I’m glad I did an in depth breakdown of my FLL thesis, because there are some things I did that turned out to be grossly wrong. Luckily, I knew in the back of my head that I wasn’t going to hit the nail on the head so I tried not to overreach on assumptions. My numbers for the FireKeeper’s contract were way too low, but I missed the boat on the Grand Victoria acquisition almost entirely in terms of deducting the EBITDA or EBIT figures. While I think the company is less undervalued now that there is more light on the Grand Victoria acquisition, there appears to be less downside risk.
The bulk of the thesis was that on a sum of the parts, peer, and absolute valuation the company was undervalued. To redo a back of the envelope SOTP calculation, Stockman’s is worth $14m (7x EBITDA), Grand Victoria is worth $43m (purchase price), and the GEM contract has a NPV of ~$40m ($10m annual payments through August 2016 with a 10% discount rate - management finally broke that out in the most recent earnings announcement) with $21.5m in net debt for a net value of $75.5m. I think this represents the prices that would be received if the company liquidated tomorrow in an orderly fashion.
This isn’t a huge discount to the current market price, but that partially hinges on valuing the Grand Victoria acquisition. Full House purchased the asset for 5x EBITDA, so it would defy rational thought to expect the market to turn around and apply a 7x EBITDA multiple to it. Recent developments indicate that Grand Victoria’s results might prove more resilient if not stronger relative to the past. My initial take was that the GV acquisition price implied that management was pricing in a huge drop in revenue and earnings. This turned out to be wrong. Hyatt Gaming, part of the Pritzker business empire, has been trying to sell the property for several years not, not just in light of upcoming competition from Cincinnati. I also totally messed up deriving the EBITDA and earnings of GV. Grand Victoria generated about $8m in EBITDA in 2010, not $8m in net income as I assumed. With that disclosure by management though, it also appears that the $8m EBITDA figure is going to be more attainable in the future. The closer to the $8m figure Full House is able to achieve post 2013, the higher valuation the market will accord to the property (closer 7x+ EBITDA instead of the paid 5x). The nice thing is that even if this doesn't happen, the price paid might end up being close to 7x normalized EBITDA.
One thing discussed on the conference call was Indiana passing legislation to reduce the required maritime crews on riverboat casinos. Previously, despite remaining permanently moored, casino riverboats still had to meet regulations for water vessels. The Indiana Gaming Commission has to approve the casinos actually reducing such staff. If the staff reductions are approved, starting July 1, 2011, Grand Victoria’s costs will be reduced approximately $1m according to management. There are tweaks management is making as well, such as converting more hotel rooms into suites. The 2010 EBITDA of $8m compared to 2010 wins of $100m(IGC figure, doesn’t include hotel, food, or beverage revenue) implies 8% EBITDA margins, which is low. Assuming a lower market share of 10% of wins (currently 14%) and the $181m drop in casino revenue projected to be taken from the 3 Indiana riverboat casinos from the casino in Cincinnati, the Grand Victoria would still generate $4m in EBITDA or 10.5x its purchase price.
The downside risk from that scenario coming to fruition is not only limited by the already demonstrated opportunity to lower operating costs, but what now appears to be wrangling over the terms of the Cincinnati casino. Currently, construction has stopped on the site as the owners and government officials argue over tax rates. While it will likely just push out the opening date a few months, it gives management more time to maximize unnormalized earnings until either very late 2012 or early 2013. Indiana is also going to try to keep the casino owners investing in their properties to continue to attract patrons and tax revenues as a result, as evidenced by the maritime crew changes. This is just gravy, but it will help the business.
This could just be narrative fluff, but I have considered an additional benefit of the Grand Victoria acquisition that is being ignored. After talking to a young guy living within the market of the Grand Victoria who enjoys gambling, I realized that the opening of the Cincinnati casino will likely have a disproportionate effect on the revenues of the 2 larger riverboat casinos it competes with – Hollywood and Belterra. The person I spoke to laughed when I mentioned the Grand Victoria and said that he would never go there. He and his friends prefer the Hollywood Casino, which is far bigger and glamorous. That demographic – the ones preferring the glitz and glamor of the casino as a nighttime/weekend outing option over a simple place nearby to gamble after work or during the day – is going to flee the casino that currently suits their taste for the even more glamorous Cincinnati casino. I can’t quantify this and only time will tell if this translates into stronger revenue and earnings.
Another tidbit mentioned on the conference call was the potential for additional management contracts. The FireKeepers management contract has been producing 64% EBITDA margins, which is incredibly high. This has attracted the attention of casino managements (including bondholders) trying to turn around their operations. FireKeepers has given Full House a very good piece of proof to tout if approached over a management contract. This isn’t anything to bank on, but it does present additional upside since it would require little capital and generate a lot of cash flow. It is also worth noting that FireKeepers has experienced practically no negative effects in light of the opening of the Gun Lake Casino.
One worrisome development was the approval of a motion to increase the number of authorized shares for the company. Full House did use a stock offering to partially finance its acquisition of Stockman’s, which didn’t result in the share price falling much. Management stated that they have the capacity to announce another deal by the end of the year, but it wouldn’t be completed until 2012. They provided some further light on what they would look for in an acquisition, namely a low multiple and management already in place. While it bears consideration, this risk is mitigated by the intelligent acquisition of Stockman’s and Grand Victoria. While acquisitive management can be worrisome, management hasn’t done anything stupid in the 5 years it has had an acquisitive stance. On the face of it dilution would be a negative due to what I perceive as an undervalued stock, but a stock offering to finance acquiring an undervalued property would net out the effect while providing a more diversified earnings stream that would be more highly valued. The current environment is filled with distressed or heavily indebted casino owners (Harrahs/Ceasers, whatever they call it) and tons of peers have high leverage ratios. They also have tons of excess cash from the FireKeepers contract including debt service, so there is also the potential that cash will be a large component of future acquisition and either modest additional debt or modest share issuance will finance the remainder. The combination of Full House's modest leverage, rock bottom interest rates, and a distressed environment increase the likelihood that any acquisition will be a net benefit.
Additionally, here is an interview with the CEO about the company from 2004. It’s outdated, but gives some nice background on the company if you are interested.
It might be tenuous to count the FireKeepers contract as traditional EBITDA (although all the proceeds drop through to net income) but Stockman’s and Grand Victoria are generating about $10m in EBITDA right now and FireKeepers is generating at least $10m in FCF. The stock trades at an EV/EBITDA+FCF of less than 5x compared to the 7-8x range of its peers, many of which have higher leverage ratios. The core thesis that the uncertainty regarding Grand Victoria is causing the market to ignore the earnings power of the business remains intact, albeit with a slightly lower upside potential. In addition to upside from business as usual though, newer catalysts that aren’t priced in or crucial have emerged in the potential for additional management contracts or much better Grand Victoria results than expected.
Disclosure: Long FLL
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