"It's not what you look at that matters, its what you see…"
Henry David Thoreau (1817-1862)
I recall a lazy summer afternoon in my childhood when a rainstorm interrupted a neighborhood pickup baseball game. We were all ten and eleven years old and still strong superhero fans. As we sat in the dugout waiting for the rain to stop, we bruited a few profound life questions. One issue triggered shouting controversy above all: Which, if any, of Superman's powers would we rather have: the flying speed of a bullet? The ability to leap tall buildings in a single bound? A bulletproof body? X-Ray eyes?
One of my friends, yelling above the racket of competing super power votes, shouted, "I'd want X-Ray eyes. That beats anything!"(Bear in mind we were pre-adolescents, so some of the more obvious attributes of X-Ray vision did not yet enter the debate as they would were we entering our testosterone roaring teens).
That kid pursued that X-Ray dream his entire life, actually finding it, figuratively at least, many decades later, when the hedge fund he would come to lead and cleaned up on the Google IPO. He would bid far above the auction floor for the shares using his version of "X-Ray eyes." Against all advice he saw that even at that fat price, he was eventually going to make a ton. And he did, on that and lots of other stocks always guided by his uncanny ability to see things in many stocks others could find. He prospered immensely, retired young and when I called last week to wish him a happy birthday, he was talking from the Luberon Valley in the south of France. He held the phone receiver away so I could listen to the babbling brook gurgle behind his fifteen room hilltop villa. "My cook catches fish at 11 and lunch is at 12," he said.
Seeing hidden values or pitfalls behind the numbers in a stock can easily evade the sagacity of the shrewdest investors as well all know. That's why only relatively few of us get to laze away afternoons in the South of France calling in our buy and sell orders amid the glories of its mountainous beauty.
Here's some ideas about a stock where I think, not having been gifted with X-Ray eyes myself, might well have eluded my attention this month. Looking at the numbers I asked myself, was there anything I was missing? I concluded, that perhaps there was. It was a bit of a stretch yet I concluded it was worth a closer look, which I share with my fellow X-Ray-challenged SA cohorts.
Boyd Gaming: A big upside surprise in the wings or a vulnerable geography?
There has been bullish sentiment among many market watchers rising lately on Boyd Gaming (NYSE:BYD). The shares have risen 22.4% last month trading above its 20-day simple moving average :
Price at writing: $19.79
52 week range: $12.88-$21.20
Market cap: $2.22b
P/E (NYSE:TTM): 47.23
EPS : 0.42
Its March 22 offering of $750 million in 6.375% senior notes due 2026 was easily snapped up in a surging junk bond market. The company indicates it plans to use the proceeds to consolidate a subsidiary owning several of its Midwest casinos, "expansion" (who knows what that means) acquisitions and $295 million in pay downs against $600 million of a current revolver. All pretty much boilerplate stuff. Moody's assigned aB3 rating to the offering.
The numbers anyone can see are nice but not particularly bullish enough to presage a rip roaring upside:
For fiscal 2015:
Revenues: $2.20 billion up 2.7%
Adjusted EBITDA was $629.5 million up 15.4% yoy-nice.
Adjusted earnings were $89.7 million or 0.79 a share.
Net income of $47.2 million or 0.42c a share.
Debt: $3.32b, of which a third was against its Peninsula, subsidiary.
Guidance for 2016: $635million.
Company strategy going forward
Management's stated strategy:
Focus on slots.
Aggressive marketing. Geographic diversity as protection against regional downdrafts. Expansion of existing properties. Strong cost controls.
All this is naturally happy talk of the kind we hear from all regional gaming operators. And it is positive in that it's simple common sense against a macro economy that is still schlepping along with a projected GDP of 2.2% for 2016, around flat with 2015. However we took this outlook a step further and conferred with former colleagues currently operating similar properties in many regional markets. Their opinions ran from cautious optimism to some skepticism that total market growth could be expected given the state of the economy in their particular markets. "Everyone is doing the same thing," said one former associate. "Pushing hard, particularly on slots and low buy-in table games. We're all giving away cars, promoting double points, yada,yada, yada."
"Boyd's a good outfit," said an executive of one of the company's competitors in the Midwest, "You know they still have the old-time sense of the customer that Sam Boyd built in the Vegas locals market. It has filtered its way down to the line employees to a reasonable extent and they do pretty well. Let's face it. This is no golden age for regional casinos."
