An Update On Boyd Gaming

| About: Boyd Gaming (BYD)

I have written about Boyd Gaming (NYSE:BYD) a few times over the past couple of months. On February 25th, I said to buy BYD ahead of legalization of online gambling in New Jersey. I also suggested that investors buying Zynga (NASDAQ:ZNGA) for exposure to online gambling were focused on the wrong stock and that it was Boyd that would actually significantly outperform ZNGA as it had more exposure to online gambling and it was trading at a significant discount to its peers. At the time of my original article, BYD was trading around $6.50 and since then it has returned a cool 77%.

BYD reported Q1 2013 earnings and I wanted to update anyone that is still long the stock. In another article, I broke down the components (asset sales, focus on outperforming properties, online gambling) that I thought would make this a stock that could run to the $20s by 2015. It even had the classic buy signal: a downgrade from Goldman Sachs when it was trading at $8 in the beginning of this year. If you follow any of my writing you will know how I viewed this downgrade (i.e., it's most likely completely bogus and intended to create a buying opportunity for the firm). True to form, it created one helluva buying opportunity.

Let's recap the value argument I laid out at $6 to $7 and see if anything has changed:

(1) Asset sales would shed underperforming assets and reduce expenses:

  1. Dania Jai-Alai was sold for $66 million
  2. Echelon site on the Las Vegas strip was sold to the Genting Group for $350 million in cash

The net impact from these sales should result in an EPS boost of $0.25 as a result of lower expenses.

(2) Strategic acquisitions of outperforming assets should improve top line and bottom line results:

  1. Acquired Property - Peninsula Gaming

    In November, BYD completed its acquisition of five Peninsula Gaming properties, which generated $134 million in revenues and $50 million in adjusted EBITDA. Annualized these properties should contribute close to $500 million in revenues and $200 million in adjusted EBITDA and significantly boost free cash flow. This was a home run acquisition for the company.

(3) Online gambling legalization in New Jersey and Nevada would provide long-term catalysts for the company.

In my opinion, BYD is in line to benefit the most out of any other casino operator, including Caesar's (NASDAQ:CZR), MGM Grand (MGM) or Zynga, from legalization of online gambling in New Jersey. I expect the lion's share of revenues from online gambling to fall to the Borgata and as a result, to BYD. While MGM owns the same 50% stake as BYD does in the Borgata, MGM is valued at almost 6X the valuation of BYD so the impact is far less.

If the NJ market plays out like the US online poker market in the mid 2000s, 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.

Management discussed online gambling briefly in the conference call for Q1 earnings:

  • "Looking ahead, we are well-positioned to take advantage of several significant long-term growth opportunities, including our agreements with the Wilton Rancheria Tribe in northern California and Sunrise Sports Entertainment in south Florida. Both of these partnerships could provide significant growth opportunities to our company in the next several years.
  • We're also quite optimistic about the potential of the emerging domestic online gaming market. We intend to be among the first that offer online gaming in the state of New Jersey and are confident that the Borgata brand will allow us to capture substantial share of this lucrative market. We are evaluating the opportunity to offer online poker in Nevada as well and are determining the best way to enter what is shaping up to be a robust, yet crowded market.
  • But New Jersey and Nevada are only the beginning. Legislation to legalize online gaming has been introduced in several states, including Illinois, California, Pennsylvania, Massachusetts and New York and lawmakers in other states are considering it as well."

Comparison of Valuations:

What had and still has me most excited about BYD, though, is its valuation. Namely, it trades at 5.5 times trailing twelve months free cash flow. Isle of Capri Casinos (NASDAQ:ISLE) and Penn Gaming (NASDAQ:PENN) trade at 6.2X and 13.8X, respectively, and Ameristar Casinos (NASDAQ:ASCA) was recently purchased for 5X free cash flow. However, my calculation does not take into account the benefit from Peninsula Gaming, a recently acquired asset that should contribute $500 million in revenues and $200 million in adjusted EBITDA and significantly boost free cash flow. Conservatively, the acquisition of this property reduces the price to free cash flow to 4.0, making it cheaper than any of its competitors by a good amount. Additionally, the long-term upside from online gambling makes this still a very cheap stock despite its recent 70% run.

Note on the Markets And Economy:

As a side note, I have been very bullish about the markets since 2009 and continue to be bullish about them. I believe the combination of improving housing markets, credit markets, and the improving European and Japanese economies over time will create tailwinds for the markets. Toss in an endless supply of naysayers and I think there is the recipe for higher stock prices for the next year or more. For the past 4 months I have said that the best way to play this is through buying beaten down stocks like BYD, Sony (NYSE:SNE), YRC Worldwide (NASDAQ:YRCW), Travelzoo (NASDAQ:TZOO), and Nokia (NYSE:NOK), among others, as they all have exposure to consumer spending and improved US, European, and Japanese economies. I thought some comments from BYD management in the most recent conference call confirm my thinking on this and I wanted to share them:

"While the first quarter results exceeded our expectations, the last several years have taught us to be cautious about reading too far into the future. Previous recoveries have become uneven or lost steam due to unforeseen events. But at this moment, we are cautiously optimistic about the economic trends that started to form late in the quarter and the overall direction of our business. Customers have started to adapt to higher taxes and the uncertainty from Washington. Tax refunds began arriving in bank accounts and investment portfolios have grown as the stock market reaches all-time highs.

In Southern Nevada, the unemployment rate has dipped below 10% and the pace of job growth has been accelerating, running almost twice the national average in January and February. The housing market in Southern Nevada continues to recover as well. Prices for existing homes in Las Vegas are up more than 30% year-over-year and new home sales are rising as well. That is helping rebuild the balance sheets and the confidence of local residents. And there is more than $6 billion in new development either underway or on the drawing board on or near the Las Vegas Strip. This is the highest level of construction activity we have seen since the Great Recession began and should provide further stimulus for the local economy for years to come.

Across the central part of the country, economic conditions remain stable. These markets recovered more quickly than Las Vegas and their unemployment rates are generally below the national average. We are optimistic that conditions should remain relatively healthy in our Midwest and South markets in the months ahead.

And at Atlantic City, the recovery from Sandy appears to be strengthening as the market enters its historically busy summer season."

Disclosure: I am long BYD, NOK, SNE, YRCW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.