All intelligent investing is value investing -- to acquire more than you are paying for. Investing is where you find a few great companies and then sit on your ass. -- Charles T. Munger
The statement above is one of my favorite quotations, and is actually something that I wrote on the inside of my front door with permanent marker, just so I have to look at it virtually every day. I believe that this quote can be applied to one of my favorite investment ideas at the moment, Nevada Gold & Casinos (UWN).
It seems that the problem with value investors, in regard to their investing in Nevada Gold, is that they generally look through its previous financials and talk about how terrible results have been. Then they talk about how terrible their debt load is. However, if you would ask that same value investor how he should value a company, the likely answer would be, "Well, you calculate all future cash flows and discount them to the present." The problem is that for whatever reason, when looking at this company, they don't seem to ever heed their own advice.
Nevada Gold is a company that has undergone one of the largest transformations that I could imagine. If you look at the assets it presently has, very few were there when present management took over just a few years ago; it's been on a buying and development spree, which should be getting ready to pay off greatly. While last quarter it only earned 2 cents a share, I believe that it's getting ready to do much better, and that the future possibilities are not valued into the price of the stock. In fact, I will argue that the coming year's worth of earnings are not valued into the stock, as it is trading at ~16x forward earnings, provided that it earns 10 cents a share over the next year. This is a scenario which I believe is achievable, especially if you exclude any potential one-time charges which may be related to items such as acquisition costs.
Before I go on talking about the future of the company, here is a recent interview with Bob Sturges, the CEO of Nevada Gold. It's about an hour long and is well worth a listen. It can eliminate (literally) hours of scuttlebutt and industry readings. Plus, it goes to show just how competent a CEO he is. I challenge anybody to find a management team of a company this small which is also as good as these guys. In fact, it wouldn't be a stretch to say that management is in the top tier of the entire gaming industry.
Now that you've listened to the radio show, let's take a look at how the newly acquired casinos are performing. Here is the data from the card rooms located in Washington State for 2009, 2008, and 2007.
If you look at just the six casinos that make up Washington II, they had revenue of $34 million in 2009 (before being owned by Nevada Gold), with a significant amount of operational losses. This year, they are making UWN money and doing so with marginally more revenue. According to the most recent filing, the company generated $29.6 million in additional revenue from the Wasington II casinos when coupled with the restaurants and the ATMs that came with them, in a period of just over nine months. Considering that 2009 was murderous for the revenue of many casinos -- and that the ones that were bought by Nevada Gold came from bankruptcy -- it is amazing what it's been able to accomplish. In many of the properties, the revenue figures had been dropping off since at least 2007. Looking at the ebb and flow of the various casinos in Washington, it is easy to get a good feeling for things to come.
When looking at the the results of Washington II for 2010 (the year ending April 30), the casinos generated $34.9 million in revenue and made $1.6 million. While it could be said that the recent profitability of the company is related to an increase in revenue, this is not wholly the case. The company has stated in conference calls that it laid off administration that came with the recent acquisitions. I would imagine that a lot of the previous revenue decreases were due to the financial distress of the previous owners; you can't employ top notch people and reinvest in the properties if you are in or getting ready to go into bankruptcy. Additionally, Nevada Gold makes all of its employees go through hospitality training to make the gaming experience as good as possible for clients. Additionally, the company has better tracking software and rewards programs, which will help integrate the properties and increase future profitability. Now that the casinos are solidly profitable, it is reasonable to think that the company can attract even more patrons.
Let's look at the revenue figures for the state, looking at card room revenue for the past few years, which end in December.
Number of card rooms: 82
Revenue: $57.8 million
Number of card rooms: 91
Revenue: $56.5 million
Number of card rooms: 98
Revenue: $62.5 million
Number of card rooms: 101
Revenue: $72.4 million
Number of card rooms: 103
Revenue: $71.25 million
When looking at these numbers, it seems that the company will be able to grow revenues in a way that beat the average casino. The industry has obviously been consolidating over the past few years and when looking at the data of card rooms, last year over half of them lost money (a lot of which are now owned by UWN). Given the amount of previous losses, it seems that there may be more consolidation. When coupling this with the fact that industry revenues have room to grow as the economy improves, this should bode very well for Nevada Gold.
