Sunday, October 2, 2011

Interview of Bob Sturges, CEO of Nevada Gold.

A week or so ago, I was fortunate enough to have the opportunity to interview one of the most talented gaming executives that you will come across: Robert (Bob) Sturges of Nevada Gold. The following post contains a mix of the interview and my commentary. As my commentary is interjected with snips from the interview, I may well have made some inferences that I should not have or are inaccurate. If you are wanting something that has little to no bias, check out my recording of the interview which does have a few edits due to problems with my software and to help the overall flow of the interview... from me to you, for your listening pleasure. :)

I'll go ahead and tell you that I have purposely omitted our discussion of the pending legislation regarding the legalization of the video lottery in Washington state (video lottery, loosely meaning slot machines in non-tribal casinos). The reason being, I am working on another post that specifically adresses the subject. It is such a huge topic, with such vast repercussions for the company (potentially, well more than doubling their revenue) that I feel it is best to split apart from rest of the interview.

As always, here is the legal mumbo jumbo that I more or less lifted from the company's website:

This interview may contain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We use words such as "anticipate," "believe," "expect," "future," "intend," "plan," and similar expressions to identify forward-looking statements. Forward-looking statements include, without limitation, our ability to increase income streams, to grow revenue and earnings, and to obtain additional gaming and other projects. These statements are only predictions and are subject to certain risks, uncertainties and assumptions, which are identified and described in the Company's public filings with the Securities and Exchange Commission.

Now, on to the interview...

The first thing that I asked of Bob, was for him to tell us a little bit about his background. This is something that I have previously addressed in other posts. Honestly, the more that I hear about him, the more that I am impressed. Sturges, originally a young lawyer, became the chief prosecutor of organized crime in New Jersey. After working his way through the gaming regulatory agency in New Jersey, he left and began working as both a lawyer and a consultant in the gaming industry, saying that "The actual practice of law was really not anywhere near as interesting to me as the business world". During this time, he attracted the attention of none other than Ted Arison (the founder of Carnival Cruise Lines), who was Bob's business mentor and came to refer to Sturges as his "right hand man".

Additionally, he spoke of previous experience with a $30 million dollar EBITDA riverboat project, as well as a "million dollar a day casino, up in the Toronto market". This is something that is always nice to hear that the CEO of a small but growing gaming company has experience with. Once Carnival sold off assets to Penn National Gaming, he was slated to be the Chief Operating Officer of the acquiring company, but parted ways, largely due to his family being located in Southern Florida. Through his consulting work, he eventually came to cross paths with Nevada Gold. After the board asked him to be the CEO of the company, he then tapped Jim Kohn from knowing him through Carnival to come in as CFO. At the time that his newly assembled team came in, it was no stretch to say that the company was in shambles; the team had to do a ton of work to make the company stop bleeding money. After paying off their previously thought insurmountable amount of debt, they had hoped to use the capital markets to borrow money to grow a great business. Then, came The Great Recession, as a result, they needed to be a lot more creative in their purchasing; largely, this has involved the use of seller's paper, rather than traditional lending from various banks.

After the introduction and talking about the various members of the management team, who when combined, have experience in well over 20 gaming jurisdictions, I asked a question that was give to me by a reader, which is also coincidentally one of my favorite's that Phil Fisher would ask: "What other operators do you admire?" After careful reflection, Sturges mentioned Steve Wynn and Ted Arison. He first talked of billionaire Steve Wynn, referring to the tight ship that he has historically run, as well at as his "tremendous track record". When listing various qualities (of operators in general), mentioned items such as the attention to detail and focus on the bottom line, saying, it " something I learned from Ted Arison, who was really a master in that regard... He was an incredibly successful businessman, and that's something I have tried to implement here, and always followed as a philosophy. Let's put ego aside, let's not do stuff to make ourselves feel good or because we make emotional decisions, but, because we see it really building our bottom line."

