Fitch Affirms Pinnacle Entertainment's IDR at 'B+'; Outlook Stable

  Fitch Affirms Pinnacle Entertainment's IDR at 'B+'; Outlook Stable  Business Wire  NEW YORK -- July 15, 2014  Fitch Ratings has affirmed Pinnacle Entertainment, Inc.'s (PNK; Pinnacle) Issuer Default Rating (IDR) at 'B+'. Fitch also affirmed all of Pinnacle's issue ratings including the senior secured credit facility at 'BB+/RR1', senior unsecured notes at 'BB-/RR3' and subordinated notes at 'B-/RR6'. The Rating Outlook is Stable.  KEY RATING DRIVERS  The affirmation of Pinnacle's IDR at 'B+' and the Stable Outlook reflect Fitch's expectation that Pinnacle's leverage will decline to 6x or below over the next two to three years even if moderate revenue declines continue. Fitch's view is supported by Pinnacle's publicly stated goal of reducing debt, with the company targeting leverage of 4x or below. The deleveraging will be facilitated by Pinnacle's strong free cash flow (FCF) profile, which is supported by limited capital spending requirements and substantial net operating losses (NOLs) that will offset most if not all tax liability through 2017, the last year of Fitch's forecast.  With a 'B+' IDR there is less tolerance for company actions that could slow down the debt reduction given the difficult operating environment across most regional markets in which Pinnacle operates. Such actions might include Pinnacle executing leveraging acquisitions and initiating dividends or share repurchases. Pinnacle's operations will be challenged by the opening of the Golden Nugget casino in Lake Charles, LA in late 2014. Fitch estimates that Pinnacle's Lake Charles casino accounts for about 15% of the company's property EBITDA.  Given the difficult operating backdrop, which Fitch expects will persist, Fitch sees Pinnacle's debt/EBITDA ratio remaining elevated above 6x until 2016. This compares to Fitch's prior expectation at the time of the Ameristar Casinos (Ameristar) acquisition that leverage would decline to below 6x within a year of the acquisition, which closed in August 2013. The 6x threshold is the maximum that Fitch believes appropriate for a 'B+' IDR given Pinnacle's business risk profile. Fitch calculates for the LTM period ending March 31, 2014 pro forma debt/EBITDA for the sale of the Lumiere casino at 7.0x.  FITCH's FORECAST  Fitch projects Pinnacle's debt/EBITDA at 6.4x for 2014 and 2015, 6.0x for 2016 and 5.7x for 2017. In Fitch's base case the debt reduction more than offsets the decline in EBITDA except in 2015, when the EBITDA decline is accentuated by the new competition in Lake Charles. Fitch believes Pinnacle's EBITDA after corporate expense will be $626 million, $586 million, $579 million and $567 million for 2014, 2015, 2016 and 2017, respectively.  Fitch's base case assumes that Pinnacle's revenues decline by 3% in the second quarter of 2014 on a same-store basis and then by 1% for the balance of the projection horizon (excluding Lake Charles). Fitch forecasts Pinnacle's property level margins to remain relatively stable in the low 30s as Pinnacle's cost synergies should offset some of the flow-through from the revenue declines.  Fitch's base case assumes a 20% revenue decline in Lake Charles in 2015 with a 50% flow-through. This equates to roughly 30%-35% decline in EBITDA for the property and about a 5% decline for the company. This is a larger decline relative to Fitch's earlier forecast with the revision reflecting the softer regional gaming trends, including in the Lake Charles market. Fitch assumes that Belterra Park in Cincinnati will largely offset the declines at the Belterra sister property in Indiana stemming from the new competition in Ohio.  Fitch's forecast assumes that Pinnacle applies all of its FCF to paying down term loan B2 and projects FCF at about $105 million in 2014 (includes roughly $135 million of capex for Belterra Park, including half of the $50 million licensing fee paid in 2014) and approximately $250 million-$260 million in discretionary FCF through 2017.  The FCF forecast for the outer years takes into account the following estimates:  --Property EBITDA of $645 million-$665 million;  --Corporate expense of $80 million;  --Interest expense of $210 million-$230 million;  --Cash tax expense at about zero ($553 million and $862 million in federal and state NOLs, respectively, as of Dec. 31, 2013);  --Maintenance capex at $100 million.  Fitch's assumption that all FCF will be used to pay down debt reflects the Pinnacle's consistently articulated goal of deleveraging, the lack of attractive growth opportunities, and the company's covenants. Pinnacle's credit agreement has a 50% excess cash flow sweep provision and limits restricted payments to $100 million in aggregate. The revolver (about $600 million outstanding pro forma for the sale of Lumiere) has a leverage-based pricing grid and leverage-based financial covenants that step down to below 6x by mid-2016. The Ameristar 7.5% senior notes assumed by Pinnacle have stringent restricted payment covenants but the notes are callable beginning April 2015.  REGIONAL TRENDS TO REMAIN NEGATIVE  With no weather or calendar impediments, gaming revenues reported by the gaming regulators for May remained negative on year-over-year basis across regional markets on a same-store basis. Revenues were mostly down in the low single-digit range with the exception of the few more fragile markets such as Mississippi where declines approached double-digits. June has been similarly weak for the states that have reported thus far. The common theme sounded by regional casino operators is that the weakness stems largely from the lower-tier customers, often described as those with a theoretical loss of $100 or less per visit.  