Boyd Gaming Rolls the Dice on Casino Deal

NEW YORK ( TheStreet) -- In rolling the dice on a $1.45 billion acquisition of Peninsula Gaming, heavily indebted Boyd Gaming ( BYD) is taking one of the more notable recent gambles in the risk-fueled casino industry.

The move may prove to be a well-timed push into southern and Midwestern economies after Boyd was unsuccessful in a larger play for Station Casino's -- as well as a diversification away from the hyper-competitive Las Vegas and Atlantic City gambling markets -- but the acquisition will add roughly $1 billion to already high debt levels and the prospect of shareholder dilution.

If it's to be the "transformative" deal for which Boyd has been searching, though, it's a gamble that hinges on the U.S. economy avoiding a slowdown. Initial analyst and shareholder reaction was mixed, and suggest the deal won't propel shares from the single digits and anywhere near pre-recession highs.

"Acquiring Peninsula Gaming is a transformative transaction that fits perfectly into our growth strategy by expanding our company's scale, diversifying our platform, strengthening our financial profile, and generating meaningful value for our shareholders," said Boyd Gaming CEO Keith Smith in a late Wednesday press release. Boyd will pay for the deal using $200 million of cash and by issuing $1.2 billion of debt.

Smith may be correct on the growth potential and diversification benefits, however, saddled with roughly $3.5 billion in debt, Boyd Gaming may not have the cash to pay off the $1.45 billion offer.

Such a dilemma is normally the case within the casino industry, which operates with large debt levels and is highly exposed to economic swings that may cause consumers to either ramp up or clamp down on leisure spending. Companies like Las Vegas Sands ( LVS), Wynn Resorts ( WYN) and Caesars Entertainment ( CZY) are all taking risks to diversify into non-Las Vegas and Atlantic City markets in a push to bump up profit margins.

"We are positive on the strategic rationale, as PenGam is well-managed with best in class EBITDA margins to cash flow. The proposed deal diversifies BYD away from the challenged Las Vegas Locals and Atlantic City markets," writes Bank of America Merrill Lynch analyst Shaun Kelley in a note to clients. The analyst estimates that after the acquisition is complete up to 50% of Boyd's earnings will come from the Midwest and South.

Kelley's comments and similar takes on the underlying diversification strategy and the profitability of the assets that Boyd Gaming is buying signals it's found a game changer of a deal, after a $2.45 billion bid for Station Casinos in December 2009 failed.

Yet the Bank of America Merrill Lynch analyst still rates the company at a sell.

"While the diversification and accretion the announced deal presents are encouraging, the proposed deal does not materially change Boyd's leverage profile," notes Kelley of Bank of America, who estimates that the company's year-end 2012 net debt may rise slightly, while free cash flow gains may be pared by a $4.5 billion in debt. "As a result and given BYD's continued weak recovery in Las Vegas and competition both there and in Atlantic City, we maintain our Underperform rating." Kelley gives shares a price target of $6.50.

In announcing the Wednesday deal, Boyd Gaming said Peninsula's Kansas Star Casino near Wichita, its Diamond Jo Casino in Iowa, its Evangeline Downs Racetrack & Casino and Amelia Belle Casino in Louisiana will boost the Las Vegas-based company's presence in some of the nation's strongest growth regions. The merger is also expected to add immediately to earnings. "We are paying an attractive multiple for high-quality, high-margin assets," adds CEO Smith.

Analysts generally agree, but again with the caveat that the company's financial condition and its existing operations in Atlantic City and Las Vegas linger as very present risks, especially in a weak-growing economy and a challenging U.S. gambling industry.

"The acquisition also diversifies Boyd from the Atlantic City market, which may become more competitive as Revel AC opens up 1,300 additional rooms by the end of this month," writes Sterne Agee analyst David Bain in a note to clients. Though he added, "Given continued issues in still key markets (namely AC and Las Vegas), we believe downside risk to shares still remains," He also has an underperform rating on Boyd shares and a $6.70 price target.

Overall, analysts polled by Bloomberg place Boyd shares at a consensus price target of $8.06, with two buy ratings, 14 holds and three sells. In Thursday trading, Boyd Gaming shares rose over 3% to $7.24. Still, the company has shed over 1% in 2012 and is off over 20% in the past 12 months, underperforming the S&P 500 and industry players like Las Vegas Sands that have promising international operations.

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It's Boyd Gaming's push to find U.S. tied earnings growth -- relative to peers that are exploiting faster-growing Asian economies -- that may prove to hand CEO Smith his "transformational" deal or linger as a headache. In fact, Smith's roll of the dice on U.S. earnings growth may face a crucible in 2012. Boyd Gaming's bet could be an early read on whether casino operators are correct in using M&A as a way to leverage U.S. earnings growth, or whether a creaking economy could trip up a gambling industry resurgence.

KeyBanc analyst Dennis Forst writes in a Wednesday note that with the debt component of the deal, Boyd Gaming may bump against its maximum allowable leverage ratios.

"In our opinion, this transaction will be accretive to earnings per share and will modestly reduce the enterprise value-to-estimated 2013 EBITDA ratio, albeit it will raise the debt leverage and leave little wiggle room should the domestic economy hit any bumps in the road," notes Forst, who gives Boyd Gaming a hold rating.

If Boyd Gaming were to find its debt to earnings or cash flow levels untenable, JPMorgan analysts note that there is a risk an equity capital raise will dilute shareholders.

Boyd is a gaming company, after all, so maybe shareholders should expect to "let it ride" on a gamble, especially if growth and diversification benefits loom. On the other hand, Boyd may be playing too strong of a hand in cutting a hoped-for transformational deal amid an uncertain economic backdrop.

For more on the gambling sector see 8 casino stocks that are on a roll . See five stocks that could be trampled for more on risky stocks to watch for.

-- Written by Antoine Gara from New York.

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