In my previous article, Buy Boyd Gaming Hand Over Fist, I suggested that as a result of a core focus of the company on gambling markets that are working while shedding non core, underperforming assets, combined with a focus on online gambling, the stock could be worth multiples of where it was trading at: around $7 per share.
While the top line results for Boyd Gaming (BYD) were weak in its earnings report, there were many silver linings. First, the company was able to shed two underperforming assets in Dania Jai-Alai and Echelon.
In comparing BYD with Zynga (ZNGA), another company that has been hyped as a beneficiary of online gambling, I think the choice is obvious: BYD has licenses for an online gambling operation in two states while ZNGA just has a popular free app but no approval for online gambling. While ZNGA could eventually obtain a license, it will come at a cost: they will either have to purchase a casino that already has a license in each state that online gambling is legalized or they will have to partner with someone that has a license and split profits with that company. Both options come at a significant cost in terms of higher expenses or reduced profits.
Sold for $66 million to Dania Entertainment LLC. BYD management stated on the conference call that this property was operating at a $4 million annual loss. Removal of this property should boost EPS $0.05 going forward.
The sale of this property includes the 87-acre land lot as well as any improvements to the site. BYD will take a non-cash impairment charge of $994 million as a result of this sale and they will increase cash by $157 million after paying a portion of their proceeds to LVE Energy Partners. On the conference call the company projected annual savings of $16 million associated with storage costs, insurance costs, and property taxes that they will no longer have to incur. This should boost EPS $0.20 going forward.
Additional Asset Sales
As BYD continues to do a complete makeover of its company, additional assets sales are to be expected…or so management would have you believe. On the Q4 2012 conference call, in response to a question about what other things the company is targeting to reduce debt, COO Paul Chakmak stated:
"I think we're not going to lay out the specific plans just like we would on a historical basis do that. I think we continue to be very focused on improving the balance sheet; we have a lot of initiatives that we are considering implementing over the near-term future that will accomplish that. And so that's what we're going to really focus on and we'll let you guys know as we kind of accomplish those rather than lay them out today."
With licenses in Nevada and New Jersey, two states that have legalized online gambling, BYD stands to benefit as much or more than any other company. In New Jersey, BYD owns a 50% stake in the Borgata, New Jersey's premier hotel and casino. The state of New Jersey is only allowing online gambling to those users with an established account with companies that have a casino license and who are physically present in their state. As a result, this gives the Borgata a huge advantage over competition because it is by far the largest player and the most well recognized brand in Atlantic City. And if history serves as any guide, the leader in any market will garner the bulk of the online gambling revenues. For example, in the US poker market the leading site garnered 40% of the revenues because players gravitate to sites with the most players. They want to be able to log on to the site and be assured that the tables are full. No one likes to play in a poker room with one or two people at a table.
If the same holds true with New Jersey's online gambling market, then the company with the most recognized brand will most likely be the one to garner the largest market share. The size of the market is open for debate but Dennis Farrell at Wells Fargo estimates the state of New Jersey to generate $1.5 billion in annual revenues from online gambling by 2015. I think this is reasonable given New Jersey's demographics and the expected popularity it will have with smartphone users. Remember that when online poker was available in the US, there wasn't the proliferation of smartphones like there is now so the popularity could be far greater than it was at the peak last decade.
If the NJ market plays out like the US online poker market in the mid 2000's, then it is reasonable to assume that the Borgata could generate up to $600 million in annual revenues from online gambling (or 40% of Dennis Farrell's estimate of $1.5 billion). Half of that would go to BYD, which means a potential boost of up to $300 million in annual revenues, assuming Mr. Farrell is correct (at the end of this article, however, I use a lower estimate to be conservative). Keep in mind the margins that online gambling possesses are far greater than traditional casinos, so a large chunk of these revenues will flow to the bottom line. For example, in 2009 Pokerstars was producing an estimated 35% net profit margin. The passage of online gambling in New Jersey could be quite a shot in the arm for BYD, as I detail at the end of this article.
The Kicker: PokerStars.com
Earlier this month, the US casino industry asked the state of New Jersey to ban Pokerstars.com from returning to the U.S. market. Pokerstars and FullTilt, now under the same parent company, own roughly 50% of the online poker market. Both companies were sued by the Justice Department in 2011 for fraud. The Justice Department claimed they used false billing codes to process bets by US residents after online gambling was barred by Congress in 2006.
The impact that this could have on the remaining players is huge. PartyPoker.com, which is owned by bwin.party and which owns a rough 7% market share, is a partner with BYD and MGM, whereby BYD would receive 10% ownership of the partnership in the event of passage of online gambling in the US. The online poker market in the mid 2000's was roughly $7 to $8 billion per year and, again, because of the proliferation of smartphones in my opinion it could be significantly larger than $8 billion, perhaps as high as $15 billion. It's reasonable that PartyPoker.com would gobble up a good chunk of the market share that PartyPoker.com has if they are banned from operating in the US. This is all dependent upon Congress legalizing online poker, of course.
Valuation is Cheap
What had and still has me most excited about BYD, though, is its valuation. Namely, it trades at 3.5 times free cash flow. Isle of Capri Casinos (ISLE) and Penn Gaming (PENN) trade at 6.2X and 13.8X, respectively, and Ameristar Casinos (ASCA) was recently purchased for 5X free cash flow. And my calculation does not take into account the benefit from Peninsula Gaming, a recently acquired asset that should contribute $400 million in revenues and $150 million in adjusted EBIDTA and significantly boost free cash flow.
I believe the market is also underestimating the benefit that legalization of online gambling will have on BYD. If we assume that the Borgata garners a 30% market share and the overall market grows to $1 billion by 2015 (33% less than what Dennis Farrell is estimating) then BYD would get 1/2 of $300 million in revenues or $150 million in revenues. Assuming slightly lower net margins than what PokerStars experienced in 2009 of 30%, BYD could generate $45 million in net profits from online gambling in New Jersey alone. On its current share count, that would result in $0.52 EPS. Add this to the current estimate of $0.65 EPS for 2014 and adjust for some modest growth and its easy to see how BYD could be generating $1.25 to $1.50 EPS in 2015.
Why the market is fascinated with Zynga, which doesn't have any gambling licenses, or Caesar's (CZR), which has an atrocious balance sheet and is losing money hand over fist, is beyond me. BYD has cash flow generating assets and licenses to operate online gambling in two states. I'd recommend buying BYD under $8 if you can with an eye for much higher prices over time.