Managing a successful business in the domestic casino industry can be tricky, considering the discretionary nature of spending and cyclicality of this market. Although some industry giants, like MGM Resorts International (MGM) or Pinnacle Entertainment Inc. (PNK), have sustained their financial volumes over time, this is not the case of Caesars Entertainment Corp. (CZR). Ever since the 2009 recession, the company has been struggling to pay off its debt and generate free cash flow, causing investment gurus like Howard Marks (Trades, Portfolio) and Richard Perry (Trades, Portfolio) to sell out their company shares. Will this firm be able to regain its once powerful domestic market position, or will it sink under competitive pressures?
More Casinos, Less Market-Share
With 52 operated casinos in 13 U.S states and seven countries, Caesars is the largest domestic casino company, as measured by U.S. gaming revenue. The firm depends on the U.S. market for 95% of its revenue and cash flow, with Las Vegas as the main cash booster (35% of sales), and operates under the Harrah’s, Caesars and Horseshoe brands. Over the past two decades, casino licenses in the U.S. have become more and more common, resulting in a scenario of 900 commercial or Indian-owned gaming facilities, spread out in 30 states. Caesars suffered particularly under this licensing proliferation, as it lost significant market share, and same-location sales dropped 8% in 2012 in its regional casinos.
The stiff competition has negatively affected the company’s growth figures since the 2009 recession, and in 2012, five of the firm’s six operating geographic regions experienced revenue declines, totalling a negative 18.3% rate for the end of that fiscal year. A worrisome aspect is Caesar’s debt level, which has been considerable since Apollo Global Management LLC (APO) and TPG’s 2008 leveraged buyout of the company. Due to the stagnant cash flow generation over the past few years, the casino operator has not been able to recover from nearly $21 billion debt. Furthermore, another recession could cause EBITDA margins to drop by more than 20%, making the company unfit to comply with any interest expense payments.
Although Caesars' financial sheet is looking very weak, the company is sure to gain over $100 million in incremental EBITDA by 2017, due to the recent approval of a federal online gambling legislation. However, the downward trend of this metric, halting at a negative 57.5% for fiscal 2013, is quite worrisome, especially considering the damage that could be sustained from another financial crisis. The last recession had U.S. casino gambling revenue down by 10%, and 20% in the Las Vegas Strip market. These declines, combined with non-existent cash flow could put the company in serious danger of defaulting. Additionally, increases in gaming taxes, regulatory issues over gaming licenses, and the legalization of online gambling could cause the negative 18.3% revenue growth to drop even further.
Another aspect which makes me very bearish about investing in Caesar’s is its negative metrics regarding shareholder returns and earnings per share. While EPS was booming in 2010, with a 20.35% growth rate, these numbers plummeted in 2012 to negative 11.9%, and have not been able to recover since. As for returns on invested capital, these have averaged less than 3% over the past three years, and fell to a negative 2% in fiscal 2013. Despite expectations for growth over the next decade, due mainly to a sharp increase in hotel room pricing and leveraged fixed costs, I believe this company’s long-term profit is too unclear for a solid investment. Also, the current $21.90 stock price is extremely overvalued considering the firm’s grim financial balance sheet.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.