Recent news on Penn National Gaming (PENN) is the pricing of both a common stock and a convertible issue totaling around $300 million each. The convertible issue has a conversion price of around $23.40, and there are 30-day options for the underwriters to buy another $90 million in both common stock and convertible shares, if they choose, at the public offering price. This issuance, which will net Penn between $600 and $690 million in order to weather the coronavirus storm, will do a lot to guarantee the company’s solvency. However, it indicates that the tether to credit markets has basically dried up, with necessary liquidity needs requiring equity capital markets as well. We think that this capital raise will surely save Penn for any reasonable length assumed for the COVID-19 crisis, and although it puts a floor on Penn’s falling price, it’s much better news for Gaming and Leisure Properties (GLPI), which benefits from its superior positioning in the industry structure.

Penn’s Newfound Runway

In our previous article, we predicted that Penn was on the edge of being able to survive the current crisis with the liquidity it had available beyond what it owed in 2020. This was vindicated by the company’s move to raise cash again. Thankfully, capital markets have continued to be responsive to Penn, recognising the intrinsic value of its regional gaming operator model and its ability to sustain massive debt loads under normal circumstances. For current shareholders, this move can help them sleep easy about the company’s solvency. As seen in our previous article, Penn has a cash burn of $83 million monthly, implying around a 25% operating leverage.

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(Source: Mare E-Lab Research Database)

This is a testament to Penn management, since one would expect a business like this, where there are so many contractual obligations, to have a high operating leverage. Nonetheless, with this operating leverage and the average monthly cash burn, we can estimate how many days of negligible activity in Penn’s facilities that the company can survive.

(Source: Mare E-Lab Research Database)

This data shows the number of zero-activity days that Penn could survive from May 17th onward. These figures assume that over-allotment will not occur. This is a substantially longer runway than what could be estimated before the capital raise, where it used to be around 90 days. Under most predictions of the length of required closures, this seems sufficient for Penn to weather the storm, especially since many facilities will start ramping up before the end of May.

Dilution Risks and Concluding Remarks

Although this is good news for Penn and its stakeholders, it comes at a substantial cost for the company. Below are the dilution factors under the various possible scenarios:

(Source: Mare E-Lab Research Database and

We showed the extent to which shareholders might be diluted in a matrix form. The over-allotment options have a 30-day duration. The dilution in the worst-case scenario is where over-allotment options are exercised for both the share and convertible issue, and that the convertibles become exercised, which would happen assuming a price of $30.42 (conversion price + 30%) for Penn shares. In this case, the dilution factor is almost 75%.

The best-case scenario from a dilution POV is where there are no over-allotments for either the share or convertible issue and the convertibles aren’t exercised. Until February 2026, when the free conversion date arrives, the best-case scenario in terms of dilution also means that Penn’s price does not recover past the $30 mark, which might be bad news for long-time holders. After February, the only way the best-case scenario holds is if the price does not recover beyond the conversion price of $23.4, implying even worse price performance even if dilution is marginally better.

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Overall, Penn’s liquidity situation is now solid enough to weather the current COVID-19 situation, and defaults, which were possible before, are not likely to become a problem for the company’s creditors and lessors. However, we think that given the vulnerable position of Penn when these measures needed to be taken, as opposed to regional competitors like Boyd Gaming (BYD) which still has clean debt capacity as evidenced by recent raises, there are likely to be more attractive ways to invest in regional gaming than in Penn. Given that some dilution is inevitable, which will be mitigated from more grievous figures only by poor enough price performance to dissuade conversions, we still find Penn unattractive with the cash flow concerns from tentative casino activity to boot. In the casino space, we much prefer GLPI, which is the main beneficiary of these liquidity actions by Penn, as it means its properties stay occupied and no defaults occur on its triple-net lease agreements regardless of Penn’s underlying performance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.