As we waited for Youbet's (UBET) 3Q09 conference call to begin yesterday, a surprise press release crossed the wire: Churchill Downs Incorporated to Acquire Youbet.com, Inc.
For all of the reasons detailed in our prior posts, we didn't expect to see a near-term sale to Churchill Downs (NASDAQ:CHDN). That said, YB's results came up short versus our expectations with the economy and other risk factors somewhat derailing our thesis.
- Instead of Y/Y handle growth on the back of new content relationships, handle of $121.3 million was flat Y/Y. Moreover, margins came in lower than we anticipated on "an increase in player incentives and track fees". The latter is no surprise, but we suspect the former is creeping higher as YB's battles other ADW players to acquire/retain customers (*management cited success: 14% Y/Y increase in new customer acquisitions and a 6% Y/Y "in the average number of active weekly wagerers on the platform").
- G&A is running higher on "increased legal fees and other costs related to the investigation of various strategic and business development opportunities."
- Online (ADW) segment EBITDA was $2.4 million, down 40% Y/Y. For the total company, EBITDA from continuing operations was $2.9 million versus $5.5 million in 3Q08.
- Finally, although the company's net cash position increased to $8.4 million ($0.19 per share, +$5.7 million Y/Y) from $5.6 million at 6/30/09 and $2.7 million one year ago, free cash generation is running below our reduced expectations of $10-12 million this year. The company did not repurchase shares during the quarter as we'd hoped, presumably because of discussions related to today's news.
The results stand in contrast to a more aggressive Churchill Downs, which previously reported 3Q09 Y/Y revenue and EBITDA growth of 33% and 31%, respectively, for the company's online segment. In the report, Churchill cited a 43% Y/Y increase in handle wagered through TwinSpires.com "driven by access to new racing content that was not available in the third quarter of 2008, an increase in customers and higher average daily wagering". Based on the 43% increase, Youbet's 3Q handle, and assuming flat Y/Y ADW handle (versus overall industry decline 10%), we estimate Churchill's share increased to 21% from 14% in the year ago with Youbet holding steady at 31%.
Thus, YB's relatively new management team is seemingly waving the white flag of surrender to join forces with Churchill, which was late to the online game and only built a foothold by purchasing AmericaTab in mid 2007. At that time, Churchill paid $86 million (assuming $6 million earn-out was paid) for properties generating annual handle of $175 million (purchase multiple of 0.49 times) and revenue of $44 million (1.97 times).
The proposed Youbet acquisition carries the following terms:
- CDI would acquire all of the outstanding shares of Youbet in a transaction valued at approximately $126.8 million based on the Tues. Nov. 10, 2009, closing price of CDI common stock.
- Under the terms of the transaction, Youbet shareholders would receive a fixed ratio of 0.0598 shares of CDI common stock plus $0.97 in cash for each share of Youbet common stock they own.
At an implied $2.84 per share, the deal represents approximately 2/3 CHDN stock and 1/3 cash as of 11/10/09. Assuming no movement in Churchill's share price, the company is paying 0.26 times Youbet's 2009E handle of $480 million (our estimate) and 1.41 times 2009E revenue of $90 million (ADW only, our estimate). These multiples appear substantially below the levels paid for AmericaTab and include no value for YB's $0.19 of net cash per share, United Tote segment, or optionality for potential legalization of other forms of online gaming (where YB has been spending lobbying money). With regard to the last point, Youbet obviously has a highly desirable domain name that other gaming companies might covet.
Still, the stock component provides an equity kicker assuming we believe Churchill Downs is currently mispriced by the Market. Prior to the company's 3Q09 report, CHDN was trading in the high $30s and, over the past five years, generally traded between $40 and $50. Churchill Downs is a larger, more profitable business today than it was five years ago. Further, we're certain that management will explain on the conference call tomorrow how the acquisition of Youbet will make Churchill even more of a powerhouse by owning and operating even more irreplaceable assets. We don't disagree -- hard to deny the scale benefit of garnering 50% of the online wagering (combined) market. Of course, one natural question is what happens to existing wagering platforms and prior investment therein (goodbye = one problem with Internet companies is that prior investment often falls by wayside through M&A or obsolescence).
Here's the implied value to Youbet shareholders under different CHDN scenarios:
We're still digesting the news. Let's see how things develop.
Disclosure: Long UBET.