Posted on: May 13, 2024, 11:40h. 

Last updated on: May 13, 2024, 11:40h.

Shares of Penn Entertainment (NASDAQ: PENN) traded slightly higher early Monday, fighting off a downgrade by Bank of America, which was stoked by concerns that the operator’s ESPN Bet unit could take longer than expected to become profitable.

An image from an ESPN Bet tutorial. Bank of America downgraded Penn Entertainment today on concerns ESPN Bet will lose more money than previously expected. (Image: YouTube)

In a note to clients, analyst Shaun Kelley downgraded Penn Entertainment to “neutral” from “buy” while slashing his price target on the stock to $17.50 from $28. That implies upside of 8.5% from current levels. Kelley deemed Penn’s first-quarter results disappointing. It appears market participants agree as the shares are off 38% year-to-date. In Kelley’s view, ESPN Bet is part of the problem.

We think ESPN Bet’s high-cost structure increases both the time to scale and execution risk, despite lowered guidance,” observed the analyst.

ESPN Bet debuted last November. At that time, there was optimism the refresh would help Penn win market share in the hyper-competitive US sports wagering landscape while potentially becoming a more credible threat to larger rivals. To date, that hasn’t played out.

Market Share Woes for Penn Entertainment, ESPN Bet

In addition to the dual headwinds of low revenue and elevated fixed costs, Penn’s ESPN Bet unit faces the specter of low market share. Bank of America’s Kelley forecasts the app will command 4% of the market in the states in which it’s available, well below the 10% initially expected.

While Penn’s core competency is operating regional casinos, the hefty price the gaming company paid to Walt Disney (NYSE: DIS) for use of the ESPN brand has prompted investors to apply more scrutiny to the sports betting side of the business.

With shares of Penn flirting with the lowest levels in nearly four years, Kelley shifted his view on the stock to “deep value turnaround” from growth opportunity. As reflected by options market activity, some traders are extoling bearish views on the gaming stock.

“Despite calls still outpacing puts, options traders are turning bearish toward PENN. This is per the equity’s 50-day put/call volume ratio at the International Securities Exchange (ISE), Cboe Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), which stands higher than all readings from the past 12 months,” according to Schaeffer’s Investment Research.

ESPN Bet Not Only Problem for Penn

ESPN Bet isn’t the only point of concern for Kelley and other market observers that are less-than-enthusiastic on Penn.

The company is in the midst of an $800 million upgrade cycle focusing on the M Resort in Henderson, Nev., as well as the Hollywood Columbus in Ohio and two Penn casinos in Illinois. While enhancements to those venues could pay long-term dividends for Penn, the regional casino operator could experience a significant increase to its debt burden to finance those projects.

Bank of America’s Kelley estimates Penn’s leverage will climb to 6.3x next year, marking a roughly 50% jump from the levels seen in 2021.

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