Penn National Gaming: 100%+ Upside Over 3-5 Years Driven By Barstool Sports Acquisition

Summary

• Enterprise Value to EBITDA projections point to significant upside potential.
• Barstool Sports acquisition marries extensive retail casino footprint with large digital audience.
• Customer acquisition costs will likely be the lowest in the industry.
• We include our valuation analysis which points to 500% to 600% returns over next 3 to 5 years.

We believe Penn National Gaming (NASDAQ:PENN), at $31, is dramatically undervalued relative to the upside potential from legalized sports gambling in the United States. Thanks to its recent acquisition of Barstool Sports, we believe PENN will be a dominant player in the online sports gambling and iCasino market. We are holders of the stock since $13 and have recently added to our position around $30. Over the course of the next 3 to 5 years, we believe PENN will generate significant positive EBITDA and the market will re-rate its stock dramatically higher.

Largest Land Based Casino Operator in the USA

Penn National Gaming is an omni-channel casino that owns, manages, and has ownership interests in 41 properties in 19 states in the USA. It owns the largest number of gambling licenses in the United States. Prior to COVID-19, the company was also developing two Category 4 satellite gaming casinos in Pennsylvania: Hollywood Casino York and Hollywood Casino Morgantown. Plans for development of those casinos have been put on hold for the time being.

Barstool Sports Acquisition

In February 2020, PENN closed its investment in Barstool Sports, a leading digital sports, entertainment and media platform, an agreement in which they purchased approximately 36% of the common stock of Barstool Sports for approximately $163 million. Additionally, 3 years after the closing of the transaction, PENN will increase its ownership in Barstool Sports to approximately 50% with an incremental investment of approximately $62 million. Lastly, PENN has rights to acquire the remainder of Barstool Sports shares three years after closing its deal at a capped value of roughly $650M for the entire company (i.e., roughly $325M for the remaining 50%).

The beauty of this deal is PENN became Barstool Sports' exclusive gaming partner for up to 40 years and has the sole right to utilize the Barstool Sports brand for all of its online and retail sports betting and iCasino products. In August 2020, they expect to launch their online sports gaming app, which will rightly be called Barstool Sports. This launch could result in a multi billion dollar annual revenue opportunity for the company (see below). In our estimates below, we show that the company acquired Barstool Sports at a significant discount to fair market value and that the acquisition will be transformative for PENN.

Expansion of Legalized Sports Gambling

In May 2018, the U.S. Supreme Court struck down the Professional and Amateur Sports Protection Act of 1992 ("PASPA") as unconstitutional. Prior to the Court's ruling, PASPA banned sports betting in most states. As a result of this ruling, the floodgates have opened for legalized sports gambling. Below is a current (as of May 2020) list of where each state stands in regards to legalization.

[Source]

Most of these states have gone live within the past 12 months and are still ramping up operations. Here is a good recap of the progress state by state.

At maturity, analysts estimate that the market for Sports and Interactive Gaming will be roughly $20 Billion.

How Much of a Catalyst is Barstool Sports?

Barstool Sports is a digital media powerhouse. With roughly 66 million monthly unique visitors, it dominates the landscape for digital media and sports. It has 14.7 Million monthly unique visitors to its website as well as roughly 73 million followers on Instagram, Twitter, SnapChat, TikTok, and Facebook combined. It also has its own radio channel on SiriusXM (SIRI). Here is a good snapshot of their digital presence per the company's recent investor presentation.

PENN disclosed in May that Barstool generated roughly $100 Million in total revenues in 2019, which were up 65% year on year, and that it was profitable. The bulk of the revenues came from audio content, e-commerce, and digital advertising.

Below is a list of some companies in the online advertising space that we compiled to help give you a sense of the potential valuation of Barstool Sports. We then applied those valuations to Barstool's current revenues to arrive at an estimated valuation. The average price to sales multiple for this group is 11 and the average revenue growth is 24.05%. SNAP is the outlier with 44% revenue growth and a 16.64 P/S. Using these as guideposts, we get a valuation range of $1.1 Billion to $1.66 Billion.

Taken just on the surface, this would equate to roughly 40% of the current market cap of PENN. However, we believe the long-term potential of converting visitors of Barstool into users of the upcoming Barstool app is much larger, and as such, we believe the acquisition may go down as one of the best digital acquisitions in the past decade, resulting in an omnichannel casino powerhouse.

