PENN Entertainment: Undervalued In Relation To Its Peers (NASDAQ:PENN)

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Executive Summary

PENN Entertainment, Inc. (NASDAQ:PENN) is a casino/entertainment company which operates over 40 properties. The majority of their properties are in the eastern half of the United States. PENN also owns and operates Barstool Sportsbook, their online sportsbook app. The combination of both online and brick-and-mortar assets leaves them in a very strong position to not only maintain, but grow their market share as gambling regulations continue to be changed across the country. Per the financial summary table, PENN is one of the few profitable in the space, in addition to being near its 52-week low. For these reasons I highly recommend buying the stock.

Investment Thesis

PENN does not have the Las Vegas Strip presence of some other stocks in the sector but is well-entrenched in the eastern half of the United States. Compare the casino properties of PENN to that of MGM outside of Las Vegas:

MGM (Non-LV US locations) – Market Cap $15.27 Billion

PENN (43 locations) – Market Cap $3.80 Billion

The crux of the recommendation lies in an undervaluation of brick-and-mortar casinos in a market rife with online gaming speculation. Take DraftKings (DKNG) for example, which has not turned a profit in several years and has a very limited physical presence. Their market cap is nearly three times higher than PENN. Per the American Gaming Association (“AGA”):

In-person gaming remains the backbone of the industry with online gaming representing a growing share of the total. In 2022, brick-and-mortar casinos and retail sports betting accounted for 80.5 percent of total gaming revenue, while combined revenue from mobile sports betting and online casinos made up 19.5 percent.

Of course, some level of speculation is appropriate. The gambling industry is still very much a “wild west” scenario with states having varied and constantly changing rules & regulations. Here is what the AGA has to say in regards to comparing market share of online gaming to nations with more developed industries:

The portion of overall U.S. gaming revenue derived from online platforms remains low in comparison to other major international markets such as the U.K. (65%), France (~30%) and Germany (~28%). At the state level, however, the combined online share of online sports betting and iGaming in states that offer both land-based and online gaming options averaged 40.7 percent.

While it is fair to expect the percentage of online gaming to increase over time, brick-and-mortar will remain a reliable source of revenue going forward.

Gross gaming revenue of US casinos by state, 2021 (in millions)

The two charts above and below, from Statista, paint the picture of in-person gambling revenue. While the data is somewhat outdated, the general idea here is that Nevada, and to an extent PA and NJ, have already been maximized from a revenue standpoint. Companies like PENN and Boyd Gaming Corporation (BYD) are well-positioned to continue to grow their brick-and-mortar revenue as more states legalize gambling.

While MGM and Caesars currently do the most revenue, I believe PENN is better positioned as the distribution of revenue by state becomes more level. Sure, they dominate the strip, but PENN has demonstrated the infrastructure to expand and launch in 20 states.

Additionally, PENN was not a player in the online space until the acquisition and launch of Barstool Sportsbook in Q3 2020. Barstool Sportsbook has done a reasonably good job of acquiring market share through their unique advertising approach. As of now they are the 5th most popular digital sportsbook, and I believe they have potential to challenge the industry leaders FanDuel and DKNG.

Top Casino Companies, 2020 (in billions)

Per Alfonso Straffon via sportshandle.com, Barstool currently has 4-5% of online sports betting market share. FanDuel leads the pack at around 45-50%, DraftKings sits in a tier of their own around 30%, and MGM/CZR both sit slightly above Barstool at under 10%. Every other company combined would also be in this tier.

Currently, Barstool Sportsbook’s reputation is not great. Their odds/interface are provided by Kambi Group Plc., a B2B sportsbook provider. Yet despite being late to market with an arguably inferior product, they managed to gain 5% market share while European giants such as bet365 struggle to make any impact, even after an Aaron Paul commercial. This is the genius of the Barstool acquisition.

While other companies pay exorbitant endorsement deals to sports media members (Pat McAfee and Dan Le Batard come to mind), what the Barstool acquisition did is provide PENN with an in-house marketing department that does indirect advertising. Rather than paying media members to vouch for their product, they have integrated vertically in a very unique fashion which advertises their sportsbook app by virtue of their media personalities. The Barstool demographic of 21-44 year-old men is perfectly aligned with the sports gambling demographic. The difference between Barstool Sportsbook and its competitors is Barstool’s rabid fanbase. To use an analogy, Fox News has a more dedicated fanbase than, say, MSNBC. Barstool, and PENN by extension, is the only company in this industry that has true brand loyalty. FanDuel may have the best product today, and DraftKings may offer the most generous bonuses, but Barstool has a loyalty and fanbase that cannot be bought through endorsement deals or celebrity advertisements.

