Tropicana Entertainment

Tropicana Entertainment owns and operates seven regional casinos in the United States and one temporary casino located in Aruba (Tropicana Las Vegas is owned by a separate entity).  Tropicana's predecessors went bankrupt in 2008, and Carl Icahn bought it out of bankruptcy in 2010, he now owns 67.89% of the outstanding shares through Icahn Enterprises (IEP).  Icahn seems to be everywhere lately and by now everyone has seen his confrontation with Pershing Square's Bill Ackman (also the Chairman of HHC) on CNBC, while Icahn ended up looking a bit foolish, it's hard to argue with his track record as an investor.  He's been particularly successful in the casino business.  For example in 2007 he sold American Casino & Entertainment Properties to Whitehall (Goldman's real estate funds) for $1.3 billion (Icahn paid $300 million), perfectly timed at the top of the market, and the casino operator has run into trouble ever since due to a heavy debt load put on it by Whitehall.  Could he do something similar with Tropicana?

Times have certainly changed, the company's largest casino is the Tropicana Casino and Resort located in the troubled Atlantic City market.  Atlantic City has been in a long term decline and now faces increased competition from neighboring states who are rushing to legalize gambling in an effort to shore up their state's finances with gaming tax revenue.  In the past Atlantic City marketed itself a destination resort for the northeastern corridor, but now with casinos popping up throughout the region, it should be considered just another drive-up market.  Unfortunately, a drive-up market with 12 casinos.

Tropicana's casinos in other markets also face increased competition from the proliferation of both commercial and native american casinos across the country.  Several states, including New Jersey, are creating legislation to legalize online gambling, creating yet another source of competition for regional casinos that don't have the non-gaming draw of Las Vegas or other destination resorts.

Below is a list of Tropicana's casinos (minus the temporary one in Aruba) which are located in markets where they primarily draw their revenue from repeat type customers who are within driving distance:

• Tropicana Casino and Resort (Atlantic City, NJ)
• Casino Aztar (Evansville, IN)
• Tropicana Laughlin Hotel and Casino (Laughlin, NV)
• River Palms Hotel and Casino (Laughlin, NV)
• MontBleu Casino Resort & Spa (Lake Tahoe, NV)
• Belle of Baton Rouge (Baton Rouge, LA)
• Trop Casino Greenville (Greenville, MS)
• Tropicana Aruba Resort & Casino (Noord, Aruba)

Tropicana does not have exposure to the Macau market like a lot of its larger peers; the Macau market continues to grow and now dwarfs the revenue of Las Vegas.  On the positive side, Tropicana emphasizes slot play, versus table games at larger destination resort casinos, leading often to higher margins and more consistent revenue (less luck).

Given the industry challenges, Tropicana doesn't deserve a market premium, but how cheap is the company?

Balance Sheet and Debt Refinancing
In the first quarter of 2012, Tropicana refinanced it's original credit facility and replaced it with a $175 million term loan from UBS as well as a letter of credit facility.  The new loan terms are LIBOR based with a 7.50% floor, which is the current rate based on today's interest rate environment.  The new loan facility replaces one financed by an affiliate of Icahn with a whopping 15% rate, so starting in the second quarter of 2012 you see a dramatic improvement in the company's interest expense and thus cash flow.

Tropicana now has a strong balance sheet with $242 million in cash, only $170 million in long term debt (rare in the casino industry), and it sells for only 70% of book value.  Not that anyone is eager to build casinos in the current environment, but many of Tropicana's properties are on the books for far less than replacement value giving the book value measure some creditability.  Tropicana has some plans for the excess cash, including capital expenditures of $30-40 million to renovate existing casinos and potential construction and development costs related Tropicana's planned permanent casino in Aruba, which could be highly accretive to shareholders.

Valuation
In December 2012, Pinnacle Entertainment agreed to buy Ameristar for $869 million plus $1.9 billion in assumed debt, pegging Ameristar's enterprise value at $2.8 billion.  Both Pinnacle and Ameristar are regional casino players, so this transaction should be a perfect comparable for valuing Tropicana.  Since Tropicana has a much different capital structure than Ameristar, EV/EBITDA is probably the best multiple to use as its debt neutral, on that metric Pinnacle paid 8.37x (2.8B/334.45MM) for Ameristar.

In 2012, despite a unprofitable 4th quarter (partially seasonality, partially Sandy) Tropicana managed an EBITDA of $84 million and an enterprise value of $348 million ($421 million market cap minus $72 million of net cash), for a EV/EBITDA multiple of 4.13, or roughly half what Pinnacle paid for Ameristar.

Why is it cheap?  Well other than the already discussed over saturation of the industry, Tropicana trades over the counter and has a limited number of holders (only 41 holders of record) with a controlling shareholder.  Often after bankruptcy, the new equity ends up in the hands of the former creditors, in this case Ares through their management of a long list of CLOs.  CLOs are not a natural holder of equity securities (need cash flow), typically they get them post default and can only hold a limited portion of their portfolio in equities or must sell them following a certain timeframe (sometimes 1 year, sometimes 3).  So it will be interesting to see what Ares ends up doing with their shares, if Icahn wants to scoop up more shares in an efficient manner, its likely he'd buy them from Ares.  Given the limited liquidity, most institutions pass on Tropicana as they are unable to build a position large enough to move the needle, and other investors are precluded from investing in casino operators due to morality clauses in their investment policy statements.  I like to invest in companies like this, overlooked by most investors for reasons other than their performance and future prospects.

Catalysts
I see a few potential catalysts for Tropicana:

• Internet Gaming: NJ Governor Chris Christie seems committed to seeing that Atlantic City's turnaround succeeds, and is pushing through legislation that would allow for NJ casino operators to conduct online gambling in late 2013 or early 2014.  I've yet to see Tropicana's plans for an online gambling operation, but competitor Caesars seems out ahead of the curve (probably because they're debt load makes them desperate).
• Acquisitions/Capital Expenditures: Tropicana has plenty of cash on the balance sheet and a huge line of credit that was recently opened, presumably this was done to renovate existing casino assets to make them more competitive and strategically pick up struggling casinos on the cheap as less well capitalized competitors get washed out.  Capital expenditures could lead to greater foot traffic and revenue, but its a difficult game to play as each competitor tries to one up each other.
• Outright Sale: Carl Icahn is always looking to do a deal, and has already shown his ability to flip casino assets in the past at a good price.
• Leveraged Recapitalization:  Similar to what Carl Icahn is proposing at Dell, Tropicana could use their cash and draw on their credit facility to pay a special dividend to shareholders and leverage up the business if they don't find any profitable acquisitions or cap ex projects.
• Improved Sentiment: With sentiment so poor, especially for Atlantic City casinos, any improvement in investor sentiment could send Tropicana's shares higher.  Additionally, with the wealth effect in full swing as housing and stock prices increase, consumers may increase their discretionary and entertainment spending.

I view Tropicana in a similar way as Asta Funding (both are fairly small positions for me), previously a distressed company that has a little too much cash and operating in disliked seedy industry without a clear strategy.  But like Asta, Tropicana is very cheap and the large net cash position limits the downside.

Disclosure: I own shares of TPCA