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Penn National Gaming (Nasdaq : PENN) is undervalued due to its opaque spinoff transaction, shortsightedness of goodwill impairment, and

the significant probability of a buyout. A buyout and/or future SEC filings will likely be a catalyst for share appreciation as PENNs enterprise multiple is approximately half peer average. Spinoff overview On November 1, 2013, PENN completed its spinoff by distributing one share of Gaming and Leisure Properties (Nasdaq : GLPI) common stock to PENN common and series C preferred shareholders. This spinoff transaction was a first of its kind in the gaming business. As a result GLPI owns substantially all of PENNs former real estate assets (19 facilities) and leases back most of those assets to PENN under a 15-year lease agreement. Penn continues to operate the gaming facilities and hold the associated gaming licenses. (https://www.sec.gov/Archives/edgar/data/921738/000110465913081228/a1 3-22103_7ex99d1.htm) Historical spinoff returns The value of spinoffs is examined in Patrick Cusatiss Restructuring through spinoffs paper. The thesis summarized in 3 points is surprisingly relevant to PENN. 1. Despite being similar to IPOs, my spinoff findings are in direct contrast to the reported IPO results: whereas IPOs offer positive returns at issuance but underperform thereafter, spinoffs initially perform poorly but provide positive returns over an extended period of time. The common belief is that forced selling occurs because of investment fund mandates (the funds strategy). An example of a mandate is market capitalization. Interestingly enough, PENNs stock has depreciated approximately 9% since the spinoff occurred. This drop started at the beginning of 2014, which is the typical time for annual portfolio rebalancing.

2. In the long term following a spinoff, positive abnormal returns can be observed for spinoffs and parent firms. These results can be mostly attributed to a high incidence of takeovers. In 2007 PENN actually committed to a buyout by Fortress Investment Group (NYSE : FIG)and Centerbridge Partners. The deal fell through in 2008 due to the banking crisis. With the deal unable to be executed, $225 million in termination fees were paid, and 12,500 shares of newly-issued non cumulative preferred B stock was exchanged for $1.25 billion. The preferred shares resemble a de facto acquisition call option given their seniority and the blowout of corporate bond spreads in 2008. This thesis was supported in October 2013 when PENN paid out $672 million and issued 8624 preferred C shares convertible at 1/1000 to redeem the B shares. It is reasonable to assume that the savvy Fortress Group would not take such a large loss unless it went toward future acquisition costs. (https://www.sec.gov/Archives/edgar/data/921738/000110465 913076379/a13-22486_1ex99d1.htm) (https://www.sec.gov/Archives/edgar/data/921738/000089882 208000750/settlementagreement.htm) Fortresses October 2013 conference call illustrated their excitement for the spinoff. Other activity we had in the quarter that was material that may not be as apparent is were a big investor in Penn Gaming. There splitting the company into an Opco/Propco as the first casino gaming REIT. I think that has got a ton of optionality to it. Were excited about that. 3. Spinoffs result in an abnormally high incidence of mergers and takeovers for both the spinoff and the parent firm. This result indicates that spinoffs, by dividing a company into two separate firms, are a low cost method of transferring control to highervalued bidders. This result is consistent with the thesis that a

spinoff improves incentives and provides economies of scope for a takeover. A takeover bid from a larger competitor like Ceasars Entertainment Corporation (Nasdaq : CZR) or Las Vegas Sands (NYSE : LVS) would ease the gaming customer acquisition wars by consolidating the market. Regardless of the acquirer, the spinoff transaction made an acquisition cheaper. The large decrease in market capitalization and enterprise value from not having the real estate assets on the balance sheet effectively lowered potential financing costs.

Enterprise multiple Enterprise multiple is enterprise value (EV) / earnings before interest, taxes, depreciation, and amortization (EBITDA). The enterprise multiple relates a firms takeover cost to its earnings potential. As such, it serves as a proxy of how long it would take for an acquisition to earn enough to pay off its costs. Therefore, a company with a low multiple is a suitable takeover target. EV reflects the market value of an entire company. To calculate EV, add up stock, debt, other pieces in the capital structure, and subtract its cash. PENN has $749 million in bank debt outstanding, $296 million in senior notes, and convertible preferred shares, which were included into the market cap for simplicity. After summing these and subtracting the $293 million in cash, EV comes out to $1.85 billion. (https://www.sec.gov/Archives/edgar/data/921738/0001104659140 07173/a14-5185_1ex99d1.htm page 6) EBITDA ignores non-cash expenses such as depreciation and amortization of intangible assets such as goodwill since they do not impact pretax cash flow. PENNs 2013 EBITDA was $695 million. Its 2014 estimated EBITDA is $280 million. The decrease is due to the $422 million rent expense paid to GLPI under the terms of the master lease.

PENNs 2013 and expected 2014 enterprise multiple is 2.67 and 6.62 respectively. The 6.62 number is a more accurate view of its economic reality moving forward. An enterprise multiple of 6.62 means that PENN can earn back its entire value in approximately 6.62 years. This is surprisingly low compared to Ceasars Entertainment Corporation, Las Vegas Sands, MGM Resorts International (NYSE : MGM), and Boyd Gaming Corporation (NYSE : BYD) which have enterprise multiples ranging from 11.4 to 16.3. The enterprise multiple will converge to peer average as the stock price increases. Goodwill impairment The recent $1 billion impairment destroyed earnings and decreased total assets. This certainly gave a bad taste to investors overly focused on the short-term. For long-term investors, it provides a cheaper entrance. Whats more is that the impairment increases the probability of a buyout since the acquirer will pay less in goodwill. Conclusion PENN appears undervalued due to the recent spinoff and the recent goodwill impairment. Future quarterly and annual financial statements will illuminate the hidden value of the spinoff. If a buyout occurs, the premium will likely resemble Fortresss 31% offered in the prior attempt. There is substantial upside and a limited downside at the current market price.