Boyd's Geographic Base
The company is a stable three-legged stool with properties in:
The Las Vegas Locals Market
The Midwest and South
And 50% of the formidable Borgata in the dead-ended Atlantic City market.
It's valuable to take a quick look at total gaming revenue reported in the states in which Boyd operates to get a sense of last year and a possible clue to 2016:
Statistics source: University of Nevada at Las Vegas
National: Total US commercial gaming during 2015 was $38.9 billion, an infinitesimal increase of 0.29% yoy 2014. (Add tribal gaming at around $28 billion to reach a total of $67 billion plus other forms of limited and/or online gaming to reach somewhere in the $70 aggregate number. Also flat yoy with 2015).
By State where Boyd operates:
State 2015 gaming revenue plus/minus
NEVADA 0.95% Locals market casinos. Boulder Strip casinos showed a 1.55% increase.
ILLINOIS 23.92 (note: spike is mostly from new tavern slots not casino properties)
INDIANA -1.11 (collateral damage from Illinois tavern slots)
NEW JERSEY -7.49 Due to continuing downdraft in AC
In all these areas Boyd showed flat to single-digit increases reflecting a sharp focus on the slot player as management has said, robust cost controls and a sprinkling of new amenities in dining, entertainment and hotel.
Boyd performed well in the Las Vegas locals market where its first properties were born. Much of its recent growth has emerged from the surge in the retiree population, which between 2000 and 2010 alone grew by 50%. Attracted by a relatively lower cost of living from their home states, low taxes and diverse recreational and entertainment offerings, retirees were the backbone of growth for locals casinos. Historically these properties depended on the gaming and industry employee base.
There has been some job growth in Las Vegas that some point is a strong positive for the local properties. However upon a deeper drill down on the numbers we find that the overwhelming majority of those jobs are low paying service occupations. Also the flood of retirees appears to beginning to ebb. So Boyd's performance in the locals market will remain stable unless we fall into recession. The job numbers won't help so the retiree population remains key.
Our takeaway: Boyd will hold stable in the locals market - but we don't see any dramatic growth there that would trigger dramatic rises in operating performance of its properties there.
South and Midwest
The numbers above show the south and Midwest is a mixed bag. On one hand the tavern slots in Illinois are bruising casinos there and in neighboring Indiana. Yet Kansas remains on a healthy rising trend and according to our sources should continue to do so in 2016, mostly due to "a better texture in jobs and the general economy" according to one executive.
X-Ray Eyes on New Jersey
With Boyd results respectable and prospects for earnings and cash flows this year coupled with possible consolidation moves emerging from its debt refinancing, we think it's currently sensibly priced. We could see an upside into the low 20s if 2015 EBITDA performance continues through Q1 and Q2 of this year.
But we believe the action in Boyd lies elsewhere.
Its Atlantic City crown jewel, The Borgata, produced 30% of all the town's gaming win last year, up 4% from 2014. This is a remarkable showing given that market's continuing decline that began in 2007, a victim of the double whammy of recession and doorstep competitors from Philadelphia and New York.
Boyd owns 50% of the property, partnered with MGM Grand (NYSE: MGM). Under its current management the property continued increasing its total win, non-gaming revenues and dominance of the market largely due to the richness and Marina location of its property. Looking at the numbers and the market trends in AC moving forward its continuing strong performance should be a given.
Here's where a glimpse behind the numbers inserts wild cards into the hand that could either send that property and Boyd shares moving strongly to the upside or to a downward drift.
The Downside What If
By most industry opinion and with talks with executives and employees in the market, the Boyd MGM partnership is going well. Boyd has managed soundly, produced great numbers in a terrible market and not sat on their market share lead. They've added amenities, kept the property fresh and continued to draw their younger customer base from a far wider geographic arc than its competitors.
However over the longer haul it is widely believed at least by our sources, that eventually one partner company will either buy out or absorb the other in light of developments and opportunities that may be lurking around the corner.
Scenario One. In a rather bizarre logic to apply a life-saving shot of fiscal serum to the Atlantic City market, legislators two weeks ago voted to put a referendum on this November's ballot that for the first time would permit the establishment of two additional casinos in that state outside of the Atlantic City casino zone. The target geography: The Meadowlands area of New Jersey, just across the Hudson from Manhattan and Jersey City, spitting distance from the Big Apple. The idea is to take gaming taxes generated from proposed North Jersey casinos to support the Atlantic City industry and economy. Sounds insane? It is, but bear in mind, this is New Jersey.
