MTR Gaming Group: The Money Lever to Pull in This Casino Is the Hold Percentage

| About: Eldorado Resorts, (ERI)

My next big investment idea is MTR Gaming Group (MNTG). My thesis is that the hold percentage is nowhere near the max allowed under the law in West Virginia and Pennsylvania, and that a perceptual disequilibrium exists whereby tiny percentage increases (1%-4%) in the hold percentage on slots means a lot to the casinos (there is amazing potential operating leverage here), but does not mean as much to irrational gamblers.

The chips in the slots would have to be switched out. There is not a software solution, but is still relatively easy and reasonably cheap to do, in my opinion. This company would be a fantastic play for an activist or relational investor who wants a simple situation whereby pulling on one lever, so to speak, is all that's needed. I love potential activist / relational situations where there is a simple lever to pull to enhance shareholder value.

I have to give the management credit on the costs side of things, they've done a lot. All that's left is to increase the hold percentage on slots. Billions go through those slot machines; increasing the hold percentage would be a very shrewd move and, in my view, would be a massive boost to income. On an EV / EBITDA basis, MNTG is already one of the cheapest casino plays out there.

This is probably my best long idea right now.

The Longer Version:

Personally, this is my favorite idea. Not only is it one of the cheapest pure-play casino stocks in the country on an EV/EBITDA basis, but there is a clear lever to pull to enhance shareholder value. In the states of Pennsylvania and West Virginia, where the company operates casinos with slot machines, (please refer to page 45, page 49, page 58, and page 60 of the latest 10-K) there is tremendous potential to enhance the operating leverage of the company's earnings from slots by increasing the hold percentage of the slot machines. Even relatively tiny changes in the hold percentage could yield significant results.

Currently, the slot machines are not operating anywhere near the maximum hold percentage allowed by law of 15% (which corresponds to the minimum 85% payout allowed under law in Pennsylvania and West Virginia). I would strongly suggest that the most rational course of action would be for the company to get permission from regulators to switch out the slot machines' chips for those with a higher hold percentage (according to MTR's CFO, to modify the hold percentage, the chips must be changed, there is no software solution). Then I would recommend that the company potentially control (modify on the fly) the hold percentage by modifying the amount of free play given to customers, which will drive business to the casino. In addition, enhancing the casinos' entertainment offerings through better live bands, concerts, entertainment acts, etc, can offset negative customer response to a higher hold percentage and drive further business to slots and table games, making the casinos a destination for more affluent gamblers, rather just than local customers with more limited discretionary spending.

Absent pulling the lever on hold percentages, there is a very liquid market for casino transactions in both Pennsylvania and West Virginia, driven by acquirers who want to enter those states, without the complication, time, regulatory hurdles, etc of building new casinos. Perhaps a favorable divestiture could be engineered which would significantly reduce indebtedness, but with a higher hold percentage on the slots, I believe a divestiture would be ill-advised. One would want to double-down on bets, no pun intended. In terms of non-debt expenses, these have largely been controlled already by reducing labor expenses and shutting down different parts of the casinos during lull periods, late at night, etc. My understanding is that there is not much more juice to squeeze in this area.

The expansion of table games might also generate additional cash flow. This may have more of a marginal effect in Pennsylvania, where tax rates for table games are lower).

In addition, given the hundreds of millions in indebtedness, there may be the potential for financial engineering, more favorable refinancing, etc, to bring down MTR's interest expense (debt for equity swap, anyone?).

This company would be a great acquisition target or activist investment. It would make much finer vehicle than an insurer, since cash could be continually extracted from the business, once debt is paid down. The major shareholder is Jacobs Entertainment and Trusts associated with Jacobs.

In my opinion, MNTG is not a suitable investment for a retail investor, but only for investment firms with the wherewithal, determination, and staying power to push for an increase in the hold percentage at MNTG's slot machines. In other words, this is a stock, in my view, which needs an operational catalyst, and as such, is most suitable for firms which will push for substantial strategic change.

Disclosure: I am long MNTG.