Elie Rosenberg is a value investor based out of Dallas, Texas. He is the founder and editor of valueslant.com
Full House (FLL) is a manager and owner of regional casinos that recently made a potentially company changing acquisition. Due to the finite nature of their management contracts, Full House has a shifting mix of assets that the market has perennially discounted. The recent acquisition of a more permanent casino asset that is their largest to date might be a catalyst for Full House’s intrinsic value to be more fully reflected in their share price.
On the management side, Full House’s primary asset is a management contract with a Native American tribe that owns FireKeeper’s Casino in Battle Creek, Michigan. The model is that Full House helps the Tribe get the casino approved and built and teaches the tribe how to run the casino. In return FLL receives a percentage of profits in the first several years the casino is open. (LACO is the other public company that is active in Indian casino management). There are several advantages of the management model for a company like Full House:
- Exposure to casino profits without taking on the debt burden to build the casino or the ongoing operating expenses of the casino, both of which the tribe handles. )However, often the management company will lend the tribe some start up capital to get the project financed.)
- Native American tribes receive tax benefits relative to their competition in the form of lower gaming taxes on their casino revenues, which flow through to the management company’s cut of the profits.
Full House owns 50% of a joint venture in the FireKeeper’s management company that receives 26% of net income from FireKeeper’s (i.e. Full House gets 13% of the total net income). The contract runs for seven years from the opening of the casino in August 2009, leaving five years remaining. FireKeeper’s has performed strongly, generating about $10 million in net income for FLL. FireKeeper’s had been the only casino in the area until February, when Gun Lake Casino opened only about 40 miles away. FireKeeper’s has not been impacted thus far by the new competition, but this is a concern. FireKeeper’s is currently building a hotel next to the casino, which they hope will help with marketing.
Indian casino management contracts are typically not renewed, as the goal is that by the end of the contract the tribe will be self sufficient. This leaves management companies like Full House in a perpetual search for new deals. In May the company announced a new three year consulting agreement for an existing Indian casino in New Mexico. An agreement to help run an existing casino does not have the large upside of advising on a start up, but it also does not bear the risk that the casino project never generates revenues to pay the manager. This deal has a guaranteed $1.2 million in consulting fees a year with unspecified incentives for profit improvement at the casino.
FLL bought Stockman’s Casino in Fallon, Nevada in 2007. This is a small 8,400 square foot casino with 264 slot machines, but it is the largest in the Fallon market. The casino has struggled in the economic downturn, but still did $2.4 million in EBITDA last year and through six months this year has a $2 million EBITDA run rate.
The big news for FLL is the April acquisition of the Grand Victoria Casino & Resort in Rising Sun, Indiana. FLL bought the 300 acre property for $43 million from Hyatt. The resort originally cost $143 million to build and has undergone $57 million in capital improvements since opening. The property generated a little over $8 million in EBITDA for a 5.1X purchase multiple. Regional casino assets generally go for 6-8X EBITDA. The discount appears to be the result of a motivated seller and the looming threat of a major casino being built in nearby Cincinnati.
In Q2 Grand Victoria surprisingly generated $3.2 million in EBITDA. Management attributed this to a change in marketing strategy that focused on their best customers. However, they were cautious to note they are unsure whether this run rate is sustainable. On top of this upside suprise, Grand Victoria stands to benefit from an imminent change in Indiana law. Indiana, with a few exceptions, only allows riverboat gaming such as the Grand Victoria. To comply with this law, the riverboat casinos need to be river-going vessels staffed with a maritime crew. The Indiana State Senate has passed an amendment that would remove this requirement and allow the riverboat casinos to be permanently docked without a maritime crew. This amendment has gone to the Governor, and it is expected he will approve it. FLL estimates this will immediately save them $1 million a year in operating expense.
These positive developments have to be tempered by the threat of the $400 million Cincinnati casino. However, the Cincinnati opening has now been pushed into 2013. And while it is hard to imagine Grand Victoria will be unaffected, it is possible the casinos will appeal to different audiences. Grand Victoria is a resort in a rural setting, while the Cincinnati casino will be in the heart of the city.
FLL also signed an agreement in June to lease and operate the casino at the Hyatt Lake Tahoe. This property is currently generating $1.7 million in EBITDA after lease expense. This is a five year lease agreement, but the company has said the expect this to be a perpetual lease opportunity.
The management contracts are best valued with a discounted cash flow due to their finite length, so it seems a sum of the parts analysis has to be used to value all of the assets of FLL. I use a 5X EBITDA multiple for the casino operating assets, which is a discount to regional casinos that are trading in the 6-8X range. It seems the market at least thus far has put a discount on FLL due to the management/owned asset mix. On the management contracts I discount the cash flows at 10%, which I think is fair given the strong track record at FireKeeper’s and the fact that the New Mexico casino is operational. As the operating asset cash flows do not include corporate level operating expense, I also attached a 5X multiple to the corporate expense.
The stock is fairly cheap to a conservative valuation, but there are overhangs of the threat of increasing competition on the ownership side and the need to eventually replace the large FireKeeper’s contract on the management side. There is a clear secular trend towards new regional casino openings as strained states look for incremental sources of revenue. That is a mixed blessing as it could make it easier for FLL to find new management contracts, but will be the source of increased competition for FLL’s owned casino assets as well as potentially hurting profits at their managed casinos. Given the risks, I would prefer a larger margin of safety to the point where a safe investment would not be dependent at all on the company finding new management deals. FLL seems to be a well run company with a compelling business model