Since the company has been preforming admirably, it rightfully feels able to take on more responsibility. It recently signed a contract on a new casino which it announced was closing on July 19. Owning the Red Dragon Casino gives it a monopoly in the Mount Lake Terrace market. Previously, the casino went from earning $0.66mm on just over $6mm in revenue in 2007, to losing ~half a million dollars in 2009 on $4.3mm in revenue. It paid $1.25 million for it. If it can do to this casino what it did and is doing with the others, it is entirely possible that this allocation will be bought for roughly the cash flow that it generates in just a couple of years. It should be more profitable due to lower administrative costs and advertising efficiencies alone.
When a company is turning around as rapidly as this one is, lenders often take note. In the interview posted above, Sturges notes that the company is in talks with numerous well-known lenders. If the company is able to lower interest on debt payments (presently, it pays in excess of 10% in some cases), it would be very good for the company's bottom line. Additionally, it would free up cash for another acquisition. Even if the company doesn't restructure its debt, it has over $5 million in cash on hand and looks as if it will generate well more than the $4 million it needs to pay off all the debt that matures next summer. Even if either of these scenarios don't play out, the company owns a few buildings and a whole lot of land, which could be sold off to generate cash (the land is presently listed for sale). As I mentioned earlier, I think that the Red Dragon acquisition shows just how confident the company is that it will be able to make good on its obligations, and the new casino should generate some cash in the next year, which won't hurt at all. Potentially, it could generate cash close to amount used in the cash portion of the purchase: A paltry $400K.
If the company's history of acquisitions proves to hold true in the future, every additional acquisition that the company does will bode extremely well for results. This is especially true in the Washington market, where it already has the best infrastructure in the state to take on more projects. Casinos that don't make sense for virtually any other operator to run can work quite well for UWN and if the numbers that Washington state is putting out are any indication, there are not going to be very many operators in a position to bid against Nevada Gold. I certainly doubt that many have the competencies that UWN possesses in regards to running a large and growing organization. One major advantage that the company has as a public entity is the ability to issue stock for acquisitions.
Normally, value investors are weary of a company using stock to acquire additional businesses, given the dilutative effects. In the instance of Nevada Gold, I think that it can, is, and will continue to work quite well. If the company is trading at a multiple of EBITDA (or any combination other metrics you feel is valid when calculating intrinsic value) that is higher than that of the entity that it's acquiring, I would support it using nothing but stock to purchase other operators with, as it would make my shares more intrinsically valuable. It's stated in numerous conference calls that it will remain diligent in its acquisitions. Honestly, when it talks of competitors doing irrational things and its philosophy of acquiring entities, it sounds about like Warren Buffet (or "Buffett," as he prefers) or Prem Watsa would if he were a gaming executive. Don't believe me? Check out the conference calls for yourself. Plus, you will get the pleasure of hearing my voice during a few of the Q&As.
If the company earns 10 cents a share in the next year, the stock is essentially trading at 16x the coming year's earnings. I believe that this has the potential to be a conservative estimate. I also think that 16x earnings for a company that is constantly improving and has so many options available to it is dirt cheap. Here is a list of potential catalysts: Restructuring of debt (very likely), payment of the Buena Vista note (too far out to know), development of the Las Vegas Motor Speedway project (better than a coin flip), legalization of video slots in Washington (?), a new management contract, more mini-casinos, improvement in the Washington gaming market, a mega acquisition in Nevada or elsewhere, sale of the land in Colorado, or any other event. These and any number of other possibilities spell good news for the company and, likely, the stock price.
There are a lot of other things that I like about Nevada Gold. The management team is top notch. The stock and company are small with a ton of room to grow. If it continues to grow, analyst coverage could help it gain exposure and, in turn, price and liquidity. Additionally, if it makes it to the size where it will be invested in by indexes, ETFs and the like, that could make for a nice pop in demand for shares. Once it has a full year where it earns money, I would imagine that the investing public and more mutual funds will be a lot more willing to look at and invest in the company as well. I figure that we will have a profitable previous year's worth of reporting in two quarters (or for the period that ends this October), which based on last year's filings will be reported in December, which is fine with me. It has made it easy for me to buy shares without a lot of competition.
While not a typical Graham-style investment, you could likely sell the company off piece by piece and have a decent protection of principle, where you likely wouldn't lose much (and potentially, would make money). This is Phil Fisher growth, with a ton of catalysts that are not factored into the stock price, and has downside protection, all for very reasonable price.