I’ve made no secret of the fact that my favorite set up for value creation is a stock trading well below book value combined with a management team committed to returning cash to shareholders through share repurchases (it’s what attracts me to ASFI so much).
With that in mind, I was intrigued when I stumbled on this share repurchase announcement by TWOC. While U.S. listed, the company is a casino operator focusing on the Czech Republic. Yahoo Finance pegs them as trading at just over half of book and under 10x earnings. As you can imagine, all of these only made me more interested. The whole description screams “value opportunity.” Let’s go through a quick check list
- Hated industry? Check (cyclical, dependent on consumer spending in a crappy economy).
- Trading on the “wrong” market? Check (It seems companies with foreign listing tend to trade for lower valuations due to investor “neglect”).
- Great value metrics? Check (half of book, low P/E, repurchasing shares).
So I decided to do a bit of digging. And I definitely liked what I found.
First, and perhaps most importantly, there’s some incredibly strong insider ownership here (see proxy statement). The CEO owns over 5% of shares, a director runs a fund that controls almost 40% of shares, and Wynnefield partners filed a 13-D and owns almost 25% of shares. Put it together and there’s a lot of incentive for insiders to improve shareholder value.
Second, the balance sheet sheet is rock solid, with cash almost completely covering total liabilities and easily multiplying debt.
Third, the company is turning in solid results. Despite a small decline in revenue for the first nine months of the year, the company’s operating income actually increased. That’s pretty impressive for a business with as many fixed costs as a casino, and points to strong management.
Unfortunately, despite the improvement in operating profits, shareholders will not be seeing as much cash and profits as they did last year.
The answer is simple. And it’s the reason I generally avoid casinos. Take a look at this chart from its 10-K.
What happened is the company paid gaming taxes but not corporate taxes.
The government decided it needed more money, so it raised taxes on TWOC. Now, TWOC has gone from effectively a 0% corporate tax rate to a 50% tax rate.
And that’s the big problem with casinos: They’re always at the whim of politicians. If politicians need money, the first place they look is to tax a casino. If a casino is doing well, the first thing a politician thinks is tax it or bring in a competitor who will promise a lot of jobs. And heaven forbid a politician who doesn’t like gambling comes into office.
Thus, a casino's performance is always at the mercy of its lobbyists.
And that’s why I decided to stop digging further into TWOC.
Of course, there are positives here, and I bet an investment at today’s price would do pretty well. At about 12x trailing earnings (adjusted for the new taxes), with a big net cash balance, and the tailwinds of an eventual European recovery, TWOC represents an outstanding risk-reward on the numbers. And I’ve seen Wynn successfully push for special dividends before. The odds definitely seem to be on a potential investor’s side.
But it’s too far out of my circle.
Disclosure- Long ASFI