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

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January 14, 2011


Fitch Ratings affirms Pinnacle Entertainment Inc.'s (Pinnacle) Issuer Default Rating (IDR) at 'B'.

Fitch also affirms the company's existing ratings as follows:

--$375 million bank credit facility at 'BB/RR1';

--$450 million senior unsecured notes at 'BB/RR1';

--$735 million of outstanding subordinated notes at 'B-/RR5'.

The Rating Outlook remains Stable.

Pinnacle's 'B' IDR and Stable Outlook reflect the company's strengthening competitive position in two core gaming markets, the prudent bottom-up building of its capital structure, and the attractive debt maturity profile. The IDR and Outlook also incorporate a negative near-term net free cash flow (FCF) outlook related to development spending and the company's cash flow concentration in markets that are vulnerable to increased competition.


Operating performance improved by most measures through the first three quarters in fiscal 2010 over the poor second half of 2009. Driving the improvement was the expansion of margins; stabilization in revenues; and good ramp-up at the River City, a St. Louis casino which opened in March 2010. EBITDA margins for Pinnacle's Louisiana properties and Belterra Casino Resort returned to their pre-recession ranges of 25%-30% and about 20%, respectively. The margin improvements can be largely attributed to a renewed focus on operating efficiencies and more targeted marketing/promotional spending. Fitch estimates that 2010 revenue declined in Pinnacle's Louisiana and southern Indiana markets by roughly 1% and 7%, respectively. Fitch's base case incorporates mid-single digit revenue growth in 2011 fuelled by the continued ramp up in River City and low-single digit growth on a same-store basis. Revenue growth in 2011 will be supported by the economic recovery in Pinnacle's markets, including Dallas and Houston areas (feeders for Pinnacle's Bossier City and Lake Charles properties, respectively), as well as minimal new supply expected for 2011. Fitch's base case incorporates the realization of additional efficiencies in Pinnacle's St. Louis properties and the EBITDA margin there to level off around 20% (compared to 17% in 2Q'10 and 19% in 3Q'10). Fitch's base case also incorporates a ramp-up of Pinnacle's St. Louis properties to $70 million-$75 million of EBITDA over the next couple of years.


Fitch views the increased scope of the Baton Rouge project as credit neutral. In September 2010, Pinnacle revised the expected cost of the project from $250 million to $357 million and also pushed forward the planned opening to late 2011 from the previously reported mid-2012. Fitch believes that the incremental development and execution risks associated with increased cost and scope (additional gaming space and doubling of the hotel rooms) of the project are offset by Pinnacle's ample available liquidity and, in Fitch's opinion, the strategic soundness of the increased scope. The latter consideration takes into account the additional level of diversification Pinnacle will gain within Louisiana, which addresses some of the concern related to potential gaming legalization in Texas. Also, there are currently three bidders for the final Louisiana gaming license, with two of the three applicants intending to build in the Lake Charles area. The third applicant -- Penn National -- is vying for a casino in a suburb of New Orleans, where it would compete with Pinnacle's Boomtown New Orleans. The project may also provide Pinnacle with a third market where the company will be the market leader, in addition to Lake Charles and St. Louis. Currently, there are two properties operating in Baton Rouge, both of which are relatively aged and do not provide the same level of amenities expected from the Pinnacle property.


On a latest 12 months (LTM) basis as of Sept. 30, 2010, reported consolidated adjusted EBITDA was roughly $185 million compared to $1.2 billion in debt for a debt/EBITDA leverage ratio of 6.3 times ([x] or 6.1x excluding the CEO severance payment). Leverage would be below 6x according to the bank facility calculation, which permits the annualization of EBITDA at River City. The IDR and the Outlook incorporate an expectation that leverage may continue to trend in the low 6x range through 2011, with the draw on the revolver to fund the Baton Rouge project being offset by what Fitch expects to be modest EBITDA growth, primarily from the ramp-up of River City. Likewise, Fitch estimates that interest coverage should remain stable around 2x, relative to the 1.5x covenant. The maximum leverage covenant in the credit agreement steps down to 7.25x by the end of 2011 and declines to 4.75x by the end of 2013, while the coverage covenant starts to step up incrementally in June 2012 and peaks at 2.0x at Sept. 30, 2013.


