Tuesday, July 19, 2011

The Future Of Nevada Gold & Casinos, & Sitting On My Ass...


The statement above is one of my favorite quotations, and is actually something that I wrote on the inside of my front door with permanent marker... just so I have to look at it virtually everyday (I can have a thick skull, and really wanted the point to sink in). I believe that this quote can be applied to one of my favorite investment ideas at the moment: Nevada Gold (UWN).

It seems that the problem with how value investors in regard to their investing in Nevada Gold, is that they generally look through it's previous financials and talk about how terrible results have been, then, they talk about how terrible their debt load is. However, if you would ask that same value investor how they should value a company, the likely answer would be "Well, you calculate all future cash flows and discount them to the present." The problem, is that for whatever reason, when looking at this company, they don't seem to ever heed their own advice!

Nevada Gold is a company that has under gone one of the largest transformations that I could imagine. If you look at the assets it presently has, very few were there when present management took over just a few years ago; they have been on a buying and development spree, which should be getting ready to pay off greatly. While last quarter they only earned 2 cents a share, I believe that they are getting ready to do much better, and that the future possibilities are not valued into the price of the stock. In fact, I will argue that the coming year's worth of earnings are not valued into the stock, as it is trading at ~16x forward earnings- provided that they earn 10 cents a share over the next year... This is a scenario which I believe is achievable, especially if you exclude any potential one time charges which may be related to items such as acquisition costs.

Before I go on talking about the future of the company, here is a recent interview with Bob Sturges (the CEO of Nevada Gold). It's about an hour long and is well worth a listen. It can eliminate (literally) hours of scuttlebutt and industry readings. Plus, it goes to show just how competent of a CEO he is. I challenge anybody to find a management team of a company that is this small, which is also as good at these guys... In fact, it wouldn't be a stretch to say that management is in the top tier of the entire gaming industry.

Now that you listened to the radio show, lets take a look at how the newly acquired casinos are preforming...

Here is the data from the card rooms located in Washington State for 2009, 2008, and 2007.

If you look at just the 6 casinos that make up "Washington II", they had revenue of $34 million in 2009 (before being owned by Nevada Gold), with a significant amount of operational losses... This year, they are making UWN money and doing so with marginally more revenue. According to their most recent filing, the company generated $29.6 million in additional revenue from the Wasington II casinos when coupled with the restaurants and the ATMs that came with them (in a period of just over 9 months). Considering that 2009 was murderous for the revenue of many casinos and that the ones that were bought by Nevada Gold came from bankruptcy, it is amazing what they have been able to accomplish. In many of the properties, the revenue figures had been dropping off since at least 2007. Looking at the ebb and flow of the various casinos in Washington, it is easy to get a good feeling for things to come.

When looking at the the results of Washington II for 2010 (the year ending April 30th) the casinos generated $34.9mm in revenue and made $1.6 million. While it could be said that the recent profitability of the company is related to an increase in revenue, this is not wholly the case. The company has stated conference calls that it laid off administration that came with the recent acquisitions. I would imagine that a lot of the previous revenue decreases were due to the financial distress of the previous owners (you can't employ top notch people and reinvest in the properties if you are in or getting ready to go into bankruptcy). Additionally, Nevada Gold makes all of it's employees go through hospitality training to make the gaming experience as good as possible for clients-they take your money with a good demeanor about them, I suppose! Additionally, the company has better tracking software and rewards programs, which will help integrate the properties and increase future profitability. Now that the casinos are solidly profitable, it is reasonable to think that the company can attract even more patrons.

Lets look at the revenue figures for the state, looking at card room revenue for the past few years, which end in December.

Number of card rooms: 82
Revenue: $57.8 million

Number of card rooms: 91
Revenue: $56.5 million

Number of card rooms: 98
Revenue: $62.5 million

Number of card rooms: 101
Revenue: $72.4 million

Number of card rooms: 103
Revenue: $71.25 million

When looking at these numbers, it seems that the company will be able to grow revenues in a way that beat the average casino. The industry has obviously been consolidating over the past few years and when looking at the data of card rooms, last year over 1/2 of them lost money (a lot of which, are now owned by UWN). Given the amount of previous losses, it seems that there may be more consolidation... When coupling this, with the fact that industry revenues have room to grow as the economy improves, this should bode very well for Nevada Gold.

Since the company has been preforming admirably, it rightfully feels able to take on more responsibility. They recently signed a contract on a new casino which, they announced closing on today (July 19th). Owning the Red Dragon Casino gives them a monopoly in the Mount Lake Terrace market. Previously, the casino went from earning $.66mm on just over $6mm in revenue in 2007, to loosing ~1/2 a million dollars in 2009 on $4.3mm in revenue. They paid $1.25 million for it... If they can do to this casino what they did and are doing with the others, it is entirely possible that this allocation will be bought for roughly the cash flow that it generates in just a couple of years! It should be more profitable due to lower administrative costs and advertising efficiencies, alone.

