Above: Penn/Barstool’s 50m plus stoolie nation has helped keep customer acquisition costs lower than peers and will continue to do so.
“The buyer is entitled to a bargain. The seller is entitled to a profit. So there is a fine margin in between where the price is right. I have found this to be true to this day whether dealing in paper hats, winter underwear or hotels.”
– Conrad Hilton
We are about a month away from Penn National Gaming’s (NASDAQ:PENN) 4Q21 and full year earnings release. I think the timing is right to review its performance and make our best educated guess on where and how many Penn chips Mr. Market could be motivated to send into the center of the table. In our last study of the company and its stock about a month ago, we concluded that at $50 a share it was a buy. Since then it has ticked down a bit to a price at writing of $47.90. It’s a solid entry point.
Overall, its general trading range has been beaten up by a 3Q21 earnings report of $0.52, a tough miss of 41.60% y/y. The stock took a hit regardless of the fact that Mother Nature in the form of Hurricane Ida and new spikes in Covid variants – not any management failures anybody could point at – were the primary culprits of the miss. In fact, overall, y/y, Penn’s brick and mortar core business recovery was ongoing with a revenue rise and its sports betting Barstool unit likewise showing gains.
There are many appropriate metaphors to characterize the nature of stock markets these days that are rooted deeply into its long history. Permit me to add one:
The stock market today is a spoiled brat.
There is much in common between the children we all love to hate and the market’s behavior since even before the pandemic. Both exhibit low to zero attention spans. Both are prone to mindless acts of mischief – note the Robinhood GameStop insanity that continues to bubble. Both get bored easily, both demand instant gratification and often refuse to take their medicine. Most are impatient with the judgments of elders.
And of course, many feel entitled to make money simply because of who they are. What many do not realize is just how much dumb money in the hands of the spoiled brat contingents in the market can be culled by little more than clickbait headlines. For that reason, smart money can zero in on Penn National right now because the price is very attractive to those who really understand this stock.
Penn has been both the beneficiary as well as the victim of a spoiled brat market. And the shame is that its wild ride up to $130 last spring totally buried the powerful brick and mortar gaming and live sports book business engine it had carefully built over the last five years. Right now, post shake-out of the sector, when cooler heads are beginning to prevail, we find the stock has fallen into the screaming bargain territory.
Above: Mr. Market is asleep on the stock’s rebound potential. Source: Dogs of the Dow
What’s changed is that the adults are in the room now and they realize that the 3Q21 earnings miss is no reason to sell.
Accordingly, after our most recent deep dive, we are upping our PT for the stock by 2Q22 from $88-$90 to $112. Current analyst consensus PT: $83. Bear in mind our revised PT is still well below some of the palpably cheerleading PTs of certain analysts that last year had guided the stock roaring to above $200 a share, and one mad call, to $252.
Our rationale springs from our inside the industry assessment of where the US gaming market lies on the recovery arc ahead.
Penn will be a real beneficiary of a sector headed for a strong rebound. A caveat of course: Moving from the sometimes befuddled, other times clear mumblings of the good Dr. Fauci, down to our survey of local infection disease physicians we have talked with since the pandemic broke, it suggests that we will arrive at an omicron endgame by spring. Conflicting takes on omicron’s duration might produce multiple pictures painted by various medical prognosticators. But the one thing on which there appears to be a consensus is this: the pandemic will become endemic.
Covid, we are told, will evolve into one of dozens of more common flu variants that have broken out every winter for hundreds of years. And getting our annual flu shots pre-pandemic will be a fact of life. Infection levels and mortality rates will settle into a pattern similar to regular flu. That said, we own up to the fact that neither we nor anyone else, including the experts, can be 100% confident that the game is over and the fat lady is belting out her song. Our call then must assume that no horrible surprise variant lies on the other side of the slowly fading omicron we now confront.
Above: Until the baseline 2019 year Penn outperformed the sector. Source: Google Stats.
As is our regular practice, we employ our inside the industry friends, consulting clients, former employees, mentees who have risen to senior management ranks to share with us their overviews of a gaming company. To this we add our own archived data accumulated over a long gaming career. It tracks gaming win by market, trends by game, demos, average bets by player budgets. I also have demographic studies of player composition by region covering the period in which I ran gaming operations in c-suite positions. For Penn I assembled a few industry folks from each region in which the company has brick and mortar properties and we compared notes.
I then added a hard look at the stock metrics, particularly its earnings, sales growth and trading history over the past three years. I like what I see more than ever.
Basic footprint: Penn has 44 properties in 20 states.
It is an active sports betting platform in 10. That will increase in 2022 as 6 more states legalize. What follows is a regional look at where Penn has properties, the revenue achieved as of 3Q21 and the number of states in that region where sports betting is legal and operative.
Penn Revenue 3Q21 – Region – Number of states legal
$672m – Northeast – 9
318m – South – 6
145m – West – 6
285m – Midwest – 4
Penn/Barstool Sports betting revenue to 3Q21: $282m from 10 states. States expected to join the 30 now legal in 2022: Arkansas. Kentucky, Massachusetts, Missouri, and North Carolina. Penn has brick and mortar properties and operative sports betting skins ready to go inside all the new states, or in easy cross border proximity.