Fitch estimates pro forma annual gross interest expense of roughly $100 million through 2011, assuming $185 million will drawn on the credit facility to fund the Baton Rouge, LA, project, while annual maintenance capital expenditures will trend around $40 million. Fitch's base case reflects Pinnacle's EBITDA (after pre-opening expenses) at around $200 million and $210 million for 2010 and 2011, respectively, implying a healthy discretionary cash flow profile. Spending on the Baton Rouge project will pressure the FCF profile until 2012, and possibly slightly beyond, if the video lottery terminals (VLTs) are approved at Ohio racetracks. Fitch estimates that if legalization occurs, Pinnacle could spend $100 million or more to develop its recent River Downs racetrack acquisition to accommodate VLTs.


Pinnacle's maturity profile is attractive, with decent cushion relative to covenant levels, $479 million of available liquidity as of Sept. 30, 2010 (pro forma for $45 million purchase price for River Downs), no debt maturing until 2014 and solid operating cash flow. The primary liquidity concerns are largely discretionary, centering on spending plans for the company's development pipeline.

As of Sept. 30, 2010, Pinnacle's cash balance was $228 million, with roughly $158 million available excluding the $70 million required for daily operations and cage cash. Pinnacle's revolving credit facility was amended on Feb. 5, 2010, pushing out its expiration to March 2014 from December 2010 and reducing the commitment on the revolver to $375 million from $531 million. As of Sept. 30, 2010, the revolver was undrawn and approximately $9.6 million of LOCs were outstanding, providing the company with a total of $524 million of available liquidity ($479 million pro forma for the River Downs acquisition). Fitch expects that the available liquidity plus the projected cash from operations should amply cover Pinnacle's capital expenditures over the next two years. The credit facility matures in March 2014 and the next bond maturity date is not until June 2015 ($380 million 7.5% subordinate notes).


Based on Fitch's recovery analysis, and Pinnacle's prudent bottom heavy capital structure, estimated recovery values are solid relative to their ranking in the capital structure. Fitch rates both the bank facility and senior unsecured debt 'BB/RR1', estimating full recovery in the event of default based on the current capital structure. The subordinated debt rating is 'B-/RR5' (11%-30% recovery estimate), which benefited from the downsizing of the bank facility in February 2010 to $375 million from $531 million. As senior debt availability increases or is issued, there could be additional rating pressure on the subordinated debt Recovery Rating, and possibly the senior unsecured Recovery Rating.


Positive rating actions are unlikely in the near term given the planned development spending and uncertainty related to potential competition, but longer term the company's increasing diversification and solid market position in two major markets are positive catalysts. In addition, if the company continues to execute on its operational initiatives and stress its operational focus, the credit profile would benefit. The following factors could contribute to negative rating actions:

--Texas legalizes gaming in the 2011 legislative session;

--Baton Rouge project opens later than expected and/or significantly underperforms relative to Fitch's expectations. Fitch's base case scenario assumes the property ramping up to slightly over $40 million in EBITDA by 2013.

--A more severe than expected impact on Pinnacle's Belterra facility from the 2012 opening of the $400 million Rock Gaming/Caesar JV Cincinnati casino. Fitch's base case scenario expects a negative impact of 25%-30% on Belterra's EBITDA in 2013.

--A more severe than expected impact on Pinnacle's Louisiana properties from the opening of one of the three proposed casinos, whose applications are now being considered by the state. Two of the applicants plan to build in Lake Charles and one (Penn National) in the New Orleans market. Since Pinnacle operates in both markets, modest impact is expected regardless of the state's decision, but a casino in Lake Charles would be a worse outcome. Pinnacle has a market share of about 50% in the market.

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