Bank of America Downgrades Penn Entertainment Amid ESPN Bet Performance Concerns

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On Monday morning, the stocks of Penn Entertainment (NASDAQ: PENN) nudged slightly higher, resiliently braving an unflattering downgrade by Bank of America. This critical assessment, prompted by fears that the profitability of Penn’s ESPN Bet unit could take longer than anticipated to be realized, injected a degree of caution into the investment climate.

Bank of America analyst, Shaun Kelley, penned the noteworthy message to his clientele, downgrading Penn Entertainment from an encouraging “buy” to a more lukewarm “neutral”. Further reflecting this cautionary approach, he cut his price target on their stock radically – from the optimistic $28 to a more conservative $17.50, suggesting a potential growth of a meager 8.5% from present levels. He pointedly expressed his disappointment over Penn’s first-quarter results which, evidently, spread through the marketplace, resulting in a 38% decrease in the company’s shares since the year began.

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With a complex mix of disappointment and foresight, Kelley opined that ESPN Bet, which launched just last November, was a significant part of the problem. “We think ESPN Bet’s high-cost structure increases both the time to scale and execution risk, despite lowered guidance”, he noted.

Ironically, at the time of its advent, many believed that ESPN Bet would be a game-changer for Penn in the American ultra-competitive sports betting landscape. Hopes zoomed as high as the stratosphere that it would enable Penn Entertainment to grab a larger market share, potentially positioning it as a strong contender against larger rivals. Unfortunately, these buoyant expectations have failed to materialize thus far.

A daunting task lies ahead of Penn Entertainment and its ESPN Bet wing, struggling against a turbulent whirlwind of low revenue and mammoth fixed costs. Kelley postulates a 4% market share for the app, a bleak prediction far removed from the initial exhilarating vision of 10%.

Penn’s core area of expertise remains the operation of regional casinos, but the sizable sum of money it handed over to Walt Disney (NYSE: DIS) for employing the ESPN brand has provoked investors to cast an increasingly discerning eye over the sports betting segment of the business. As Penn’s shares hover at their lowest in nearly four years, Kelley revised his opinion on the stock from an emerging growth prospect to a “deep value turnaround”.

Options traders also suggest bearish views on the gaming stock, despite calls still overshadowing puts. The equity’s 50-day put/call volume ratio on exchanges like ISE, CBOE, and NASDAQ OMX PHLX projects a figure higher than any recorded in the previous year, a warning flag that warrants cautious deliberation.

As the market’s gaze intensifies over the fate of the beleaguered ESPN Bet, one must take a moment to recognize that this is not Penn’s sole concern. The company is currently engaged in an ambitious $800 million renovation spree, which includes the M Resort in Henderson, Nev., the Hollywood Columbus in Ohio, and two of its casinos in Illinois. While these upcoming enhancements could yield long-term returns for Penn, they also come with a hefty price tag. The hefty financial load required for these projects looks set to inflate Penn’s debt burden significantly. Kelley predicts an ascension of Penn’s leverage to 6.3x in the coming year, a daunting increase of nearly 50% from last year’s figures.