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Full House Resorts, an underfollowed small cap with strong earnings and a low valuation
Posted by: Frogs Kiss (IP Logged)
Date: March 13, 2011 02:23PM

Full House Resorts is an ever-changing company with a small track record. In the resulting confusion, the underlying value of its assets is not being reflected in the stock price. The core of Full House consists of three assets: its Stockman Casino in Nevada, a 50% stake in a casino management contract at FireKeepers Casino in Michigan, and the awaited closing of its acquisition of the Grand Victoria Casino in Indiana. Full House is an attractive collection of assets that are trading at an overly pessimistic price.

A Peak Over the Abyss: A Brief Look at the Downside
While it appears the market is unaware of the upside from the Grand Victoria Casino, let’s briefly assume this acquisition falls through. The company has already deposited $5m in a non-refundable escrow account, which no value will be assigned. Ignoring a few more million dollars that the company earned from a management contract in Delaware that ends in 2011, the company has earned $14.5m in EBITDA and $7.7m of net income in the past year from its Stockman Casino and FireKeepers contract. The company has $13m in net cash, a market cap of $77m, and an enterprise value of $64m. So even ignoring the acquisition of the Grand Victoria, the company trades at a fair price of 4.5x EV/EBITDA and 10x earnings (8x if you net out the cash). Since the investor is well protected on the downside, it is time to see if there is anything on the upside.

Asset and Valuation Summary
Stockman’s $1m net income + GEM’s $10m net income + Grand Victoria’s $3m net income - $3m in corporate costs (net attributable to company) = $11m net income Stockman’s $2.5m EBITDA + GEM’s $12m EBITDA + Grand Victoria’s $8.6m EBITDA - $3m in corporate costs (net) = $20m EBITDA

The company will also receive approximately $2m in net income for the remainder of a management contract it has at a Delaware casino that expires in August, 2011.

There are 19.3m shares outstanding and a current price of $4, for a market cap of $77m. The company trades at 7x normalized earnings and 5x EV/EBITDA.

This ignores 2010 and 2011 earnings from its contract at a Delaware casino which are ~$3m and ~$2m respectively.

A look at the company’s assets:
Stockman’s Casino

Stockman’s Casino is located in Fallon, Nevada. Fallon has a Naval Air Station. The town and casino are essentially built around its existence and it provides a solid recession resistant economic anchor. It generated $2.5m in EBITDA in 2010. In 2010, its slot machines accounted for 23.5% of the slots in Fallon and their share of slot revenues for 2010 was approximately 31.5%. This shows its relative popularity. There are 9 casinos in the market and the company considers 3 of them to be its main competitors, all of which are smaller. While this is not the Bellagio, the casino is the in the market and is doubly recession resistant as a casino and its location in a military town. The casino did lose some sales in 2009 and 2010, but maintained profitability and seems to be rebounding. In recent months, there have been YoY improvements in revenue, which bodes well for future results, but I won’t make any assumptions on the degree.

Stockman’s Casino also provides evidence for the management style and their execution of acquisitions. It was acquired in February, 2007 for $28m. At first glance, for an asset now generating $2.5m in EBITDA it looks like a failed acquisition. As part of the acquisition, the company also got a hotel that it was able to sell in February, 2008 for $7m, so the net purchase price for the casino is $21m, so the casino itself was bought for around 8.5x 2010 EBITDA. The company didn’t break out the earnings on Stockman, but I calculate EBITDA to have been around $5m in 2008, so the acquisition was done at a valuation of around 5.5x EV/EBITDA. The acquisition was done in February, 2007 – before even the Bear Stearns hedge funds imploded – at a reasonable multiple and even after the world went to hell in a hand basket, the company has done alright with the acquisition. Keep this in mind when examining the Grand Victoria acquisition.

FireKeepers Casino /Gaming Entertainment Michigan (GEM)
GEM is 50% owned by the company and is a JV that developed and now operates the FireKeepers Casino in Battle Creek, Michigan. GEM agreed to help finance the construction and part of the deal was that they would then manage the casino and earn a portion of its revenue. Especially if the casino is a tribe’s attempt to better their lot, they need help with the initial capital and know-how to do so. Laws governing Indian gambling only allow a limit of 7 years on management contracts, but it is the big incentive for companies to come in and stump up capital and expertise to get a casino up and running. The contract to run the casino will expire in 2016 and will very likely not be renewed. The contract is generating about $10m in net income annually.