Struges also noted that he liked to see stability in the staff of an organization. He is a person who considers himself to be nurturing, yet serious- not very "Hell-raising" in regard to his managing style. I then asked his intent with the company (in terms of his working time horizon), to which he gave me the impression of being in for the long haul. Specifically saying it would likely be his last job, that he had a 5-7 year time horizon, and that he wanted to see the company become a big player- all the while implying that his holding of stock and options are a huge incentive for him to do good things with the company.

Who knows? He's by no measure an old executive and at the ripe young age of 63, may well have more than just 5-7 years at Nevada Gold. Obviously, with the newly filed S-3, he is incentivized by these very options to not do anything stupid, such as blow company resources on an overpriced acquisition. He later characterized the S-3 as "a weapon in our arsenal, that for the right opportunities, for this to be waiting on the shelf... it's something that we've got 3 years to decide what to do with it, and we just thought that it would be a good weapon to have, without any preconceived notions about when, where, and how it's used." These, plus the rest of what he said about the registration, should put weary shareholders to rest about the ill-effects of any potential dilution.

The new credit line with Wells Fargo is going to be entered into, giving the company breathing room with the due date of their debt, despite being at roughly the same interest rate. The real kicker here, is that Wells Fargo has expressed an interest in a long term relationship, especially for the right deal, as they like what the company has done and is comfortable with the management team. While the deal has yet to close, an announcement will be made with the terms. Given that the company was shopping the deal around to several banks (per various conference calls), it is likely that the held out for the best deal and implied banking relationship. It isn't like Wells Fargo is a stranger to lending to gaming operations.

When I asked Sturges about the status of the Las Vegas Motor Speedway project, it came out that the new owners of the property, Rialto, are indeed the guys with strong ties to home builder Lennar. Despite Whitney Tilson being bearish on home builders (and, I would presume developers of virtually anything), I view this as a net positive for the development, as they have a lot of experience with property development. Just because the outlook is bearish on a price to value ratio with one (well, actually, numerous) fund managers, doesn't mean that the people that are involved in the development of properties dont' know how to develop; which, in my mind, is all that matters in this scenario with Nevada Gold. If there is anything that we can learn about Rialto, it's that they actually do know how to get stuff done.

While the previous contract for the project is with the previous owners, and, more or less done with, it does seem that the prospects for the development are getting juicier for Nevada Gold. In this press release, the company noted that it is attempting to negotiate a greater equity stake and management contract. Sturges made sure to say that the company is willing to take on minority stakes where they can also get a management contract in order "to control our own destiny", with no interest in simply buying a minority stake and not being able to ensure that operations run smoothly (and profitably).

Additionally, I questioned him about the ~$250K in the company's latest 10Q that were allocated to "Capitalized Development Costs". While Sturges wasn't readily able to answer the question and readily admitted it, rather than bumbling around about it; which, to be fair, is a question that is much more suited for the CFO the company. He emailed me the response of "The 250k is comprised of expenses associated with the Las Vegas Speedway project and licensing expenses in Nevada and a few other minor expenses." I view this as a net positive, as the company has more or less tapped out the total amount that they were contractually bound to spend under the old contract. This spent money may give UWN a degree of leverage that they can use in the new negotiations. After all, if they have spent money on things for the project, why would the new owners want to re-spend the money on the same thing? While I don't know exactly what the money was spent on, I would imagine that there was a certain amount of time dedicated to the items that the money was spent on. If this holds true, I would also imagine that Rialto would like to have a quicker process for the development. Nevada Gold has no learning curve whatsoever for this project, which any other company coming into the project would have.

Moving along, I asked about the process for getting a gaming license in the state of Nevada. Sturges estimated that the company is "well past the 1/2 way mark". Basically, this means that around the beginning of 2012, they should have a license. In this vein, the company is still actively looking for deals "where we can exert operating leverage" and more specifically, due to capital constraints, they seem to feel comfortable making an acquisition in the $10-$15 million dollar EBITDA range.

