Tropicana Entertainment Inc. was formed from the remnants of Tropicana Entertainment, LLC which went bankrupt in 2008. Famed investor Carl Icahn brought the company out of bankruptcy in 2010 and used a company subsidiary to purchase the Tropicana Casino in Atlantic City, which had earlier been lost to creditors. As part of the reorganizing process, an entity associated with Mr. Icahn provided $150 million in exit financing (at a healthy coupon of 15%!). After selling or closing a few under-performing properties, Tropicana now owns and operates seven casinos across the US as well as one in Aruba. Carl Icahn owns 67.89% of shares outstanding.

I don’t write this post to encourage investing in casino companies. Many investors (myself included) choose to avoid the sector for reasons of ethics and social consciousness. I present this post more as a case study in how large unlisted companies can remain cheap and over-looked, especially post-bankruptcy.

Since exiting bankruptcy, Tropicana has operated successfully, generating GAAP profits totaling $22 million and free cash flow of $46.9 million for fiscal 2011 and the three quarters since. The company successfully refinanced its exit facility, replacing it with a $175 million term loan facility from UBS as well as a letter of credit facility. The new term loan facility is LIBOR/corporate base rate-based with a 7.50% floor, quite an improvement over the previous 15% rate. Interest savings from this refinancing are not fully reflected in trailing four quarters earnings, so I present a pro forma trailing four quarters income statement below. Revenue, sales and operating costs are actual historical figures, while interest and tax expenses have been adjusted for current balance sheet figures. All one-time items have been removed.

Tropicana’s balance sheet is strong, with $79.2 million in net cash. This is notable when most of Tropicana’s competitors in the casino industry are heavily debt-burdened. Many of these competitors paid the price during the last downturn with firms like Las Vegas Sands falling to less than $2 per share on fears of bankruptcy.

Tropicana shares go for around $15, giving the company a market capitalization of $395 million and an enterprise value of $316 million. On an adjusted EBITDA of $87 million, the company’s EV/EBITDA ratio is a scant 3.63. Tropicana produced $33.65 million in free cash flow in the last twelve months for an 8.5% free cash flow yield.

Ratios like these often point to a promising investment, but it’s usually prudent to suss out the market’s opinion of a company’s quality and prospects by comparing its valuation with its competitors. I found 11 public competitors that operate mainly in the US, ranging from giant Las Vegas Sands to tiny Nevada Gold & Casinos. First, a look at profitability ratios. How efficient are Tropicana’s operations, compared to competitors? The chart below compares revenues to EBITDA and operating income, each of which are adjusted for one-time items like goodwill impairment.

From this comparison, it’s easy to draw a few conclusions.

1. In the casino industry, there are some benefits to scale. Revenues and EBITDA margin are correlated at 0.47. Tropicana’s largest competitor, Las Vegas Sands, converts 31.07% of its revenues to EBITDA. At the other end of the spectrum is Nevada Gold & Casinos which converts only 10.84%. Interestingly, operating income is much less predictable with a correlation of 0.32. The difference in depreciation & amortization as percentage of revenue may have to do with the relative ages of casino properties. A newer, expensively built casino will have a higher depreciation figure than an older, cheaper casino, even if their revenues and operating expenses are similar.

2. Tropicana is a mediocre operator. Tropicana’s EBITDA margin of 13.67% falls below the median figure of 18.60%. Tropicana’s operating margin of 8.64% fares better but still falls below the median figure of 9.57%.

Why are Tropicana’s operations sub-par? The company’s segment data from the most recent quarterly statement shines some light on the issue.

Tropicana’s East Coast operations are the heart of the problem. While all other regions produce results ranging from acceptable to excellent, the Tropicana Atlantic City performs poorly. It’s not a surprising result. The Atlantic City gambling industry’s struggles are well-documented, with a declining and aging clientele and increasing competition in nearby Pennsylvania and New Jersey. What’s more, damage from Hurricane Sandy was extensive and the city and industry face a long road to recovery. For the trailing 9 months, revenues from the Tropicana Atlantic City made up 44.5% of Tropicana’s total revenues, but only 19.1% of operating income before corporate-level expenses.

While Tropicana is not a a premier operator, it is also not the worst. And it has arguably the strongest balance sheet in the industry. Despite this, Tropicana has the market’s lowest valuation ratios, and not by a little!

The mean and median EV/EBITDA ratios for Tropicana and its competitors are 9.65 and 9.34, respectively. (And 10.20 and 9.65 if Tropicana is excluded!) Tropicana’s trailing EV/EBITDA of 3.63 represents an incredible 60+% discount to these average valuation metrics. The market is giving Tropicana no credit at all for its large excess cash balance and improved operations.

If Tropicana were to trade up to a market average 9.50x EBITDA valuation, its shares would go for $34.42, 129% higher than current levels. Then again, there are good reasons why Tropicana should not be valued at the industry average including its illiquid shares, single controlling shareholder and its weak Atlantic City operation. However, even valuing Tropicana at 6.65x EBITDA, a 30% discount to the industry average, would yield a share price of $25, 67% upside.

Much depends on what Carl Icahn intends for the company and especially how he chooses to invest the company’s cash. Mr. Icahn’s Icahn Enterprises Holdings purchased 733,047 shares of Tropicana in November, 2012, bringing Mr. Icahn’s ownership up to 67.89% from 65.01%. Perhaps he will engage in an acquisition strategy, rolling up smaller casinos and building scale. Or maybe he will eventually increase his ownership of Tropicana to 80%, qualifying for the dividend received deduction and using the company’s free cash flow to make distributions to his holding company.

Disclosure: No position.