On the topic of acquisitions, PENN acquired theScore, a digital sports betting/media company in 2021. This was another excellent decision in terms of vertical integration. theScore has an amazing product in their app for following sports. It is a direct rival of the ESPN app. Also, their betting interface is a key asset in their in-house migration of their betting product. The plan as of now is to finish digital integration by Q3 2023 for the start of football season, with brick-and-mortar casino integration to follow in early 2024. It is likely that this new product will be a significant improvement over the Kambi product and will help grow market share with Barstool fans who preferred the interface of other sportsbook apps.

Risks

The upside of the Barstool partnership is very strong, but there are also some risks as it is a very controversial media company. In a highly regulated market, you can never be too careful as losing licenses would be devastating to their business model. We saw this with the recent firing of blogger/media personality Ben Mintz, who was let go for accidentally saying a slur on a live broadcast. This was a very polarizing decision. Also, founder of Barstool, Dave Portnoy, is a highly controversial figure. This can serve as a double-edged sword, as he is a big part of the reason Barstool is what it is. In the sense that all press is good press, he is great for business. At the same time, he might be dangerous depending on what comments he makes and if gaming industry regulators take issue with it.

Most of PENN’s brick-and-mortar locations are owned by Gaming and Leisure Properties, or GLPI. GLPI is a real estate trust that was spun off from PENN in 2013 and still has a strong partnership with its parent company. The idea of leasing the property has allowed PENN to be flexible with their cash flow, but certainly is something to be aware of.

Additionally, the buy recommendation here is largely in comparison to other gambling stocks. If the industry as a whole underperforms, it is hard to say with confidence that PENN would buck that trend. However, if the industry continues to grow, and more states legalize gambling, they are extremely well positioned to not only maintain, but grow their market share both in-person and digitally.

Financial Analysis

As of Friday, May 12, at day’s end:

(Data courtesy of Yahoo Finance)

From the table above, one can see that PENN has one of the lower-end market caps compared to its peers, despite its hold in both online and offline gaming markets. Additionally, its strategic acquisitions have left it plenty of room to scale in both areas. The company is currently profitable, which is more than many in the space can say. It is also at the low-end of its 52-week range, while its competitors trade near their respective peaks. For these reasons I would strongly recommend buying PENN at $24.64. I see no reason that it could not rival CZR and MGM in terms of having a dominant presence in the digital sportsbook world in addition to the brick-and-mortar space.

If PENN has about 2/3 of the casino revenue compared to that of CZR/MGM, along with around 2/3 of their digital market share, then a reasonable assumption for market cap would see at least $7-8 billion, in line with Needham’s $44 price target. Additionally, PENN’s profitability metrics rival any company in the space. They are much healthier than DKNG, who continually operate at a net-loss in spite of their strong market share.

Then, factoring PENN’s ability for growth both in person and regionally, they can match CZR/MGM. Meeting in the middle, the market cap would be around $12 billion. That would triple the stock price to $75/share. I believe this is a possible price point for late 2024 after theScore integration takes place and boosts Barstool Sportsbook’s market share for the upcoming football season.

In terms of debt, PENN has nothing maturing prior to 2026, with the majority of it due in 2027 and beyond. Additionally, of their $1 billion Amended Revolving Credit Facility, $977.5 million was available as of December 31, 2022. PENN’s outstanding debt is $2.8 billion per their 2022 Annual Report, while Yahoo lists their debt at $11.66 billion. This discrepancy is likely due to the implementation of ASC 842, a new accounting policy that requires long-term leases to be listed under a company’s assets & liabilities. PENN’s capital structure does not contain a large amount of a risk pertaining to near-term debt refinancing, and their available liquidity remains high.

Conclusion

We have seen from the first few years of legal sports gambling in America that name recognition only takes you so far. In the UK, bet365 holds 28% of market share yet has hardly made a dent in the United States. I see no reason why the rabid fanbase of Barstool, combined with the improved product from theScore integration won’t see Barstool jump above MGM and Caesars in terms of mobile gaming market share.

Additionally, while MGM, Wynn and Caesars dominate the Las Vegas Strip, it is PENN who is better equipped to expand as other states begin to legalize in-person gambling, whether that be sports betting or general casino games like slots and table games. PENN is here to stay. Their balance sheet is strong, and their upside is enormous.