Who Will Acquire Harrah's This Time?

 |  Includes: HET, PENN
by: Yaser Anwar

On October 2, 2006, Harrah's Entertainment (HET) received a proposal from Apollo and Texas Pacific Group to acquire all of HET's outstanding common stock for $81 per share in cash, which the board of directors quickly rejected and were then offered $83 per share.

Penn National Gaming (NASDAQ:PENN) is also considering a bid for HET. The details indicate that Harrah’s has been taking its time reviewing the Apollo/TPG bid in order to encourage competing bids. The report also mentions that D.E. Shaw would join PENN and Lehman Brothers (LEH) and Wachovia (NASDAQ:WB) will provide financing.

HET has been growing through acquisitions for almost six years now. From the acquisition of Showboat '98, Rio Hotel and Casino in '99, Players Int. '00, Harveys Casinos '01, Horseshoe Gaming '04 & Cesar's Entertainment in '05. Frankly, I'm a little surprised PENN is making a bid for HET, since PENN is a smaller company.

Let's analyze the important licensing troubles that need to be paid attention:

Transaction & Interest Structure: The way D.E. Shaw’s equity interest is structured for the transaction could affect licensing issues, similar to those faced by Apollo/TPG.

b) The License Overlaps: There are two license ownership restrictions in Indiana, which would mean that the combined entity would need to sell one of its three licenses. PENN and HET will own five of the nine licenses in Illinois, with three in the Chicago market and four of the seven if including the Northwest Indiana riverboats.

** Investors need to remember that Illinois does not have economic concentration statutes.

In Pennsylvania, a company is limited to only one license, which means that one property would be sold. Lastly, PENN and HET, if merged, would own four of the ten casinos in the Tunica/Lula market in Mississippi.

Even though HET was up today, HET is trading 5 points below the $83 per share acquisition price proposed by the aforementioned companies.

The other reasons for this discrepancy:

1) Whether HET directors will favor the proposed transaction

2) The prospect of a lengthy regulatory review process and also

3) HET's board of directors looking for a higher bid.

If either of the deals go through, expect it to close at around 3Q07.

How can you make money? Similar to what I recommended for Freeport-McMoRan (NYSE:FCX) and Phelps-Dodge (PD), there are three ways to play this:

1) Buy call options in HET and PENN [call in PENN if you believe it won't go through, as this acquisition will be accretive to its earnings]. I won't be surprised if they are trading at a premium, or derivatives if you're an institutional trader, such as CDS for PENN's senior subordinated notes [which according to word on the street will be kept outstanding].

2) Short PENN and long HET's stock as a paired hedge trade, if you believe PENN will be successful.

3) Just buy HET's stock because they will be trading high, closer to acquisition price if merger goes through.

Remember there is quite a significant risk, hence the arbitrage opportunity.

PENN-HET 1-yr comparison chart

PENN HET 1-yr comparison chart