Timing has a lot to do with the outcome of a rain dance.
—Old cowboy proverb
Last week, rumors hot and heavy began swirling around the Street that Caesars (NASDAQ: CZR) was the recipient of offers for its Caesars Interactive Entertainment business topping $4 billion from a number of serious bidders. The company is said to be interested in the bids and will continue that exploration despite still be bogged down in bankruptcy negotiations with its junior lenders. The business is predominately a social gaming site that includes its World Series of Poker and the popular Slotmania and other games acquired from Playtika.
In the last Quarter, the interactive division was almost totally responsible for the parent's 6.7% increase in revenue, contributing $278 million, up 29% yoy. The site has 22 million active users who play free but can unblock higher levels for cash buy-ins. News of the online business being in play came simultaneously with a new offer by the company to junior lenders that upped the recovery to a total of $4 billion comprised of a deal for the parent to complete its merger with the interactive unit and then issue $1 billion in convertible notes. Note holders will also receive 47.5% of pot merger common and some cash. It's a long way from the original $1.5 billion management first offered. In exchange for the new deal, the juniors would drop all the lawsuits.
Not so fast.
Going by public statements and some insider intelligence we gathered, there is, so far, little enthusiasm from the juniors for the revised deal. Whether this is all part of the very expensive and ongoing chess game between Leon Black of Apollo private equity and David Tepper of the Appaloosa hedge fund and his co-litigators is hard to fathom at this point. The court appointed examiner has already weighed in and set a $5.1 billion price tag on the juniors' claims yet they're still on the record as insisting on receiving 60% of face on their notes. The seniors, already inside the management tent are scheduled to receive almost 90% of their principal in a settlement substantially agreed to at this point.
Whatever does finally go down, it is clear that any possible transaction in the interactive business will be vulnerable to yet another legal fender bender with the juniors. But what commands our attention now is the valuation for the online business by presumably deep-pocketed, dead-serious buyers.
We've never been fans of online real money casino gaming because we see it as a contradiction of the mainstream mantra of the industry as evidenced by the performance of companies who own and operate integrated resorts. MGM (NYSE:MGM), Wynn (NASDAQ:WYNN) Las Vegas Sands (NYSE:LVS) and Boyd Gaming Corporation (NYSE:BYD). Their non-gaming, live experience amenities comprise significant components of their revenue flowthroughs and are growing.
Implied in that trend is that the brick and mortar experience is what the dominant chunk of consumers want, not merely sitting in front of a laptop or mobile device tapping away at imps dashing between pop-up obstacles. Whether it's social gaming or pure gaming, what is becoming clear is that with the $4 billion offer to Caesars, we are beginning to see valuations of online businesses moving rapidly north. And with caution, we believe investors need to take notice of the space now. The timing might be right for an entry point depending on what's already out there.
Meanwhile Caesars' legal fees soared past a court approved $22 million so far and the $1,300 a day time clock average lawyer fee is still ticking away. And it's an army of lawyers from two big firms.
So what does this dangling $4 billion boodle tell us about the real valuations of online social and real money gaming operators?
Caesars is currently sitting at $6.71 a share against a 52-week trading range of $3.30 to $10.61. Its earnings profile in the last two quarters have been positive but essentially meaningless relative to valuing its shares because of the worse case Chapter 7 bankruptcy possibility in mediation fails.
With revenues of $768 million and rapid growth in the total space, Caesars Interactive as a standalone business ups the ante. Does this warrant a toe-dip into Caesars at the moment, even given the ongoing insecurities of the bankruptcy lawsuits? We caution not yet - but urge you to keep your ear to the ground on the progress of the mediation. As soon as it appears the litigants are reaching close to a consensus, it would be time to move. Our view is that soon after a settlement, Caesars Interactive will be set free in one way or another to generate a ton of cash for its parent.
Amaya (NASDAQ:AYA): Sitting in a legal swamp but like Caesars, is generating impressive numbers.
We've been watching Amaya, the world's biggest player in the online poker space since early last year. In April '15, the shares were $26. Later in October, after it had gotten the green light from New Jersey regulators to re-start its PokerStars real money site in that state, we wrote that the stock looked like a good buy to us at $23. All this of course was contingent on the outcome of an investigation by Quebec authorities into the sudden run-up of shares when the Montreal-based operator acquired PokerStars. Accusations of insider trading and other ills shadowed the upside. We based our view with that as a caveat, but largely based on the company's dominance of the space, its pending approval to start live gaming in New Jersey and possibly other states.
However once Quebec authorities decided there had been insider trading on the shares and other misdeeds, the stock rightfully tanked. Gunslinger Chairman David Baazov stepped aside, saying he planned to make a bid to take Amaya private. He has subsequently also left the board. The legal tangle choked the stock. It dived down to near the low side of its 52-week trading range: $9.67-$31.44 to where it now sits at $13.75
The board has formed a committee to explore strategic options for Amaya, among which is the Baazov offer. Though he and his associates have proclaimed their innocence, it would appear at this point, that the ground game has changed. With the Caesars Acquisition bid of $4 billion floating out there for a unit with less revenue and global reach, it would seem to us that if Amaya hits the sale block it has a fatter valuation because of the bid for the Caesars business.
