Full House Resorts: Our Bargain In Hiding Has Come Out To Play

| About: Full House (FLL)


Shares have moved 28% since our first alert late last April.

Completion of acquisition and refinancing deals set the stage for more upside.

New management team led by Wynn alumni will continue to pursue aggressive, but smart, growth.

Three things cannot be long hidden: the sun, the moon and the truth. —Buddha

Note: Subscribers to The House Edge site on Seeking Alpha had an advance look at this research, which was published for them exclusively June 18.

On April 21 we called readers' attention to the little-known, small, domestic gaming company Full House Resorts. While we normally don't cover small-cap, low-priced, thinly traded gaming operators, in this particular case, we saw opportunity hiding in plain sight.

Here's why:

  • 1. The company had been taken over in a proxy fight led by an industry acquaintance in whom we had a high level of confidence. We saw the potential in margin improvements coming fast.
  • The new leadership had triggered two initiatives: One was the pursuit of acquisition of a profitable Colorado casino property for $30 million.
  • As part of the acquisition, Full House (NYSEMKT:FLL) sought a refinancing deal that would provide part of the capital for the deal; refinance existing debt; and negotiate a package of $100 million in new, manageable debt to continue its runway to expansion.

Based on these facts, plus our strong sense that management had its eyes on much bigger prizes going forward, we though the stock was a bargain near its 52-week low.

  • Price at the time of our alert (April 21): $1.50
  • Price at Friday, June 17, market close: $1.91, near a 52-week high
  • Increase since our alert: 28.5%
  • Our target price: $2.25 to $3.00
  • Our revised guidance: $3.25 by Q3 2016.
  • FLL market cap: $36 million.

Since our alert

1. As forecast, FLL successfully completed the acquisition of Bronco Billy's Casino Hotel in Cripple Creek Colorado for $30 million. (Note: Part of the contingency in the deal points was an EBITDA target for the property. This was accomplished.)

The property's main feeder market is Colorado Springs, with a population of 770,000 that continues to add to its numbers in demos highly favorable to the casino business: Older millennials and early retirees. It ranks above national averages in education and income.

2. The company successfully closed its deal, which refinanced $6 million in existing debt and added a $100 million cushion as follows: $45 million in first-lien debt and $55 million in second-lien notes with maturities ranging from 2020 to 2022.

First-lien notes will be subject to extended maturities depending on performance. Second-lien note holders were awarded options to buy up to 1,000,000 shares of FLL common at given dates.

The company also has available an unused $2 million revolver.

Refinancing bears a rate of LIBOR plus 375 bps.

FLL Q1 Results

On May 21, FLL released its Q1 results:

  • Revenues: $32.01 million
  • Gross margins increased from 37.38% to 41% yoy
  • Operating EBITDA margins grew from 6.80% to 10.97% yoy.
  • Earnings growth yoy went from -62.2% to +81.2%
  • Operating cash flow was flat yoy at 16.96%.
  • Earnings growth entirely came from operating improvements.
  • Return on equity: -12.39% in 2015 to -2.34% in 2016.

This indicates FLL has held market share and had not grown margin with earnings management.

Full House is heading higher because, in addition to cleaning up its balance sheet, making strong margin improvements, and completing an acquisition that will be accretive to earnings, its management, we believe, is strongly committed to more growth going forward.

Consolidation of the US regional gaming markets is coming, and FLL will either be acquired or will acquire more properties in markets in which it currently doesn't operate. It presently has casinos in Rising Star, Indiana; Bay St. Louis, Mississippi; a locals casino in Fallon, Nevada; the management contract for the Hyatt Regency Lake Tahoe hotel casino; and now the aforementioned Bronco Billy's in Colorado.

The company seeks both management contracts for tribal casino owners and acquisitions.

Leadership has shown early results, primed for more.

We've known FLL's new CEO, Daniel R. Lee, over many decades, from the time he was a top-level gaming analyst at the old Donaldson, Lufkin and Jenrette investment house, to his movement to First Boston and from there, his entry into the industry during the 1990s as CFO of Mirage Resorts for Steve Wynn.

After Wynn, Lee moved on to Pinnacle Entertainment, where he planned an entry into the Atlantic City market with a $2B+ boardwalk property at the height of that market's apogee in 2006. When the combination of the financial collapse and ever more regional competitors materialized, he pulled the plug on the project, and the company was forced to sell its boardwalk realty at a sacrifice price.

The other AC mega-property developer at the time was the Morgan Stanley-sponsored $2.4 billion Revel Casino Hotel, which, clearly not recognizing the same writing on the wall, opted not to take the route Lee did to cut his losses, and soldiered on foolishly to an eventual bankruptcy. It was eventually sold at auction for $82 million.

There's never any glory, of course, in eating a huge loss, as Pinnacle did on its AC project, so we're not presuming that event to be a golden moment on anyone's résumé. At the outset, AC looked like a no-lose bet in 2006, still in a healthy yoy growth mode. In the aftermath, it was clear that, while the Pinnacle project tanked, it did, under Lee, understand the time had come to cut its losses rather than face a potential multibillion-dollar disaster.

Lee left Pinnacle after a siting dispute with local Missouri political figures escalated into brief media frenzy.

Since then he has owned and developed properties both in the US and abroad, and was brought in by dissident shareholders of FLL in 2014 to head a proxy fight aiming to wrest control of the company from its underperforming management.

Our point here is that in Lee's 36-year career in gaming, he has built a strong reputation as hands on manager in good times and bad. Given the scope of his career, we think he understands how to build bigger companies out of smaller ones, knows what works in marketing, keeps a gimlet eye on costs, and, above all, brings to the company much invaluable insight into how to build a gaming company — insight gained during his years working with Wynn.

Note: Lee is not now, nor has he even been, a client of my consulting business.

The simple magic of a good, cheap stock

A good many penny and low-dollar shares are admittedly high-risk crap shoots and not worth much attention. They don't have logical growth stories, and their trading bases are far too thin for investors to generate the kind of volume than can bid the shares dramatically higher.

In this case, we think the risk/yield logic is stronger:

1. The very low cost of the shares enables you to buy a large block and potential participate in a serious profit if the shares do move.

2. The company isn't some fly-by-night garage dream of a pair of tech nerds among the thousands who never become tomorrow's Apples (NASDAQ:AAPL), Amazons (NASDAQ:AMZN) or Oracles (NASDAQ:ORCL) and essentially represent a common form of financial masturbation for some true believers. That's all fine and good, be my guest.

But FLL is now a solid little gaming operator, with a nice balance sheet, a good geographic spread of quality properties, a firm hand on both marketing and margin controls run by a management headed by a big picture CEO. Now that the company has long passed its near death experience and is on an improved earnings and margin roll, we think its still got upside left. Happily, some of our subscribers and followers heeded our April 21 alert, bought in and now show a 28% increase in their positions in less than two months.

We think at the very least a visit to FLL's website might be enlightening and help you decide whether or not to pull the trigger on this most interesting little company. Q2 earnings release date not yet announced as of this writing.

Author's note: Howard Jay Klein is a 25 year C-level casino executive and consultant. He is the author of Mastering the Art of Casino Management and the publisher of The House Edge. His own gaming shares are held in a blind trust for hi family to avoid possible conflicts of interest emanating from past, present or future consulting assignments in the industry.

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.

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