One thing that I found of interest was the company's imagination for uses of the land in Colorado, located off of the Central City Parkway. While presently in an appraisal process (for mineral rights and such), the company had the thought of potentially using it for a golf course. Sturges pointed out that the carry on the property was only $20K, so, they are waiting for the right opportunity to dispose of it. Regardless, from talks I have had with a person in the area, it is apparently a really pretty parcel of land. Don't believe me? Travel the whole thing via Street View on Google Maps.

Moving along to Washington, Bob had actually just returned to Texas from a trip to the properties in Washington state. We talked about the sorts of things that he goes through on his regular trips to the Pacific Northwest, which occur "at least once a month". Items such as day long roundtable discussions with the general managers of the properties and various company executives, visits to the gaming sites, and updates as to the politics going on in Washington occupied the bulk of his 3 day visit. He mentioned that the company continually does hospitality training (they are doing a refresher course after having one just a year ago) - Sturges saying "I'm not a believer that training is a one shot deal... that you do once a decade or once every 5 years. It's gotta be a constant process to remind everybody- top of mind awareness, that we are in the hospitality business."

As previously mentioned, he visited every property in the eastern part of the state (which make up the vast majority of the company's card rooms) to personally verify that the properties are preforming and looking as they should be, and to also get a feel for the customer experience.

One of the items that I had previously suspected, but finally got the chance to verify, was that the company doesn't have to put a whole lot of money back into the properties. In fact, despite giving a face lift to 2 of the properties (Mill Creek and Seatac) to get rid of what Sturges described as a "half baked tropical theme, that used to be in there from the old days", the company only allocated a $250K budget for the properties for the year. This is a big deal, as it certainly sheds light on the future cap ex expectations that the company will need... "They're not very capital intensive" according to Sturges. If you look at the recent depreciation and amortization expenses for the past few quarters, a lot of it comes from things such as customer lists, and is in excess of $425K for just the last quarter, after taking out $62.5K (1/4 of $250K in yearly cap ex, also deducting some stuff like the capitalized development costs)... Furthermore, when asking about the accounting for such maintenance, Sturges said that it was a combination between repair and cap-ex... so, in my mind, an even greater amount of the cap-ex on the balance sheet can come through to the owners of the company company, as some was of the maintenance was already expensed.

While the EBITDA margins of the Washington 1 casinos are ~20%, he does not believe that the Washington 2 properties will be able to get up to the same margins due to geographical differences in the properties- the Washington 1 properties, mainly being in the west, less densely populated part of the state, have a different set of economics. However, he does seem to believe that the Washington 2 properties have a lot of room left to run, with a goal of 75% of the EBITDA margins that Washington 1 presently operates at... or, roughly 15% EBITDA margins, which, still leaves a lot of room for operational improvement.

After talking about margins, we moved on to the financial performance of other card rooms in the state. Sturges noted that there is at present, a great deal of financial distress in the card rooms of the state, and as a result there could be more buying opportunities. While more than receptive to expanding in Washington, especially since the company presently has great infrastructure for taking on a greater role in gaming market of the state, he noted that "We keep our eyes open for sure... to buy something at what we call 'a reasonable multiple'... the only caveat I have in my own mind is, becoming a totally Washington based gaming company. We really would like to keep some level of geographic diversity and not put all of our eggs in that basket." He mentioned that 3-5x EBITDA "seems reasonable", though, there could be exceptions.

And, pretty much, that's it... other than the talk of slots, which, as I have already mentioned, deserves it's own post. So, come back in a few days (or, just add me to your reader program of choice via RSS) to read about it. The coming post is ~90% finished, I just have to do a touch more research and number crunching.

I am sure that it comes as no surprise from this, and my previous postings, that UWN is my favorite stock at the moment. They have a really bright future that I believe I have not paid a single cent for. I believe that due to a lack of understanding about a host of things (management, acquisition criteria, income vs. cash flow, certainty of contracts, debt issues, and others) in regard to the company, Mr. Market has been perpetually discounting the security. For me, it is amazing that the company can borrow money at interest rates that are solidly in the double digits, and still cash flow like crazy- which, not only shows how selective they are in acquisitions, but also how good of operators they are.

