Penn National Gaming's (NASDAQ: PENN) $2.8 billion acquisition of Pinnacle Entertainment (NASDAQ: PNK) would further cement the casino operator as the largest regional gaming player. By giving it a total of 41 casinos in 20 locations after four Pinnacle properties are sold to Boyd Gaming (NYSE: BYD) to fend off expected antitrust concerns, Penn National will have around $5 billion in annual revenues.
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To put that in perspective, of all the domestic casino operators that derive most of their money from the U.S. only MGM Resorts and Caesars Entertainment will be larger (Las Vegas Sands and Wynn Resorts derive most of their revenues from Macau).
Of course, Penn and Pinnacle have been closely aligned for years, as Gaming & Leisure Properties (NASDAQ: GLPI), the real estate investment trust Penn formed to house the properties it operates, also houses Pinnacle's properties. Officially combining them brings together what has been slowly playing out.
A heavy hidden risk
The broad geographic diversity of the merger makes the deal look smart and gives Penn the ability to increase cross-selling opportunities to its customers. Yet there lurks some significant risk too.
Although both Penn National Gaming and Pinnacle Entertainment have offloaded almost all of their properties to Gaming & Leisure Properties, they're still on the hook for all the payments associated with them. The REIT is a triple-net REIT, and was the first one focused solely on the gaming industry. Under such an arrangement, properties are sold to the REIT, but it is the tenants -- the casino operators in this case -- that are responsible for paying all real estate taxes, building insurance, and maintenance on the properties.
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Under Penn National's agreement with the REIT, it has over $10.4 billion in future minimum lease payments to Gaming & Leisure. The lion's share is due in 2022, and later in 2018 and 2019 it has more than $700 million due, with total debt payments amounting to $1.55 billion also due.
Similarly, Pinnacle's master lease agreement with the triple-net REIT has over $11.4 billion in financing obligations, with more than $9 billion due beginning in five years and $680 million due within three years beginning next year. It also has almost $870 million in total debt payments coming due now.
How to pay down the burden
By combining these companies, the merged casino operator will add some $4.4 billion in Pinnacle's long-term debt to Penn's existing $4.8 billion. Then the master lease obligations are placed on top and there is a significant pile of debt for gaming operations that aren't about to see a big growth spurt.
The rationale behind the merger, and other similar industry mergers that have occurred in recent years, is that revenues are not going to decline, and the success of the deal will come down to wringing efficiencies out of the new properties. Though the deal gives Penn National enhanced scale and the potential for a more efficiently run integrated gaming company, it will be one that's significantly indebted.
While casinos are built every day on the backs of debt, it's also the bane of their existence. Time and again gaming operators have imploded due to too much debt, including President Donald Trump-owned properties, the Revel in Atlantic City, New Jersey, and the convoluted case of Caesars Entertainment.
There's certainly a lot to like about this deal and Penn National Gaming has proven to be a shrewd and effective regional gaming leader. But investors expecting this merger to be easy money should remember that the economy heading into a period many economists believe is ripe for a recession. That could be poor timing as Penn has billions of dollars in debt obligations coming due -- with tens of billions more to follow -- which may make this a riskier investment than many people believe.
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