FireKeepers is much larger than Stockman’s Casino - Stockman’s has 47,000 people aged 25+ in a 50 mile radius – with 1.1m adults within 50 miles. In February 2011, the Gun Lake Tribe opened a casino in Grand Rapids, a little over an hour away from FireKeepers. Economics 101 – supply and demand – means that FireKeepers will see decreased demand. The Gun Lake casino is smaller. For example, it has 1,400 slots compared to FireKeepers 2700. FireKeepers is also in the process of constructing a hotel – to which Full House has no financial obligation – that will be a further draw and also be a perk for the more free spending wealthy types that will cost nothing to add from Full House’s perspective.

There’s also competition further away in Detroit and Toledo will get a casino within several years time. The Detroit casino has existed for a while. FireKeepers still maintains a favorable position in Battle Creek, Kalamazoo, and arguably Lansing (based on distance) even with the new Gun Lake Casino. The uncertainty in outcome is exaggerated because there is not an overall glut of casinos in the area. There is certainly increased competition, but the overall market dynamic is still one of localized monopolies and regional duopolies or oligopolies depending on the direction you drive in. It is still too early to see the effect, but management has a pulse so they are aware of it.

Grand Victoria
Full House has a definitive agreement to acquire the Grand Victoria Casino & Resort, in Rising Sun, Indiana at the intersection of the Kentucky, Indiana, and Ohio borders. The deal is fully financed and should close within 2 months at the latest. They are purchasing the property from Hyatt at what appears to be a very cheap price. The feuding of the Pritzkers, who own Hyatt, might partially behind the price, but there is a whole new slate of casinos set to open up nearby in Ohio, most importantly in Cincinnati.

The Grand Victoria is smaller than FireKeepers, but the company controls the assets 100%. The property was built for $143m and has $57m in capital improvements. In addition to the casino, the property has a 201-room hotel with some meeting space, theatre, and 18-hole golf course. Management has no stated intentions with the non casino aspect – note that while they sold the hotel attached to Stockman’s, that property was in the middle of a city – but they are potentially valuable hard assets the company could sell off to pay down debt quickly.

For all of the above, the company is paying $43m for the property (excluding $8m in cash and net working capital balances) consisting of $19m in cash and is using debt for the remainder. The debt carries an interest rate of LIBOR + 550 bps. They have a term loan of $33m and a revolver of $5m already approved.

Since Hyatt is private, there is little disclosure about the earnings of the company other than “the purchase multiple is expected to be approximately 5x.” It is 5x earnings on the $43m or is it EBITDA or does it include the $8m? I don’t know. For the sake of conservatism, lets assume it is 5x EBITDA on $43m, so the property generates $8.6m in EBITDA. Assuming they use the entire term loan and revolver and end up paying 8% interest, that is $3m (On the most recent conference call, management said they expect interest to fall between $2.3-2.5m). With a 40% tax rate, it generates $3.3m in net income excluding D&A, which is minimal for the continued operation of a casino (my numbers are likely understated because of the exclusion of D&A, which would be included in the pretax number, ultimately lowering the number that taxes are calculated from). There might be some debt taken on with the acquisition, but as the next paragraph will discuss, it will likely not be very large.

The Grand Victoria has been in longstanding competition with the Hollywood Casino (formerly Argosy) in Lawrenceberg, Indiana and Belterra Casino in Florence, Indiana. Hoollywood is the largest of the three. From a presentation I found on the Indiana Gaming website, Grand Victoria produced $24m in EBITDA and had $6.6m in capex in 2003. Their estimate for 2006 (in 2003) was $34m in EBITDA and $4.5m in capex. Also, judging from the long-term debt repayment at Grand Victoria, I don’t believe that the company is acquiring too much in the way of additional debt with the Grand Victoria, although it hasn’t been disclosed. Their 2006 estimate was to have LT debt paid down to $36m. Between the projected 2006 and 2010, the company likely continued to pay down debt, although the actual number now is unknown.

