"Value investing is at its core the marriage of a contrarian streak and a calculator."~ Seth Klarman (Trades, Portfolio)
Atlantic City is set to close another three casinos in a matter of days and the gaming business in the city is steadily dwindling. Raise your hand if you want to purchase a company whose largest property resides along “The Boardwalk.” My hand is not only up, it is vigorously waving because Tropicana Entertainment (TPCA, Financial) is currently selling at a large discount to its intrinsic value. Furthermore, its published book value is dramatically understanded--more on that later.
The upcoming closure of the Atlantic city casinos is likely to increase the revenues of the remaining casinos; although it should be noted that dramatic increases in the number of regional casinos has steadily eroded the gaming revenues for Atlantic City. Moreover, the erosion of gaming revenues in Atlantic City is likely to continue. That said ,the closure of the local casinos is likely to provide a catalyst for TPCA in the form of increased profits which could propel the company to a price more commensurate to the underlying value of its net assets.
Tropicana Entertainment is a collection of of seven hotel/casinos, restaurants, and retail spaces which hold a modest market capitalization of approximately 453 million and an enterprise value of around $592 million. The properties are scattered throughout the country representing a diverse geographical base. The most interesting properties include a casino in Evansville which benefits from a decided lack of competition, the beautiful Lumiere property in downtown St. Louis and the Tropicana Atlantic City.
The company has generated positive free cash flow the past three and half years. Its current published book value is about $24.5 a share and its published tangible book value is approximately 21 dollars a share. However, those numbers do not represent the large discount to its book value that the assets of “the Trop” represent. Allow me to elaborate: the assets of the collective properties trade at a tiny percentage of their replacement but more importantly, they still trade at a huge discount to their intrinsic net asset value when depreciation expense is taken into account.
True book value of TPCA
In analyzing the intrinsic value of the assets of the properties, one needs to investigate the filings of the business since it emerged from bankruptcy a few years ago. According to the filings, the Tropicana AC was purchased for 200 million dollars in 2010 (refer to the 2010 annual report to verify the following discussion).
It should be noted that the assets of the Tropicana AC were recorded on the books reflecting a negative goodwill figure of approximately 80 million. For those of you who are accounting-challenged, negative goodwill reflects the payment of a purchase below the value of its tangible assets. It is a condition which rarely presents itself in security analysis. Hold on it gets much better.
Further analysis uncovers that the 280 million in tangible equity was already written down profusely. Tangible assets, mainly in the form of plant and equipment, were written down an additional 506 million in regard to the Tropicana AC in the company's initial 10K filing. That amount included an increase in land value of slightly more than 20 million. Hold on I am just getting started, the other properties were “marked down” an additional 208 million, again mainly in the form of plant and equipment fair value adjustments. So far that is a tangible equity adjustment approximately 794 million (~80M in negative goodwill and ~714M in P&E adjustments). And you probably thought reading security filings was boring. Keep on reading because I have more good news to announce
Recently, the company had the good fortune of being able to purchase another property at a large discount to its tangible assets. The property is the luxurious Lumiere in downtown St. Louis. The assets were the result of a forced sale by Pinnacle as a result of their recent purchase of Ameristar. Following the merger, the company had three casinos in the area which would have resulted in a greater than 50% share of the market, thus government regulation required that they sell one of their properties.
The Lumiere was purchased by TPCA for about 260 million earlier in the year. According to an 8K filing, Pinnacle marked down the plant and equipment of the facility approximately 130 million prior to the sale. Therefore, the purchase reflects a price of slightly over tangible book value on the books of TPCA;while in reality, the purchase of the property should have included an additional 130 million in tangible assets.
So let's take our calculator as Seth Klarman (Trades, Portfolio) recommends and tally up the underlying tangible book value of the Tropicana’s holdings:
- Stated tangible book value of about 21 dollars a share
- Unrecognized book value of about 35 dollars a share (925M/26.3M shares)
- Less unrecognized depreciation expense of approximately 7.6 dollars a share (200M/26.3M shares)
The unrecognized depreciation expense was based on an average estimation of 25 years of usable life for the property and equipment for the assets purchased in bankruptcy. The average life of P&E is estimated from 10-40 years in the latest 10K filing.
The estimation of the intrinsic tangible book value of the company come out to around 48 to 49 dollars a share. The current share price is slightly over 17 dollars resulting in an estimated intrinsic book valuation of about .35.
It should also be noted that the company holds some legitimate economic goodwill which is not included in the aforementioned estimation of book value. The Evansville property has average operating margin in the 22-23 percent resulting from a near-monopoly situation in regard to gaming competition. The only other gambling venue in the area is Ellis Race Course which recently instituted instant racing machines; a mechanism similar to a slot machine. Since the institution of the machines the average slot revenues of the Evansville casino have dropped approximately 2 percent.
Ownership and float of TPCA
Carl Icahn (Trades, Portfolio) controls nearly 68% of the stock and Ares Management holds about 6 % the outstanding shares. The extremely limited float and the fact that the company trades on the OTCBB results in a condition of limited liquidity for potential buyers or sellers of the equity. That said, the illiquid nature of the equity should not dissuade long term investors from purchasing shares with one caveat: Investors should never use market orders or place stop loss orders when investing in TPCA or any other small or illiquid company for that matter.
Summary
-Tropicana Entertainment trades at a large discount to the intrinsic net asset value of its property holdings and is generating significant cash flow from operations.
- An examination of its filings reveals that the company purchased assets out bankruptcy at very favorable prices in 2009.
-The recent purchase of the Lumiere property in downtown St. Louis was consummated at a sizable discount to its intrinsic value which was the result of a forced sale by Pinnacle.
-The upcoming closure of three large Atlantic City casinos is likely to provide an earnings catalyst resulting in an appreciation in the price of TCPA stock.
- A sum-of-the parts intrinsic book value estimation suggests that TPCA trades at around .35 of its underlying book value
-The large discount exists due to excessive P&E write downs which are revealed in the SEC filings of the company.
Disclosure: long TCPA
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