While a lack of coverage is frustrating for the company (after all, it was mentioned by Bob), I find comfort in the fact that the stock is almost totally uncovered in the press, the blogosphere, and even in message boards. Generally, it seems that my best ideas have been small, uncovered, and unloved. Until suddenly, they weren't.

Disclosure: I am long shares of UWN. This is not advice or a recommendation 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.


Josh said...

Great interview! Thanks for posting. Why does the company have to borrow at such high interest rates, double digit, right?

jeff said...

Seller's paper is often a way to sweeten a deal for the seller's of a business and as such often carries a high interest rate. As a good example, remember the debt that SNS (now, BH) issued to the holders of WEST's common stock?

In regard to the bank debt bearing a high interest rate, I would imagine that it is due to the fact that the company is buying assets that need to be turned around. From the perspective of a lender lender, they would likely be a little skittish, and would want to be compensated for the risk I would take on. After all, when there are casinos with a history of profitability, that is a lot easier to justify when assembling a loan portfolio. I would imagine that once UWN has a year or 2 of profitability, their borrowing rates will fall drastically (if nothing else, it should happen when a lot of their stuff is done being amortized in a few years).

That said, as an equity holder, I obviously don't see there being a whole lot of risk in them defaulting on their debt, as I am behind their lenders in the event that they manage to navigate the straights into a bankruptcy. ;)

Saj Karsan said...

Thanks, Jeff. Good interview. I see that you are very positive on the stock, but when I look at the financials I don't quite get why you are so confident that this management team can deliver above-normal returns on capital. Are you looking at their records running the companies you discussed at the beginning of the interview? (I have not)

As an observer, I just get the impression that the company is focused on growing profits through growth and acquisition, not necessarily through profitability. But I could be way off; just trying to figure out why you believe the future is so bright relative to how things stand at present.

jeff said...

I am very confident in their management team, because of their previous experience, but, also due to how they have acquired present properties. Look at what they bought (I mean, actually look at where they disclose the specific numbers for each property, when they bought them) and look at what they bought them for. Then, compare that to the results after they took control. They do actually improve the properties performance.

This company is totally different than it was a little over a year ago; even more so if you look at 2-3 years...

It is true that in large part, they will be growing both revenue and profits through acquisition; and that is fine with me, since they have a good record of acquiring profitable operations on the cheap AND they have previously outlined a strategy for expansion that I like. I am confident that they won't be making an acquisition that doesn't make a lot of sense.

They have a lot of things going on right now, which, if any of them go, will be huge for the company. (I have previously written about a lot of them)

Furthermore, as something I like, you can look at the potential in Washington: 1) They just bought a casino for $1.25 million. This is a casino which should do more than $4 million in revenue quite soon (a number that you can find from historic results) and if they get the thing up to just the 10% EBIDTA margins that most of their other properties are already starting to surpass, it will be a great deal for the company.
2) There is still room to run with the bulk of their casinos in Washington; they are working on improving operations there... Especially in the 6 casino that they closed on about a year ago.
3)You add in the potential that a legalization of slot machines would have (the chance of, you are presently not paying a cent for) and you have some tasty "icing on the cake".

Check out that write up here:

This investment requires a bit of digging thought SEC filings, as, there are some things (like amortization of customer lists, to the tune of ~$1m/year) that suppress earnings. Arguably, that is part of why I like it so much, as people tend to pass by it simply because the financials look bad on the face of things... Despite this, they are starting to cash flow nicely; last quarter, despite losing money, they cash flowed a nice bit after adding back in the costs/investment in the Red Dragon (in the worst quarter in the Washington gaming market mind you).

Does that help out?

Saj Karsan said...

Yes, makes sense, thanks!