While I believe my projected EBITDA of $8.6m is low, I don’t think that these historical figures will be attainable as there is increased competition – the actual figures predated the opening of the Belterra Casino. While the casino has not exactly been mismanaged, management at Full House likely believes they can increase EBITDA margins. In 2003, Grand Victoria only contributed 5% of Revenue and EBITDA to Hyatt, so it is possible the more focused attention of Full House will allow the company to increase margins. I don’t incorporate any assumptions of that in my valuation.

Management has been competent with their execution of the management contract at FireKeepers. According to one of their presentations, the marketing fore FireKeepers consisted of a billboard on the freeway and the sending out of 50,000 cards, which has resulted in a customer list of 500,000 people. As previously discussed with Stockman’s and just from the general direction of the balance sheet, they have been aggressive in paying down debt.

One great thing about the company is that Lee Iacocca owns 5% of it and is on the board. The founder of the company Allen Paulson, who recently passed away, was a friend of
Iacocca and he brought Iacocca into the business. Andre Hilliou, the CEO owns a little over $1m worth of shares, which is about 2x his annual compensation. The CEO is 63 and Iacocca is now 86, which might pose a more abstract threat, but the executive suite does have people who have been at the company for several years.

There are only 13 full-time corporate employees, 6 of which are senior management. This is an increase of 30% from the 10 people who worked there in 2007, but the company now has the FireKeepers contract and is acquiring Grand Victoria. This indicates that management runs a pretty tight ship, likely a positive benefit of Iacocca’s presence.

Potential Acquisitions and Lack of Historical Record
Management has indicated that they would take advantage of opportunities to acquire asset or engage in development projects if they were comfortable with the valuation. Normally this would be annoying, but the execution has so far been solid on the casinos and they haven’t overpaid. There are only 2 data points – Stockman’s and Grand Victoria – to go off of, but both fit a margin of safety/value framework.

While the company itself lacks what a value investor would consider a long track record of earnings, they have a record of operating casino operations. Their assets, except the FireKeepers casino, have been around for a while. The Grand Victoria was built in 1996. FireKeepers opened up in 2009 and is now earning $10m for the company. While I don’t think management has done anything to deserve the label of morons, one would be hard-pressed to find a moron incapable of making money operating a business that faces little competition and is psychologically addictive. The economics of the casino business, as well as the presence of Lee Iacocca, should give one confidence that the earnings are not transient. The company has done a great job at incrementally increasing the normalized earnings power over the past several years.

The one risk with the Grand Victoria is that the agreement states Full House cannot use the Grand Victoria name. They have 6 months to transition to a new name, but have indicated they plan on doing this as soon as they can when the acquisition closes. This might have a short-term effect due to the confusion, but the economics of a casino seem pretty overwhelming and there are few alternatives in the area.

While there already seem to be a few casinos slated to open as government revenue generators and job creators, this does not mean than no more will be planned starting 3-5 years out. This is a risk with most businesses – that new competitors will emerge. Casinos are highly regulated by the government, and many states ex. Nevada view it as a revenue generator. While several casinos might maximize revenue, states also have to contend with negative sentiment towards casinos.

Once the acquisition closes, the earnings from the Grand Victoria should begin to flow through the balance sheet. While this might be met with skepticism as a casino opening in Cincinnati looms, the earnings are real. The threats of the Gun Lake Casino and a casino in Cincinnati are real, but the stock price is already reflecting a very pessimistic view. Full House is not like a local supermarket and these casinos are Walmart moving into town. The company’s casinos will continue to generate earnings and the company will remain solidly profitable. The casino business is pretty resilient and

Full House resorts is a company that possesses excellent economics and strong normalized earnings going forward. Its recent acquisition of Grand Victoria has not been fully recognized by the market and it will greatly increase shareholder value over the ensuing months. At a modest valuation to the earnings power of the current assets and low valuation to the earnings power of its current assets plus the Grand Victoria, the company should receive a more suitable valuation as its earnings become more apparent to the general market. The overly pessimistic view of the market is assuming that casinos don’t possess the strong competitive position that they have and Full House will fail to earn an adequate return on its investment.

Disclosure: Long FLL

Stocks Discussed: FLL,
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