Updated from 1:13 p.m. EST

Shares of Penn National Gaming ( PENN) and Argosy Gaming ( AGY) soared Thursday as investors bet on a big payoff from their merger.

Late Wednesday, the companies said Penn National plans to pay $47 a share in cash for Argosy, a 15% premium to Argosy's Wednesday closing price of $40.75. The transaction, valued at about $2.2 billion and expected to close in the second half of next year, includes roughly $805 million of Argosy's long-term debt, but the companies said it would be "immediately" accretive to Penn National's earnings a share.

The resulting company will be the third-largest casino operator in the U.S.

In reaction, Argosy shares jumped $4.59, or 11.3%, to $45.34. Penn National shares gained even more, however, and were up $10.06, or 24.3%, at $51.50, as investors bet on a big boost to the company's EPS.

The announcement appeared to prompt speculation about which other smaller-capitalization gaming companies might make attractive acquisition targets, boosting shares of Isle of Capri Casinos ( ISLE) $4.92, or 24.0%, to $25.44.

Merrill Lynch analyst David Anders estimated that if the combined company can generate $25 million in cost savings, the purchase will add about 91 cents to Penn National's annual EPS. Before the announcement, Wall Street analysts' average EPS estimates were $2.38 in 2005, and $2.93 in 2006, according to Thomson First Call.

"We are maintaining our price target of $47 on Penn, however, in light of yesterday's announcement we believe this target may be conservative," Anders wrote in a research note. He added the shares could be worth between $50 and $53, assuming cost savings, a combined adjusted EPS of $3.31 and a price-to-earnings multiple of 15 to 16. (Merrill Lynch does and seeks to do business with companies covered in its research reports.)

Penn National's purchase of Argosy would create a gaming powerhouse with annual revenue of more than $2 billion, more than 20,000 slot machines and about 700,000 square feet of casino space. The deal would "essentially" double Penn National's revenue and EBITDA (earnings before interest, taxes, depreciation and amortization), said Peter Carlino, Penn National's chief executive.

The merger adds to the consolidation sweeping the gaming industry. MGM Mirage ( MGM) said in June that it would acquire Mandalay Resort Group ( MGG). The next month, Harrah's Entertainment ( HET) inked a deal to acquire Caesars Entertainment ( CZR). Both mergers are still pending.

Consummation of the Penn National deal depends on approval from Argosy stockholders and regulators in the states where the companies operate.

"In Baton Rouge, La., the company would own both riverboat casinos in the areas, which could prove to be a problem with regulators," wrote Smedes Rose, a J.P. Morgan analyst, in a research note. "However, we are assuming the sale of one of these properties does not significantly alter the acquisition multiple or pro-forma capitalization given recent transaction multiples." (J.P. Morgan does and seeks to do business with companies covered in its research reports.)

In order to finance the deal, Penn National has received a $2.9 billion commitment from Deutsche Bank ( DB), Lehman Brothers ( LEH) and an affiliate of Goldman, Sachs ( GS).

J.P. Morgan's Rose expects Penn National's pro-forma debt will increase to $3.23 billion from its $910 million level at the end of the third quarter, including $2.2 billion to acquire Argosy, along with $212 million in expenses and fees. Such leverage would be high compared with that of other gaming companies, but the combined company would have minimal capital spending requirements and should be able to generate "significant" cash to quickly pay off debts, Rose wrote.

Still, the deal raised eyebrows at Moody's Investor Service, which placed both companies' debt ratings on review for possible downgrade. The pro forma debt-to-EBITDA ratio for the combined company is 5.8, a level Moody's called high for its Ba3 senior implied rating on Penn National.