Description

Description:

Trump Entertainment Resorts, Inc. (ticker:  TRMP, Nasdaq) owns three casino properties in Atlantic City:  Trump Taj Mahal, Trump Plaza, and Trump Marina.  TRMP is a unique turnaround story, offering investors pure-play exposure to the Atlantic City gaming market and an option on the Pennsylvania slot market.

TRMP shares have traded since May 23, 2005, when they emerged from reorganization proceedings – this represented the end of long process that had left TRMP an undercapitalized and troubled company.

Donald Trump is the largest shareholder with 30% of the stock and is Chairman of the Board.  Our impression is that while he is close to company, his operational involvement is limited (a departure from the company’s past life).

Thesis:

Lack of leadership, low employee morale, antiquated yield management systems, a limited customer database, and general disorganization has lead to declining EBITDA margins and market share in Atlantic City.  Additionally, and perhaps more importantly, TRMP has had an extremely limited capital expenditure budget due to excessive leverage – this has left TRMP with a stable of “tired” properties that have become less competitive over the last few years.

1)       EBITDA margins are well below the Atlantic City average (roughly 27% versus 16.5% for TRMP for the first six months of 2006).  This makes little sense given that win/day is at or near the AC average for TRMP’s slot machines and at or above the average for their table games.  We believe a combination of more efficient use of promotional allowances, the implementation of a contemporary yield management system, the development of a customer database, and employee headcount reductions will combine to close the gap for TRMP’s margins relative to the overall market.

2)       TRMP’s financial distress limited its capex budget for quite some time – in the years 1998-2004, the company averaged $27M/year, which I would estimate is roughly half of a  normal maintenance capex requirement and obviously left no room for revenue-generating, project capex.  With financing in place, TRMP now has the liquidity for its “re-theming and updating” capital program of $110M, as well as an annual maintenance capex budget of $60M.  We believe this capital will go a long toward TRMP’s goal of achieving the Atlantic City average EBITDA margin.

Recent data released by the New Jersey Casino Control Commission (casino only, excludes hotel and other revenue) would suggest that management has the company moving in the right direction:

3)       In addition, TRMP recently began construction on a $250M, 786 room hotel tower at the Taj Mahal which is expected to be completed in the summer of 2008.  Historically, hotel expansions have done very well in Atlantic City.  One recent example is the Tropicana, which spent $270M on a 502 room hotel tower, new meeting/retail/dining/entertainment space, and additional parking.  The result is an increase in EBITDA at the property from a low of $82M in 2004 to an expectation of $160M in 2007.  While it is difficult to quantify the ROIC of this project (construction disruption and a collapse of the parking garage clearly took 2004 to an artificially low level), I feel comfortable with assuming this project yield a 20% return (as defined by additional EBITDA generated divided by total project expense).  We believe the Taj Mahal hotel tower will generate a similar result, as it is clear that the city is in desperate need of more hotel rooms.

Financials: 

Considering that TRMP’s properties have been neglected, both from a management and capital standpoint, we find it encouraging that the company did not do worse in 2004 and 2005 (despite a 42% decline in EBITDA, net revenue was only down 10%), and that the new management team (in place starting July 2005, fully assembled by end of 2005) has stopped the bleeding so quickly.  Further, it is noteworthy that the company did $260M of EBITDA on $1,102M of net revenue in 2002, despite inferior management and a measly capex budget.

As evidenced by the numbers below, the gaming business has intense operating leverage – note that a $110M decrease in revenue from 2002 to 2005 resulted in a $110M decrease in EBITDA.  There were other things at work during these years that amplified this 1-for-1 relationship between revenue and EBITDA (namely a bankruptcy filing), and under more normal circumstances most managers would be able to offset some of the revenue loss with decreased expenses.  However, these years illustrate just how much operating leverage exists in this business.

Atlantic City properties are currently commanding 9-10x next year’s EBITDA (as dictated by the value put on Borgata by most Street analysts, and the implied multiple paid for Tropicana Atlantic City by Columbia Entertainment), and in some cases higher multiples (e.g., Pinnacle Entertainment’s purchase of the The Sands).  In the interest of conservatism, we are using discount to the market.  Assuming investors are willing to pay 8-9x 2009 EBITDA in mid-2008, we arrive at a 2-year price target range of $27-35 per share, which implies a price / FCF multiple of 13-16x.

Not included in our price target range is the possibility that a partnership that is 63.6% owned by TRMP could be awarded one of two licenses to operate a slot machine facility in Philadelphia.  We believe our assumptions on win/day (significant discount to what slots do in comparable cities), EBITDA margin, and the EV/EBITDA multiple placed on the facility are conservative – obviously, upward revisions to any of these assumptions would result in significant increases in the value of the project to TRMP shares.  A decision on the licensees is expected in late December of this year.

From what we can tell, the major knock on the bull case for TRMP shares is that Atlantic City is getting more competitive and promotional, making it difficult for TRMP to hit the above projections.  We disagree, and we believe that fears surrounding the supposed “promotional war” going on in Atlantic City will be proven unfounded.

Further, Borgata has proven that there is a place in Atlantic City for a true luxury facility that is complete with upscale amenities – the property has materially outperformed expectations, probably by somewhere around 50%.  In addition, Tropicana has proven that the addition of hotel rooms, shopping, dinining, etc. will generate excellent returns.  While the city will never rival Las Vegas in terms of a destination location, it does not have to do so in order to successfully expand from its current state.  Atlantic City is located in a tremendous demographic region, and we believe the wave of investment capital now going into the city will benefit all – quite simply, the city has been neglected from a capital standpoint for many years.  Any upgrade to the product there will likely result in increased visitation and enhanced financial performance.

New Management Team:

CEO Jim Perry most recently turned around Argosy Gaming Company, having joined that company as CEO in April 1997 (Argosy shares were in the mid $3’s at that time).  Perry stepped down as CEO in May 2003 (stock had reached over $20) and stayed on as a Director through the sale of the company to Penn National Gaming in October 2005 at $47/share.  Perry also spent 20 years with Aztar and has meaningful experience in the AC market, having been President and General Manager at what is now Tropicana Atlantic City for several years.

COO Mark Juliano has had a long career in the gaming industry, having been President of both Caesar’s Atlantic City and Caesar’s Palace in Las Vegas.

CFO Dale Black spent 12 years at Argosy and was CFO there from April 1998 through the sale.

Risks:

Catalyst