Sizing The Sports Betting and iCasino Opportunity

Recurring Revenues from FanDuel and DraftKings

As the owner of the largest number of gambling licenses in the USA, PENN also owns the most gambling skins in the USA ("skins" is a term used to refer to unique brands allowed under each individual online gambling license). Other players in the online gambling space need these skins in order to operate in each state (states require all owners of gambling apps or websites that wish to operate in its state to either own its own skins or license a gambling skin from an owner of a gambling license).

Below is a list of PENN's regional footprint and the skins they have sold to competing digital platforms. Note that in the chart below TSG is a part of Flutter Entertainment (OTCPK:PDYPY) which owns FanDuel, while DK is DraftKings (DKNG).

How much revenue comes from skins?

A typical deal between a partner brand and a master gambling license holder likely involves an annual revenue share payment of between 3% and 10%. The revenue sharing percentage depends on the strength of the brand attached to the skin, the marketing budget for the skin operator, and the supply and demand dynamics in a given market, among other factors.

In Indiana, Ohio, and Texas, a combined population of roughly 46 million, PENN will be able to generate revenue from its upcoming Barstool Sports app and will also be getting license revenues from FanDuel and DraftKings of between 3% and 10%, depending on the license agreement. That is, in roughly 14-15% of the USA population, PENN will be generating revenues from what will likely amount to 75%+ of the entire market.

Penn recently put together this slide in its investor presentation which shows how it stacks up against its competition and you can see at the bottom that it anticipates "meaningful recurring revenue from skin partnerships".

The Sports Betting / iCasino Opportunity

PENN also put out this slide in its May 14 presentation that shows the potential revenue and EBITDA windfall from its upcoming Barstool Sports app launch in August. Per the company:

"If we convert 5% of both the 66 million Barstool audience and the 5 million active members in mychoice to sports betting and iCasino customers, we could achieve 13% market share by revenue at maturity"

At a 13% market share, they anticipate that at maturity this could result in $2.6 Billion revenues and $800 Million EBITDA for PENN. If they convert 7%, then it could result in $3.6 Billion revenues and $1.1 Billion EBITDA.

How big is 5% conversion?

Assuming a 5% conversion, this would result in roughly 3.55 million users for the Barstool Sports App. By comparison, DKNG disclosed in its recent IPO filing that it has 4.3 million unique paid users and 684,103 average monthly unique payers. A 5% conversion rate would put Barstool Sports app at roughly the same number of monthly users as DKNG. DKNG currently has a market cap of over $14 Billion.

(Source: DKNG IPO papers)

Valuation Estimate

In 2019, PENN generated $5.3 Billion revenues and $1.04 Billion EBITDA. Combining 2019 results with the above estimates for sports betting and iCasino, PENN could potentially generate $8 Billion to $9 Billion in revenues and $1.8 Billion to $2.1 Billion EBITDA within 3-5 years, at which point it would own 100% of Barstool Sports. Using a current enterprise value of $15 Billion and the above EBITDA estimates, PENN is trading at roughly 7.1X to 8.3X EV/EBITDA.

As a comp, we look to the combined entity formed by the merger between Flutter Entertainment, owners of FanDuel, and The Stars Group (TSG). The combined entity will result in an enterprise value of $33 Billion, $5.2 Billion in revenues, and $1.3 Billion EBITDA. The EV/EBITDA of the combined entity is 25.5. The Flutter Group is mostly online, so it would likely warrant a higher multiple than PENN.

If we use the same EV/EBITDA multiple for Flutter and assign a 25% valuation discount, we arrive at a projected share price of $187 to $233 for PENN by 2023 to 2025.

Conclusion

Even with the recent rise in the stock, we don't think the market is close to accurately pricing in the long-term potential of the upcoming Barstool Sports app, the value of PENN's licenses in 19 states in the USA, and its potential revenues from skin licenses.

When comparing PENN with EV/EBITDA multiples for Flutter and using our estimates of over $2 Billion in EBITDA by 2023 to 2025, we believe the company's stock price could rise 6 to 7-fold over the next 3 to 5 years from $31 per share. We believe it is realistic that the company can convert 5% of Barstool's 66 million monthly unique visitors into users of the Barstool Sports gambling app, which would result in a user base on par with DKNG, which is currently valued at $14 Billion.

While there are certainly near-term headwinds surrounding COVID-19 and its impact on retail casino operations, we take the long-term view that post-COVID-19, the company will be generating significant EBITDA and revenue growth and the market will dramatically re-price the stock.

Analyst’s Disclosure: I am/we are long PENN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.