Published: December 29, 2008

This company first entered the gaming industry in 1997 with the acquisition of Boomtown-branded resorts in New Orleans and Reno. It then remained a second-tier niche player for the next several years, before upping the ante with the introduction of Belterra Resort & Spa -- a well-placed property halfway between Cincinnati and Lexington that caters to a population of over 5 million potential customers. Pinnacle (NYSE: PNK, $7.27) was well on its way to becoming a leading operator of riverboat casinos in the Midwest and Gulf Coast.

In 2005, Pinnacle made another stride forward when it opened the luxurious L'Auberge du Lac in Lake Charles, LA. The property is a true destination resort, featuring private cabanas, upscale shopping and dining, a tropical lagoon playground, and a Tom Fazio-designed golf course winding through scenic Contraband Bayou. The casino wasted no time in overtaking Harrah's Horseshoe in Bossier City as the state's top-grossing riverboat.

The newest jewel in the collection is Pinnacle's Lumiere Place, which opened in downtown St. Louis this time last year. The property, which sits in a busy entertainment district below the Gateway Arch, rivals even Las Vegas in terms of style and amenities -- not to mention a bustling 75,000 square foot casino.

These additions have elevated Pinnacle from an also-ran with a few mediocre regional properties into a major player. Some of its other properties had less than stellar results, but this was partly due to a number of unusual one-time events -- including severe flooding on the Mississippi River and back-to-back hurricanes in Louisiana. And despite these disruptions, Pinnacle is still far stronger than many of its rivals.

Like other consumers around the country, Pinnacle's players in Louisiana, Missouri and Indiana are feeling the pinch of this economic slump. But these regional markets are holding up better in many respects than Las Vegas -- and they aren't being cannibalized by a wave of new capacity.

In fact, voters in Missouri just approved a ballot initiative that will limit casino operating licenses and remove inexplicable betting restrictions ($500 max in gaming chip buy-ins) that hindered Pinnacle's ability to attract affluent players from other states.

Meanwhile, financial health (a big question mark for most gaming companies) is another positive for Pinnacle. Several years ago, the company walked away from an overheated bidding war for a small Las-Vegas company called Aztar. In hindsight, that decision has been a blessing for shareholders.

Having the restraint not to overpay kept Pinnacle from shelling out a pile of cash for Aztar's coveted real estate and then spending a billion or two more to develop that land just in time for this downturn. And for its trouble, the company pocketed around $45 million in breakup fees and expenses.

Those proceeds, combined with a $180 million stock offering and the sale of two card clubs in California (which netted $28 million in pre-tax gains) left the company with nearly $380 million in cash on the balance sheet. Today, the company is still sitting on much of that cash and maintains a reasonable debt-to-equity ratio of 0.9 -- versus 2.5 for MGM Mirage (NYSE: MGM), 3.5 for Wynn Resorts (Nasdaq: WYNN) and 4.5 for Las Vegas Sands (NYSE: LVS).

So while other gaming companies are being dogged by liquidity-related concerns, Pinnacle remains on solid financial footing. And looking ahead, there are several projects on the drawing board that will boost cash flows dramatically once they come online.

First, the company bought the old Sands casino in Atlantic City and is waiting for the opportune time to resurrect a glitzy resort on that site. Further south in Louisiana Cajun country, Pinnacle is pushing forward with plans to construct a $350 million Caribbean-themed resort called Sugarcane Bay to lure high-rollers from nearby Houston.

Across the state, management has big plans for Louisiana's last idle casino license. The company quietly bought up 550 acres of land and intends to introduce a new entertainment complex to Baton Rouge -- an underserved market whose population has swelled with displaced New Orleans residents.

Finally, construction is proceeding nicely on the River City resort in the suburbs south of St. Louis. At a cost of $375 million ($90 million of which has already been spent) the ambitious property will soon feature become the new flagship of Pinnacle's growing portfolio.

To demonstrate just how attractively valued Pinnacle has become, consider this: The firm reported EBITDA of $70 million in 2003, and the shares closed the year above $9. Despite this rough patch, the company will earn more than $140 million this year, but the shares have sunk to $7.

In other words, profits are more than double what they were five years ago, but the stock is cheaper now than it was then.

Once Pinnacle's new casinos open for business, I will adjust fair value accordingly. But for now, even without modeling in these future cash flows, the company is still worth $16 per share -- meaning investors willing to bet on a rebound could easily double their money from here.

There is little doubt that we are in a near worst-case operating climate for casino operators, but Pinnacle is still holding up well.

The firm will be banking heavily on the Missouri gaming market, where competitors like Harrah's and Ameristar (Nasdaq: ASCA) will put up a good fight. But Lumiere Place continues to show increased traction each month, and the market as a whole is quite healthy. In fact, the state's 12 casinos reported a surprising +9% increase in gaming revenues in November.

Pinnacle has come a long way in recent years, and has already sunk about $600 million in assets for future growth -- assets that haven't yet earned the first penny of income. Overall, the company has a book value of around $17 per share, more than double the value that Wall Street is giving it credit for. I think PNK has been unfairly punished and will recover strongly in time.

Nathan Slaughter
Editor
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Nathan Slaughter has developed a long and successful track record over the years by investing primarily in deeply discounted securities. He uses advanced discounted cash flow techniques, along with a host of fundamental research, to uncover quality stocks that are trading well below their actual intrinsic value.

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Several years ago Nathan switched gears and decided to devote his time exclusively to financial analysis and writing. He has since published hundreds of articles for a variety of prominent online and print publications, and he now writes exclusively for StreetAuthority.com.

Nathan's educational background includes NASD series 6, 7, 63, & 65 certifications, as well as a degree in Finance/Investment Management. He currently resides in Shreveport, LA with wife Julie and sons Aidan and Riley. 

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