Our estimate of 4Q21 for Penn will bring its annual sports betting revenues to near $400m based on NFL early to mid-season action, playoff betting, Super Bowl and new states.
The national total sports betting revenue since the Supreme Court decision has reached $6.5b over the years between 2018 (partial) to the end of 2021. Of this, approximately $3.2b was won in 2021 alone. I am estimating Penn’s share of market at the end of the 2021 year at ~10%. We must add the Penn revenue stream to benefit from the October 2021 $2b acquisition of Canada’s Score Media. It would include the lucrative NHL Hockey playoffs beginning on May 2nd and running through early July.
Above: The key to Penn’s sports betting unit is not a revenue chase but a steady growth against a significantly lower cost of marketing vs. peers. Source: VIXIO
The key here: A broad consensus of our associates estimated that on average Penn is spending around half or less on customer acquisition media and promotion than its major competitors. That leads to our conclusion on the sub-sector.
Because of its Barstool data base of some 50m stoolies, merged and de-duped to the 24m Penn casino patron database produces a per new customer acquisition cost considerably lower than competitors. Sector leaders like DraftKings (NASDAQ:DKNG) and FanDuel (OTCPK:PDYPY) have been harvesting crossover customers from their DFS business for years now. That cornucopia may be starting to thin out, which may in part account for their continuing massive marketing spends.
We believe Penn/Barstool will be among the first platforms to turn a profit meaningful enough to contribute to total 2Q22 Penn EBITDA. Our calculations estimate that Penn sports betting could go into profit by 2023/4-nearer profitability to most or all peers assuming their marketing expense levels do not take a major haircut in the near term.
Penn Brick and Mortar business on the recovery cycle
We have done a match between present and projected contagion levels of the omicron variant, state government mandates and eyeball estimates of daily footfall on Penn properties by our industry friends in those markets.
Stipulation: These are not scientific numbers or click counts by employee counters at entrances. They are bodies eyeballed by professionals walking casino floors at varying times, weekdays and weekends. These people are pros who can read casino floor action in minutes and be pretty accurate. It is gut feel, instinct, experienced eyes, but not science.
So in that context our educated guesses: Midweeks are still on the light side but getting stronger in the last month. Weekends are pretty much full. Game spreads on blackjack appear to be strong. Comments: Several of our associates confirmed that there is discernible flow of younger players from sports books weekend College and NFL games to the blackjack tables. This is confirmed by Penn’s own reports that its database membership composition age wise is getting younger. It says in particular, its 21-31 age database alone was up 57% by the end of 3Q.
The company is currently testing cashless and touchless transactions throughout the entire property experience and thus far, early indications are that customers either like it or embrace it as a contribution to the seamless experiences they have come to demand in the entire spectrum of retail.
Slot activity has been very strong propelled by higher responses to promotional offers sent out to the 24m Penn customer database, though slot action by the usually strong older demo folks is decidedly off due to pandemic fears among the elderly.
Overall our summarized forecast is that Penn brick and mortar business will probably be high-single digits or more in sales growth against 2021 comps – still pandemic impacted to a degree. As omicron fades by spring we see Q3 and Q4 sales growth moving into low double digits.
Market cap at writing: $8.12b
Revenue (ttm): $5.3b
2021 YTD revenue growth: 33.80%. Realistically 2020 comps clearly were a disaster sector wide so the comparison is distorted. However, the underlying propulsion of Penn’s business region by region does support a range of 11% to 16% in our current thinking.
EBITDA (ttm): $1.36b.
Balance sheet highlights
Cash on hand (mrq): $2.73b.
Cash per share: $16.15. Nearly 30% of current valuation is cash.
Total debt (mrq): $11.68b.
Current ratio (mrq): 2.82. A bit on the high side, but still comfortably within parameters that suggest no problem meeting all known debt obligations.
Levered cash flow (ttm): $627m.
The adults are staying in the room
During the first run up of Penn shares to nose-bleed heights, there was considerable spoiled brat money chasing ever higher prices convinced the sports betting piñata could be banged at indefinitely and pour out endless goodies of cash. Many managed to get out in time – good for them. Others got stuck in the dive after the apogee. What became clear was that the frenzy had disguised so much of the real story of this stock that in and outers simply did not understand.
Major institutions by and large have stuck around. Right now over 80% of Penn shares are held by institutions, the top five of which represent the who’s who of hedge funds, banks and private equity people. Most recently 473 positions were either opened or held, vs. 249 reduced. The holder move we like best, the one we believe that buttresses our case that Penn remains a great buy at its price here, is BlackRock.
They were sitting on 14.1m shares of Penn and in September added another 1.1m when the stock was trading in the $70s. Of course we a) don’t know what they paid and 2) whether they were price averaging the portfolio. Their total holding now is 14.2% of the stock and we don’t know if that position is still way above water, even, or below waiting for the next change in sentiment we see.
But the key is that taking into account all the headwinds that may lie ahead regarding pandemic duration, Fed action on rates and the quirks of Mr. Market’s spoiled brats, they are sticking.
It’s great company for investors at $47 a share.
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