Fitch attributes the weakness in regional gaming to near-term and long-term headwinds. Near-term, the end of the federal unemployment benefits at year-end 2013 and the individual health insurance sign-ups related to the implementation of the Affordable Care Act (ACA) are having an impact. Annualized unemployment benefits are down $31 billion in the 1Q'14 and the Congressional Budget Office expects six million to be enrolled in an ACA-compliant plan in 2014 with about five million getting some form of a subsidy. Longer-term headwinds include stagnant wages among the 99%; reprioritization of discretionary income; lower interest rates (which affects investment income) and proliferation of lower cost, more convenient gaming (e.g. video gaming terminals at bars, casino-themed social games, and lottery).  On the bright side, the EBITDA flow-through from the revenue declines has been relatively modest for most operators in 1Q'14 at around 40% as operators continue to cut costs. The low flow-through partially reflects the regional markets' high tax rates (Mississippi is a notable exception) and admission fees (common in the Midwest). Fitch notes that the flow-through may increase closer to 50% as the cost savings begin to anniversary.  POTENTIAL FOR A REIT SPIN-OFF  Since Penn National Gaming (Penn) spun off its assets into a REIT (Gaming & Leisure Properties, Inc.; GLPI) in late 2013 there has been market speculation whether any of the other regional operators will consider a REIT spin-off. GLPI has been well-received by the equity markets with the company trading at about 14x-15x EV/EBITDA relative to the 7x-8x regional multiples. PNK has been routinely mentioned as the most likely candidate to do a spin-off given its better-than-industry-standard balance sheet, quality of assets, size and diversification. On April 16, 2014, Pinnacle received a letter from Orange Capital, which owns 4.5% of the company's stock, making a case for a REIT spin-off. The company responded by saying that the management and the board 'regularly review its strategic priorities and opportunities, and assess a variety of value creating options.'  Fitch views the probability of Pinnacle executing a REIT spin-off as low in the near term and somewhere in the 50/50 range longer term (past 2017). Should Pinnacle pursue a REIT spin-off, Fitch may consider it a credit negative depending on how the transaction is financed. In the case of Penn, Fitch viewed the transaction negatively since the lease-adjusted leverage increased following the transaction.  Fitch believes Pinnacle may consider the spin-off once leverage improves, most of its bonds become callable, and its NOLs are close to being depleted. These conditions will not likely be met until 2017 at the earliest. Also, according to GLPI and Penn, a REIT spin-off is very complex and takes a long-time to execute. Nevertheless, should GLPI's multiples hold up, Fitch believes a spin-off would be tempting for Pinnacle, especially given the lackluster organic growth prospects.  TRANSACTION RATINGS  The 'RR1' Recovery Rating (RR) on Pinnacle's senior secured credit facility results in a three-notch uplift from the IDR and takes into account Fitch's expectation of full recovery in an event of default. The 'RR3' on the senior unsecured notes (one-notch uplift from the IDR) reflects Fitch's expectations of better-than-average recovery for the senior notes in an event of default. The senior notes benefit from a quick paydown of Pinnacle's term loan and tight lien covenants in Pinnacle's senior notes indentures.  Pinnacle repaid $660 million of term loans since the credit facility closed in August 2013 using proceeds from asset sales and FCF. The paydowns were partially offset by draws on its revolver to fund Belterra Park. Pinnacle is restricted to 3.5x capacity on its credit facility per the senior notes' indentures. The notes mature in 2021 and are not callable until August 2016 (April 2015 for the 7.5% notes).  The 'RR6' on the subordinate notes reflects Fitch's expectation of minimal recovery in an event of a default and results in a two-notch negative differentiation from the IDR.  RATING SENSITIVITIES (Fitch forecasts in parentheses)  Negative: Future developments that may, individually or collectively, lead to negative rating action include:  -- Fitch having less confidence that PNK's debt/EBITDA ratio will approach 6x by 2016 (FY16: 6.0x and FY17: 5.7x);  -- Same-store revenue declines significantly exceed Fitch's 1% per year projection for an extended period of time;  -- Discretionary FCF declining below $250 million, or $200 million once the NOLs are fully utilized, for an extended period of time (FY15: $256 million, FY16: $259 million);  -- The company's adopts a more aggressive financial policy and starts to de-emphasize debt reduction;  -- PNK pursuing a REIT spin-off that would result in the rent adjusted leverage to increase.  Positive: No positive rating action is expected over the next 24 months given the company's high leverage. However, positive rating action may result from:  -- Debt/EBITDA declining below 5x;  -- Revenue growth stabilizing at or close to 0%;  -- Discretionary FCF exceeding $300 million, or $250 million once the NOLs are fully utilized, for an extended period of time (FY15: $256 million, FY16: $259 million).  Additional information is available at ''.  Applicable Criteria and Related Research:  --'Corporate Rating Methodology', (May 2014);  --'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers', (November 2013);  --'U.S. Gaming Recovery Models - Fourth-Quarter 2013', (May 2014);  --'2014 Outlook: U.S. Gaming (Deleveraging Potential)', (December 2013);  --'Pinnacle Entertainment, Inc. -- Ameristar Acquisition Financing Considerations', (July 2013).  Applicable Criteria and Related Research:  Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage  Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers  U.S. Gaming Recovery Models ¬タヤ Fourth-Quarter 2013  2014 Outlook: U.S. Gaming (Deleveraging Potential)  Pinnacle Entertainment, Inc. -- Ameristar Acquisition Financing Considerations  Additional Disclosure  Solicitation Status  ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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