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Shares of Pinnacle Entertainment (PNK) rose 21.3% in Friday's trading session. The operator of casinos, hospitality and entertainment facilities announced that it will acquire Ameristar Casinos (ASCA) in a deal which would double the operations of the firm.

The Deal

Pinnacle Entertainment announced that it has entered into a definitive agreement in which Pinnacle will acquire all the outstanding shares of Ameristar for $26.50 per share in cash, for a total enterprise value of $2.8 billion.

Shares of Ameristar rose 20.1% in a response to the offer, closing at the offer price of $26.50 per share. The offer values the equity of the firm at $869 million. The offer price represents a 45% premium over the average closing price of the past three months, according to the firm.

Pinnacle will more than double its size by acquiring Ameristar, operating some 17 properties. The deal will furthermore significantly diversify its operations across different regions.

CEO Anthony Sanfilippo commented on the deal, "The acquisition of Ameristar is a transformative transaction for Pinnacle that will provide us the scale and diversification to more effectively compete. The coupling of Pinnacle and Ameristar properties will create a terrific portfolio of quality assets to serve our combined guests. Both companies have developed cultures where team members are focused on providing a high quality experience to their guests and delivering outstanding financial outcomes for their shareholders."

The deal values Ameristar at 7.6 times trailing annual EBITDA according to the press release, which excludes expected synergies totaling $40 million per year. Ameristar generated annual revenues of $1.21 billion for the year ending in December 2011, which values the firm at 0.7 times annual revenues.

Pinnacle has already obtained committed financing for the deal.

The deal is subject to ordinary closing conditions which includes shareholder approval and regulatory approval. The deal is expected to close by the end of the third quarter of 2013.

Valuation

Pinnacle ended its third quarter with $158.8 million in cash, equivalents and short term investments. The company operates with $1.44 billion in total debt, for a net debt position of roughly $1.28 billion. The financial position excludes the impact of the announced deal.

For the first nine months of the year, Pinnacle generated total revenues of $895.5 million. The company reported a net profit of $10.6 million for the period, impacted by a $20.7 million loss on the early extinguishment of its debt. The company could generate annual revenues of $1.15-$1.20 billion on which it could report a modest profit.

Factoring in Friday's 21.3% jump in the share price, the market values Pinnacle at $955 million. This values the equity of the firm at roughly 0.8 times annual revenues.

The company does not pay a dividend at the moment.

Some Historical Perspective

Year to date, shares of Pinnacle have risen some 60%. Shares started the year around the $10 mark and shares gradually rose over the past months. The deal sends shares to year high's around $16.20 per share at the moment.

Shares peaked at $35 in 2007 as the economy was booming. Shares fell back to lows of $3 during the financial crisis in 2008. Between 2008 and 2012, revenues rose roughly 20% from $980 million in 2008 to an estimated $1.17 billion this year. The company mostly reported sizable net losses over the past years.

Investment Thesis

Shares of both firms reacted very favorable to the announcement of the deal. The deal will double Pinnacle's total revenues, expected to come in around $2.4 billion on a pro-forma basis. Combined, both companies are struggling to report meaningful profits.

Shareholders are applauding Pinnacle's acquisition, even though the deal would increase the estimated net debt load of Pinnacle to roughly $4 billion. The combined market value of both firms increased by roughly $315 million on Friday. Despite the significant premium that Pinnacle pays for Ameristar, shareholders of Pinnacle are applauding the deal, as a reflection of the estimated annual costs synergies of $40 million.

The deal gives the combination more power to compete with other large players in the US casino industry. Despite the deal, which doubles Pinnacle's operations, competitors like Penn National Gaming (PENN) and Las Vegas Sands (LVS) still have larger operations.

Pinnacle's equity is valued at almost $1 billion after the deal, while the company operates with a significant $4 billion net debt position, making the company very leveraged. The new firm is only valued at roughly 0.4 times annual revenues. Unfortunately the increase in leverage, and consequential higher interest payments, will largely outweigh the positive impact of synergies in the short run.

I remain on the sidelines. While I applaud the efforts to create economies of scale, the leverage ratio's increase too much as a result of the deal.

Source: Investors Applaud Pinnacle's Deal With Ameristar Casinos