for use under the New Jersey Casino Reinvestment Development Authority (“CRDA”).

• IEP’s NAV Estimate: for what it's worth, it is clear that Icahn Enterprises assumes Tropicana is undervalued because IEP’s Q4 2014 NAV estimate for its 68% stake is $497m, implying  a value of $25 per share (IEP uses a 7.5x EBITDA multiple).

Financial Overview

1. 2014 includes results from Lumiere Place for three quarters of the year (from April 1, 2014 to December 31, 2014). 2015P includes a full year of Lumiere revenue and EBITDA.

2. AC. Down: AC market decline since 2005 of -7.5%, some share capture in 2015. Base: market declines, but revenue is supported by share capture from closing casinos (similar to the dynamic in 2014). Up: market stabilizes & TPCA retains captured share.

3. Lumiere. Down: accelerated gaming declines. Base: 3% gaming decline. Up: stabilization.

4. Driven by operating leverage: 50% gross margin and $122m fixed cost.

5. Driven by operating leverage: 38% gross margin and $44m fixed cost. Up assumes modest margin recovery closer to historical levels.

6. Assumes no shielding from NOL and 38% tax rate.

7. Includes management’s cited $36m of maintenance capex plus $9m for Lumiere consistent with pre-acquisition levels. Management noted in the 2014 10K that even the $36m maintenance capex is discretionary.

8. $60m of growth capex in 2015, of which $18.8m is funded by previously accrued CRDA deposits held as investment assets on the balance sheet (note: not included in cash for net debt calculation), $4.8m funded from NJ grants and a $24m one-time improvement to Montbleu that will lower future capex requirements under the revised lease agreement.

Risks / Concerns

• Liquidity: Tropicana has a limited float (8.4m shares out of 26.3m outstanding) given its large insider ownership and only trades ~$60k of average daily volume ($300k around earnings), making this a tough stock to buy.

• Regional Competition: casinos have considerable fixed costs so accelerated declines in Atlantic City and St. Louis could lead Tropicana’s properties to operate at a loss and impair their value. Additionally, new regional competition in Kentucky or other states bordering Tropicana’s properties could impair performance. The St. Louis Rams may relocate to Los Angeles in 2018, which would adversely impact performance at Lumiere Place, which is across the street from the Edward Jones Dome.

• Volatile Monthly Gaming Revenue: regional gaming revenue is reported on a monthly basis and aberrant year-over-year comparisons can generate volatility in the stock.

• IEP Majority Ownership: IEP could potentially pursue a transaction in its own interest that effectively “crams down” minority shareholders. While possible, this would entail marking down IEP’s $500m NAV value for Tropicana, which is 6% of IEP’s NAV as of YE 2014. Investing with IEP is more likely a potential source of upside as you are investing alongside Carl Icahn who has a great track record in the gaming space.

• No Investor Relations: Tropicana management does not hold earnings calls and does not take calls with investors.

Catalyst

• Selling real estate or individual casinos

• Stabilization of Lumiere Place and Tropicana Atlantic City

• Increased investor awareness