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Summary

  • Shares of Pinnacle Entertainment Undervalued if a REIT is spun out.
  • Pressure from Orange Capital will likely lead to REIT.
  • Penn National shareholders saw gains of 56% from the REIT announcement to present time.

The old saying related to casinos is "The house always wins". For anyone who's ever gambled, those words likely run true. However, when it comes to investing in casinos, there's a new way to win along with the casinos. The ownership of casino properties is becoming increasingly valuable, as the shifting to real estate investment trusts is capitalized. With pressure from Orange Capital, Pinnacle Entertainment (NYSE:PNK) shares are likely headed for a split and shareholders should be seeing jackpot in big letters.

Orange Capital sent a letter to Pinnacle executives on April 16th. Since that time, Pinnacle has not been too vocal or bullish about a possible spinoff of the owned properties into a separate entity. Orange Capital did issue a statement on Thursday updating investors on the progress it has made. Orange Capital remains dedicated to seeing a REIT spinoff through.

Orange believes the separation of the business could increase the total share price of PNK by 60 to 90%, with a targeted share price range of $35 to $42. Orange owns 6.7% of Pinnacle shares and continues to press the company for an investigation into a possible REIT. Orange believes Pinnacle trades at an extreme discount to its competitor Penn National Gaming (NASDAQ:PENN) and its respective REIT Gaming and Leisure Properties (NASDAQ:GLPI).

Back in November of 2012, Penn National Gaming announced its intention of splitting into two separate companies, one which was a gaming operator, and the other a REIT owning 17 casino facilities. The split is complete and investors of Penn now have stakes in two companies and have been pleasantly rewarded along the way.

After announcing its plans to split, shares rose 17% in the after hours market on November 15th (2012). The following day, shares rose 38% in pre-market trading. A year later, the deal was finalized and shareholders got one share of PENN and one share of GLPI. Shareholders also got dividends from GLPI totaling $12.88 since that time. Here is a short timeline of the return on a PENN investment.

· 11/15/12 PENN share price: $37.61

· 11/16/12 PENN share price: $48.23

· Current PENN Share Price: $10.94

· Current GLPI Share Price: $34.86

· Combined Value PENN and GLPI: $45.80

· Dividends: $12.88

· Total Value 1 Share of PENN prior to split: $58.68

· Total Return: $21.07, +56%

As you can see investors in PENN were rewarded for the split of a REIT. Investors will also be rewarded going forward with GLPI shares currently yielding 6.3% and offering a nice income stream from the former PENN casino properties. Investors who hopped into PENN shares after the REIT announcement still made more than 25% in less than a year. Also consider that GLPI shares are actually down 31% in 2014, so investors who cashed out after the conversion made even more than the 56%.

A look at this timeline offers several key pieces for Pinnacle. An announcement by Pinnacle that they are exploring a REIT or have filed to create a REIT will send shares significantly higher. The dividends that will come later from the REIT will be substantial. Investors like conversions like this and shares will end up significantly higher. This is what Orange Capital means when they say shares are undervalued by 60% or more. REITs trade at higher valuations, due to their high dividend payouts.

Pinnacle Entertainment owns and operates 15 gaming properties. The casinos are located in Missouri, Louisiana, Indiana, Mississippi, Iowa, Colorado, Nevada, and Ohio. In 2013, Pinnacle acquired rival Ameristar, which brought eight casino properties into the portfolio.

The most recent second quarter saw revenue rise 108% to $555.2 million. Without the additional Ameristar properties, revenue actually declined 2.6%. The quarter was hit by heavy operating costs, including the upgrade to a company wide loyalty program called mychoice. The Midwest region, which gained the most from the Ameristar acquisition, saw revenue rise 240% to $296.4 million.

Shares of Pinnacle trade close to mid-range of their 52 week range ($19.88 to $26.77). The company sports a market capitalization of $1.3 billion. Shares are now down 13% in 2014, after finishing 2013 off strong. Over the past two years, Pinnacle shares are up 133%, with much of the gains coming from enthusiasm of the Ameristar properties.

Analysts are estimating earnings per share of $1.68 for fiscal 2014 and revenue of $2.2 billion. These are large increases from the prior year, due to the full year of realized Ameristar gains. Fiscal 2015 is a bit more telling, with earnings expected to rise to $1.92 per share. Revenue is forecasted to rise only 0.7% in fiscal 2015.

Regional casinos are a tough market to be in, with saturation throughout many regions of the country. The additional licenses coming to major markets in New York, New Jersey, and Pennsylvania will take traffic away from several neighboring areas. As Pinnacle feels the pinch on top line sales, it needs to be aggressive here to maximize shareholder returns. Pinnacle has seen what Orange Capital layed out in valuation and also watched the Penn National spinoff occur. Pinnacle executives would be wise to split the company into two and reward shareholders.

In my opinion there is a 75% chance that Pinnacle unloads its property ownership into a REIT. I recommend following this casino play for awhile on the hopes of the REIT. Without a conversion in a year, the stock could end up being a failed play.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.