Right now our information is that approval of the referendum currently sits at 60% to 40% against. Expect heated public debate waged with big media dollars to begin this summer or before. Naturally the sentiment in North Jersey is presumed to be in favor of the idea, giving the population heavy counties of the north easier driving access to gaming. Yet there will be strong opposition from South Jersey stakeholders in the status quo.
The one blatantly apparent potential disaster from such legislation is the threat from a counterstrike from New York. Its recently passed casino legalization of four casino sites in its upstate tourism areas deliberately bypassed a proposal by giant Genting to put a $3 billion integrated casino resort complex in Orange County - a doorstep away from both North Jersey and metro New York. The rationale: The necessity of not sandbagging its approved site in the more northerly Catskill resort area - well under two hours from the metro area.
The last unissued license was kept in the governor's pocket. Faced with a threat to its metro base it would, according to our sources in Albany, provoke the governor and the legislators into quick action to amend the state's casino law and approve a casino somewhere in the five boroughs. Staten island is seen as the most likely spot, literally walking distance from New Jersey.
There are many other reasons advanced by the antis. Yet in valuing Boyd shares now going forward we need to consider the possibility that within two years a pair of huge casino properties in North Jersey could severely poach Borgata's revenue base. It would hit its powerful millennial business very hard. To what degree is hard to know since all the wannabe developers who have already raised their hands are essentially realty people. The big question is this: Las Vegas Sands (NYSE:LVS) CEO Sheldon Adelson is on the record as expressing interest in putting a Vegas style integrated resort there if the legal signal turns green - even at the risk to his Bethlehem PA, casino, now doing very well.
For Borgata that prospect remains terribly bearish, potentially reducing its standalone valuation dramatically. If there is bad news it could come as early as this November and that we believe would put a downside risk of 30% or more into Boyd shares as the implications of the move become known.
The Upside Scenario
Now let's assume the referendum fails. By itself that will build confidence in Borgata's future and by implication Boyd shares. In theory take half of that property's revenue and assign it to Boyd and you have 15% of the corporate total no longer at risk. It's not catastrophic if North Jersey casinos are a go for certain, but a real blow by any measure.
With Borgata secure we now have to turn our attention on the looming IPO for MGM Growth Properties, Inc., the REIT spinoff of parent controlled MGM Grand Resorts.
Scenario Two: MGM proposes and Boyd's board approves and the selling of the Borgata into MGM Growth Properties, a move that not only presumptively unlocks shareholder value for MGM as advertised but also, with one fell swoop, does the same for Boyd.
This could be accomplished in two possible ways:
1. MGP buys Boyd's Borgata stake entirely, only having to put up 50% of the purchase price. Boyd gets either cash or MGP shares for its half, gets a long-term management contract as the Opco and signs a triple net lease for the property. The deal is easily financed given the operating stability of the Borgata's cash flow.
2. MGM buys Boyd outright, values each of its properties and spins off Borgata and any other REIT candidates for MGP.
The X-Ray Clue
In reading MGM's red herring for my MGP post this month on SA, there is language that essentially says that the proposed REIT spinoff will seek acquisition opportunities to enfold other gaming operators into its REIT.
Just one sentence but could it be an X-Ray clue? The logic is there:
1, MGM and Boyd are already partners.
2. Boyd has performed well but bogged down in a sluggish regional market for the foreseeable five out years.
3. Borgata's valuation could be compromised for both companies if casinos come to north Jersey. Their interests in that outcome match.
4. Both MGM and Boyd appear committed to reducing leverage.
5. Where is there a better inside the industry fit for an MGP candidate than Boyd? There might just not be anyone else where the numbers work so well. The deal would be strongly bullish for both stocks.
Our bottom line on Boyd: We like the stock because it's stable and because there is a clear wildcat element entering the game because of the MGM partnership and the MGP IPO.
North Jersey is a wild card without doubt. Whether it's a welcome ace or a picture card that busts a blackjack hand we can't yet tell. We have to believe though that MGM and Boyd will both be players when it's dealt.
About the author: Howard Jay Klein is a 25+year c-level veteran of the casino industry. He is now a consultant in that industry and the author of Mastering the Art of Casino Management. He is the publisher of The House Edge premium site on Seeking Alpha. Note: All his gaming shares are held in a blind trust for his children and grandchildren in line with the conflict of interest policies of his consulting business.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.