Note: This article was originally published exclusively to The House Edge subscribers through Monday, May 16, 2016.
We've been closely watching developments in the regional casino space now for about 6 months. Our conclusion here is that the timing and economics are now pregnant with opportunities in the sector for several key reasons. First, the growing attraction of REIT structures to operators pressured to unlock shareholder value from their realty assets. Gaming & Leisure Properties, Inc. (NASDAQ:GLPI), a spin-off of Penn National Gaming (NASDAQ:PENN), has already folded Penn and now Pinnacle Entertainment, Inc. (NYSE:PNK) into its REIT portfolio and is grazing the landscape for more as we speak. MGM Growth Properties, LLC (NYSE:MGP), a parent-controlled REIT (NYSE:MGM), has acquired a portfolio of some of its parent's legacy Vegas and regional properties in an IPO. It has publicly avowed its intention to expand that portfolio both within the MGM family as well as seek acquisitions of gaming company realty assets outside its own corporate group.
The Caesars Entertainment (NASDAQ:CZR) plan for its restructured post bankruptcy life was to convert most of its realty assets to a REIT as well. That plan's fate will be determined by the outcome of a mediation currently in progress between Caesars and its junior lenders who have cried foul and are pressing for a better deal than that offered them in the original plan. Regardless of that outcome, what we are seeing is the REIT structure becoming the flavor of the month gaming operators are moving toward to placate growing dissatisfaction among shareholders clamoring for managements to be more aggressive in unlocking value.
Whether REITs are the best choice or not remains to be seen. However those strategies only point out how in post-2008 recession America, regional gaming companies are facing a new normal. Due to increasing competition from tribal casinos, expansion of border-kissing properties in states adjacent to current jurisdictions, more high capex integrated resorts being planned, have set up a perfect storm for consolidation in the space. If not REITs, we expect to see mergers and acquisitions, particularly where regional companies can produce accretive EBITDA by spreading marketing, capex and corporate costs, use leverage and branding diversity to spread to more jurisdictions.
Regional gaming shares then are all ripe for transactions of one kind or another. Not only do they need to act to unlock value but also they must likewise recognize the demands of the new normal, much of which leans on their ability to attract millennials as their traditional customer segments begin to thin. In our view, by any measure one regional operator presents a most intriguing opportunity to buy in at the right price: Isle of Capri Casinos, Inc. (NASDAQ:ISLE).
- Price at the time of writing: $15.99
- 52-week trading range: $10.62--$26.43
- Market cap: $623.3m
- P/E: (ttm): 25.73
- EPS: 0.59
- Annual revenues (2015 FY): $996m
- Enterprise value at the time of writing: $1.51b
Isle of Capri operates 14 casinos under the Isle and Lady Luck brands in Colorado, Florida, Iowa, Louisiana, Mississippi, Missouri and Pennsylvania. Interesting note: Almost as an afterthought, Isle has recently announced it expects to go all in on social gaming, using its Lady Luck brand to market its site.
The company's latest two quarters indicate declines in revenue largely due to weather related issues. In its Pompano Florida racinos, visitation was sharply down due to the unusually past warm autumn and winter seasons, which depleted the snowbird market segment. In the Midwest, Isle's business was severely impacted by widespread flooding during the same period. Bad weather also adversely hit the numbers of its properties along the Mississippi. In our view, these declines were not indicative of a long-term trend.
Isle is a conservatively managed company with a strong balance sheet despite the declines of the last two quarters. Our research revealed that its capex programs to keep its properties fresh, well maintained and responsible to market trends is strong and ongoing. Next month it will open its expanded 500-room hotel casino servicing the Quad Cities market in Iowa. This should be accretive to earnings in subsequent quarters.
Most recently, the company's long serving CEO, Ms. Virginia McDowell, a fellow Atlantic City industry veteran of mine, retired. Her successor is former Isle CFO Eric Hausler who had previously headed of Strategic Planning for the company. Before that, he was a Wall Street gaming analyst both at the old Bear Stearns and Deutsche Bank. Hausler is another veteran of the bruising Atlantic City competitive wars so he was well prepared to assume the CEO role both from a financial and operation perspective.
In his recent remarks during the earnings release meeting with analysts Hausler commented that he did see, given the right timing, deal and multiples, Isle's continuing interest in acquisitions and expansion into markets it does not presently serve. We believe under Hausler's leadership we are bound to see these things:
1. Continued strong stress on cost controls and improving margins. These are already under way and likely to be accelerated.
2. A conservative, solid balance sheet with over $66 million in cash and cash equivalents, strong free cash flow of $90 million against $1 billion in debt with 2020 maturities. Hausler told analysts the company prefers possible acquisitions bearing a 15% return on EBITDA as criteria. There will be lots of properties to consider this year and next in our view.
We think that while Isle could indeed be a buyer of casino properties, we see an equal likelihood that it could be a seller or a merger partner of another regional facing similar strategic options. Either way we sense a transaction of some kind on the horizon of Isle, which could move the shares into an entirely new dynamic.
The mean target of analysts on price is $17.75. We believe given the new energy, strong hands in the operating style of the company, its balance sheet and geographic mix that could be on the low side.
Going forward with the abnormal weather impacted numbers behind it, we think the stock is worth $25 to $28 a share to a potential buyer. Given the fact that in the regional sector multiples are not unduly inflated, we see Isle at that price as being most attractive to potential larger buyers.
Right now the company sits in a kind of no man's land relative to its size, its property mix and runway to expansion. Its market cap is small enough to attract a larger buyer yet large enough to be meaningful to a bigger operator. It could be it a REIT like Gaming & Leisure or MGP or a merger partner like Boyd Gaming (NYSE:BYD), a strong company with footholds in both Nevada and New Jersey. As we've written in prior articles on SA, we believe that Boyd is a no-brainer candidate for a REIT deal with MGP, given its current partnership with its parent, MGM. Better yet, a more geographically diverse, merged Boyd and Isle would command a strong market premium.
We can't discount the possibility either that if the Caesars mediation with its junior lenders fail, many of its regional properties could well go on the block. Isle would have to shop them. And just last week, Red Rock Resorts (NYSE:RRR) issued its big IPO and announced it was buying the once hot but now forlorn Palms Hotel Casino in off-strip Las Vegas, a property long on the sale block. Red Rock, the Stations Casinos legacy company, is a total bet on the Las Vegas locals market. For better geographic balance, Isle could also present an interesting merger partner.
We see Isle as a solid, regional operator coming off two bad quarters because of an issue really out of management control: weather, disruptions to capex projects and their consequent effect on volume in affected jurisdictions. We see it getting even more aggressive in a commitment to improve margins, update properties. Led by a transaction minded new CEO it appears to us that Isle is now positioned to become a bigger, more profitable version of itself through a transaction. And at its current price, it's worth a good hard look by investors who see its fundamental risk ratio low relative to its intermediate-term upside.
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.