When a company is turning around as rapidly as this one is, lenders often take note. In the interview I posted above, Sturges notes that the company is in talks with numerous well known lenders. If the company is able to lower their interest on debt payments (presently, they pay in excess of 10% in some cases), it would be very good for the company's bottom line. Additionally, it would free up cash for another acquisition. Even if the company doesn't restructure it's debt it has over $5 million in cash on hand and looks as if it will generate well more than the $4 million it needs to pay off all the debt that matures next summer. Even if for some reason either of these scenarios don't play out, the company owns a few buildings and a whole lot of land, which, could be sold off to generate cash (the land is presently listed for sale). As I mentioned earlier, I think that the Red Dragon acquisition shows just how confident the company is that it will be able to make good on it's obligations that, and the new casino should generate some cash in the next year, which won't hurt at all. Potentially, it could generate cash close to amount used in the cash portion of the purchase: a paltry $400K.

If the company's history of acquisitions proves to hold true in the future, every additional acquisition that the company does will bode extremely well for results. This is especially true in the Washington market, where they already have the best infrastructure in the state to take on more projects. Casinos that don't make sense for virtually any other operator to run can work quite well for UWN... and if the numbers that Washington state is putting out are any indication, there are not going to be very many operators in a position to bid against Nevada Gold- I certainly doubt that many have the competencies that UWN possesses in regard to running a large and growing organization. One major advantage that the company has as a public entity, is the ability to issue stock for acquisitions.

Normally, value investors are weary of a company using stock to acquire additional business with, given it's dilutative effects. In the instance of Nevada Gold, I think that it can, is, and will continue to work quite well. If the company is trading at a multiple of EBITDA (or, any combination other metrics you feel is valid when calculating intrinsic value) that is higher than that of the entity that they are acquiring, I would support them using nothing but stock to purchase other operators with, as, it would make my shares more intrinsically valuable. They have stated in numerous conference calls that they will remain diligent in their acquisitions... Honestly, when they talk of competitors doing irrational things and their philosophy of acquiring entities, they sound about like Warren Buffet or Prem Watsa would if he were a gaming executive. Don't believe me? Check out the conference calls for yourself... Plus, you will get the pleasure of hearing my voice during a few of the Q&As. ;)

If the company earns 10 cents a share in the next year, the stock is essentially trading at 16x the coming years earnings. I believe that this is has the potential to be a conservative estimate. I also think that 16x earnings for a company that is constantly improving and has so many options available to it, is dirt cheap. Here is a list of potential catalysts: Restructuring of debt (very likely), payment of the Buena Vista note (too far out to know), development of the Las Vegas Motor Speedway project (I'd imagine, better than a coin flip), legalization of video slots in Washington (?), a new management contract, more mini-casinos, improvement in the Washington gaming market, a mega acquisition in Nevada or elsewhere, sale of the land in Colorado, or any other event, it spells good news for the company and likely, the stock price.

There are a lot of other things that I like about Nevada Gold. The management team is top notch. The stock (and company) and company are small with a ton of room to grow. If it continues to grow, analyst coverage could help it gain exposure (and in turn, price and liquidity). Additionally, if it makes it to the size where it will be invested in by indexes, ETFs and the like, that could make for a nice pop in demand for shares. Once it has a full year where it earns money, I would imagine that the investing public and more mutual funds will be a lot more willing to look at and invest in the company as well. I figure that we will have a profitable previous year's worth of reporting in 2 quarters (or, for the period that ends this October), which based on last year's filings, will be reported in December... Which is fine with me. It has made it easy for me to buy shares without a lot of competition.

While not a typical Graham style investment, you could likely sell the company off piece by piece and have a decent protection of principle, where, you likely wouldn't lose much (and potentially, would make money). This is Phil Fisher growth, with a ton of catalysts that are not factored into the stock price, and has downside protection-all for very reasonable price... All I have to do now is sit on my ass. ;)

Disclosure: I am long UWN. This is not advice of any kind. Always do a ton of your own research in regard to anything that I say, do, write, or so much as even think about.

2 comments:

Chris said...

Jeff,

Good post. One thing I think you should make clear is that GAAP earnings don't tell the whole story. Management is going out and buying businesses (casinos) that are asset light. Generally they are just leases + personal property. So after they do the purchase accounting they end up booking a lot of intangible value. This intangible value needs to be amortized in reporting GAAP earnings, but really is just a fictitious distortionary charge IMO.

jeff said...

Chris,

You raise a great point. I think that your comment fully addresses the issue, so, there is no need to alter the article :)

To further your point, they recently impaired their casino in CO, which present management had nothing to do with the purchase of. This made the company take the best out of a former allocation blunder.

BTW. To anyone reading this: check out the blog that Chris has. It is worth a read.