In the teeth of the Quebec problems comes news of a raft of class action lawsuits yet to be qualified, but expected to be filed on behalf of shareholders against the company for anyone who bought Amaya between January 8, 2015 and March 22, 2016. The claim: Insider trading and misleading info. So besieged by this legal warfare ahead, is Amaya at its current price worth a roll of the dice?
Its current market cap is $1.84 billion with a P/E of 8.04 and an EPS (TTM) of $1.71. And even though a comparison between a live poker business and a social gaming site isn't a perfect analogy, it's hard to see how it doesn't spike perceived valuation to whoever might wind up owning Amaya. (Barclays Bank Canada is currently at the helm of finding the best strategic solution).
Like Caesars, Amaya has been posting some strong numbers:
- The company doubled its profits in Q1 yoy. Net earnings rose to $55.5 million or 28c a share up from 12 c.
- Debt was $2.57 billion, down from Q1 15 due to a pay-down of some debentures.
- The company has 102 million registered users.
- Its new live PokerStars entry in New Jersey accounted for 46% of the total real money wagered in that state last month. Overall, the state's online wagering was 32% up over last year.
While real money gaming is still only legal in New Jersey, Nevada and Delaware, there is fuel to be added to that fire if and when the government clarifies its policies toward the fantasy sports space.
The recent congressional hearings to determine whether fantasy sports are gambling were muddy. Neither of the two big kahunas of the business, DraftKings nor Fan duel showed up to testify.
The inevitable here is clear. Daily fantasy sports are gaming and ultimately will join the online casino gaming space. However, they'll find lots of company waiting there. Not only has Amaya set its sights on the business, but the ever hypocritical pro sports leagues have remained hovering in the shadows, making anti-gaming public statements while at least two of their owners have invested in the business. Add to that Yahoo Fantasy Sports, a good site, also in the bullpen since the DFS scandals broke at DraftKings and you have what we believe is a gathering perfect storm for investors who grasp the state of play in all online gaming and are prepared to either watch closely or see an entry point.
Churchill Downs' (NASDAQ: CHDN) Big Fish Division online social gaming is the special sauce that in our view keeps the shares wildly overpriced.
As we've previously written on SA, we believe that Churchill Downs, operator of the eponymous track, its online component TwinSpires and a handful of local casinos doesn't warrant its lofty 52-week trading range of $118.33-$152.98. It's overpriced given that half of its revenues come from legacy horse racing businesses, operations with highly problematical demographic allure. However, the firm's Big Fish Division, an excellent online casual social gaming entry is carrying the load for investors in the company.
Churchill's annual 2015 revenue was $1.2 billion of which Big Fish games accounted for $413 million, or more than 35% of its total and almost all of its yoy revenue growth.
So what does this all tell us? That the market is revaluing online social and live gaming entities. And those valuations are growing fast. This means that when and if a Caesars Interactive transaction happens - if it does - the entire field of play is thrown wide open and investors aware of this can make serious money.
Our takeaway: If you have the inclination to dive into the interactive gaming space the play now is for high risk tolerant investors to move on Amaya or Caesars. In both cases, a mega-transaction could be in the offing. Your bet is on the possible bullish outcome of the legal woes of both companies. If Caesars settles with the juniors, Caesars Acquisitions will either be sold or folded into an entity that puts common stock that includes the online business into your hands at a potentially attractive price.
Amaya's troubles from both government punishments and class action lawsuits would clearly be more easily solved if and when a new, hound's tooth clean ownership takes over. Way back before the government brought down the hammer, on fundamentals, we saw Amaya as possibly a $35 to $45 stock. Freed of its troubles, expanding its powerful franchise and gaining momentum both in live poker, social gaming and its nascent fantasy sports business, Amaya is also worth a good, hard look now.
Both Boyd and MGM are both potentially formidable players in the space but have for the moment bigger fish to fry. Boyd's Borgata site in New Jersey is a strong performer, MGM is toying with social gaming in Nevada. We don't see either company as a strong possible play for several years down the road. Churchill is wildly overpriced due to big time hedge fund dominance of its ownership profile and the drag of its low growth to flat legacy businesses.
For now, both Amaya and Caesars are eyes wide open, no illusions, strong gut instinct plays for investors who believe that at some point, the time clocks will run out on the lawyers and bankers, the legal bramble bushes will be cleared and either of these companies can make a big run to daylight in the online gaming space.
Howard Jay Klein is a 25-plus-year C-level casino executive and consultant to the industry. He is the author of Mastering the Art of Casino Management. His gaming investments are lodged in a blind trust so as not to pose conflicts with consulting assignments for casino operators.
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.