2023-09-14 13:00:36 ET
Summary
- PENN Entertainment's recent performance fell short of expectations, with a decrease in corporate EBITDAR and disappointing profit margins.
- The ESPN deal, which includes cash payments and warrants, presents challenges in a competitive market and requires aggressive marketing strategies.
- Uncertainty surrounding PENN's business trajectory and lack of guidance for 2023 contribute to a hold rating and caution regarding future growth.
Overview
My recommendation for PENN Entertainment ( PENN ) is a hold rating as I am uncertain about the business trajectory. The recent weak performance and uncertainty regarding the ESPN deal – requiring a lot of investments into a very competitive industry, is something I am not a fan of. Note that I previously had a hold rating for PENN due to concerns regarding its future growth and uncertain macro and risk around tech implementation, and I am reiterating it again.
Recent results & updates
PENN's primary business is experiencing a lackluster performance. In the second quarter of 2023, PENN reported results that fell short of market expectations. What concerns me even more is that they decided not to provide guidance for the full year 2023, suggesting a lack of confidence. While PENN did manage to achieve consolidated revenues of $1,675 million, which represented a modest 3% year-over-year increase, their corporate EBITDAR of $477 million showed a concerning 5% decrease compared to the previous year.
On a regional level, PENN's EBITDAR of $515 million also failed to meet expectations. Furthermore, their profit margins in this segment were 36.3%. Additionally, the digital aspect of PENN's business reported a disappointing EBITDA of $(13) million. What's even more concerning is the complete absence of commentary regarding PENN's outlook for 2023. Previously, the company had guided for an EBITDA range of $1.875 billion to $2.0 billion for the year, but now there is no guidance available, raising questions about the company's future prospects.
The ESPN deal
For background, PENN made a significant announcement and revealed its entry into a long-term and exclusive agreement for online sports betting in the United States with ESPN. Under this agreement, PENN will hold the exclusive rights to use the ESPN Bet trademark for online sports betting in the U.S. for an initial 10-year term. This deal comes with substantial financial components, including $1.5 billion in cash payments and approximately $500 million in warrants, equivalent to 31.8 million shares, which will vest gradually over time. In addition to this, PENN has divested 100% of its common stock in Barstool Sports back to David Portnoy. This exchange includes certain non-compete clauses and other restrictive agreements. As a result, the online Barstool Sportsbook will be rebranded as ESPN Bet in the autumn of 2023, while theScore Bet will continue its operations in Canada. PENN has also outlined an estimated target of achieving annual long term Adj EBITDA potential ranging from $500 million to over $1.0 billion.
Under this agreement, PENN is expected to allocate significant marketing funds as part of its collaboration with ESPN. However, to attract customers in a highly competitive online sports betting and iCasino market that is already saturated and dominated by a select few players, PENN will likely need to adopt a more aggressive promotional strategy than it did with Barstool. For context, it's worth noting that Barstool initially attracted customers but struggled to retain them. PENN has been working on implementing theScore's technology infrastructure, but now it will need to integrate it with a new brand, possibly requiring a new combined app. I am worried that this pattern might be repeated again. Hence, I remain cautious about overestimating the influence of the ESPN brand when it comes to acquiring customers in this sector. This skepticism is particularly relevant given the late entry of this partnership into an already established competitive landscape. If PENN fails to acquire customers after their significant marketing investment, it will definitely hurt their bottom line.
Valuation and risk
Considering the present state of PENN's business, I am unable to hold a view of how the business will grow as the uncertainty with the ESPN deal is too high with a wide range of outcomes. From a qualitative perspective, I hold reservations regarding its future growth potential. The recent quarter's performance has been lackluster. While the ESPN partnership is a positive development, I'm apprehensive about its return on investment, given the substantial marketing expenditure required. I'm also cautious not to overestimate the ESPN brand's influence on customer acquisition, especially in a competitive market where PENN has entered relatively late. I will be updating my model once we have more clarity into the business progress in 3Q23.
Summary
My recommendation for PENN remains a hold rating due to significant uncertainty surrounding the business trajectory. Recent weak performance and the uncertainty associated with the ESPN deal, which demands substantial investments in a highly competitive industry, are sources of concern. The lack of guidance for the full year 2023 further underscores management's lack of confidence.
In particular, the ESPN deal, while promising, poses challenges in a crowded market, necessitating aggressive marketing efforts to acquire and retain customers. Given these uncertainties, I cannot confidently assess PENN's growth prospects at this time. I will closely monitor its performance in 3Q23 to update my model and provide further guidance.
For further details see:
PENN Entertainment: Uncertain About The Business Growth Trajectory