"When a train goes through a tunnel and it gets dark, you don't throw away the ticket and jump off. You sit still and trust the engineer…" Corrie Ten Bloom
This article needs to kick off with stipulations:
1. Wynn (NASDAQ:WYNN) bears have often accused me of being a knee-jerk cheerleader on the shares. I plead: Guilty. I am and have been a long-time fan of the company, its stock and its leadership. I knew Steve Wynn early on in my gaming career, have competed against him, know dozens of his former executives, have long witnessed up close both his blunders and acts of genius. On balance, I believe the proof is overwhelming that he's done very well for shareholders over many decades. And because of that, his stock will always trade at a premium.
2. I periodically review value analysis on the Capital Cube website not only for gaming shares but in companies in related industries such as hotel, leisure, cruise lines, online social gaming, entertainment and restaurants. In general their analysis can provide useful perspective. The broader based wisdom of crowds we find on SA isn't their brief. The diversity of opinion on investing we all partner in here is really unique. So again: To accusations of being somewhat of an SA homer, I also plead guilty.
3. I remind readers as I always do that my opinions on gaming stocks are mostly informed by my career as a gaming industry executive and consultant. I'm not a CFA or professional investment advisor. But over time the returns on my blind trust in gaming shares have produced strong percentage returns. They are run by a former industry colleague. From the beginning my instructions to her were simple: always take a wide-angle view. She keeps her own counsel.
With these stipulations for perspective I'm going to provide my view of a recent value analysis report CC did on Wynn Resorts. As usual readers are free to dispute, challenge or agree with my own conclusions. That's part of what makes for the wisdom of crowds so important to regular readers on this site.
1. The report rated Wynn as Overvalued, giving it a fundamental 38 score based on its metrics vs. 50 for its peer group. The peer group included: Las Vegas Sands (NYSE: LVS), MGM (NYSE:MGM) Penn National Gaming (NASDAQ: PENN) Boyd Gaming (NYSE:BYD), Melco Crown (NASDAQ:MPEL) Monarch Casinos & Resort (NASDAQ: MCRI) and Caesars Acquisition (NASDAQ:CACQ).
My view: This is not the best choice of peers from which to extract a median number. LVS, MGM and Melco are fine but the others occupy other gaming planets. Boyd is a nice regional with no properties in Macau. Monarch, a solid little US regional, has no properties in Las Vegas or most of the regional gaming markets. Caesars Acquisition is a tinker toy construct of its parent's bankruptcy filing and likewise isn't a good contributor to a peer median number.
The key parts of the rationale:
1. Underperformance last month is down from median of last year.
Comparisons yoy by month mean little in a Macau market slowly inching its way back from 24 straight months of decline. And to use that as a yardstick literally weeks away from the opening of Wynn Palace seems to us charitably a real stretch as a viable metric.
2. Its current Price/Asset ratio of 0.92 only hits the median among peers.
Again you need to look at the peer group. The overvaluation of Wynn vs. its peers is and has always been based on what the market sees as a company with the best assets that deserve the premium historically associated with the stock.
3. Compared with peers, the company's annual revenues and earnings change at a slower rate, implying a lack of strategic focus and/or execution success.
To conclude Wynn's metrics imply a lack of strategic focus begs credulity. Over time it is specifically Wynn's tight focus that commands the premium. Its stress on product quality, its sharp focus on the upscale part of the gaming patron while keeping its "wow factor" properties mass friendly has been its greatest strength. And it's why investors have awarded the shares a premium over 30 years.
4. Over last five years, reports CC, Wynn's US return on assets has fallen from above median to about median, indicating declining relative operating performance. This decline likewise is all about Macau. Longer term, the stock will continue to show premium resilience in the minds of investors as Macau recovers and new product flies out of the pipeline.
5. Margins are around peer medians and do not suggest superior pricing performance or operating margin superiority vs. peers.
This is a slippery eel conclusion. Despite periodic discounting common to all operators in the peer group including Wynn, the company on average over time has commanded higher prices for its rooms, suites and non-gaming amenities. More critically its win per gaming position in slots and table games consistently outperforms its peer group in every market in which it has operated.
5 Wynn debt-EV has declined 9% from last year's high but remains above its five-year average debt. This metric is about the pipeline of new properties and good cost controls going forward. But it's a snapshot, not a portrait. This metric becomes far more meaningful by Q2 2017 when the transformation of debt to EBITDA from Wynn Palace begins to work through the system.
There's more but we'll spare you the floodtide of technical and other metrics cited. We don't question their accuracy, only the conclusions drawn from what we consider a tunnel vision view of the stock to be found on the site and many others as well.
Their conclusion: Wynn is overvalued at its current trade in the mid-to low 90s relative to peers. Fair enough. We disagree and stick to our target number of $125 to $135 anywhere between Q3 this year through Q2 in 2017.
But now let's look at one of the few positives raised in the report:
Wynn Macau has generated $687.5m in EBITDA, over $200 million more than the single best resort generator of EBITDA in Las Vegas. Guess who? A company called Wynn Las Vegas.
1. The report seems a bit puzzled why the market continues to give Wynn a P/E ratio that is around peer median and "seems to see the company as a long term strategic play."
2. The report sees the company as possibly too levered to raise additional debt going forward. Its interest coverage is lowest relative to its last 45 years though it's stable at 1.76x since 2015 from a high of 4.48x in 2011. Compared with peers interest coverage fell below the peer median of 2.50x.
It seems to us that three basic issues pop up as worthy of broader examination here: One is debt and two is completion of the Wynn pipeline by early to mid-2018 and three, the flexibility of the company to borrow if and when a huge new market opens-read Japan.
Currently sitting at over $9 billion, Wynn's total debt, like most of its peers, is high due to the voracious appetite for capital common to all casino operators. Fat IOUs come with the territory. It's nothing to flick away like an annoying bug for sure, but it is likewise necessary to couple the debt with a peek at interest coverage and maturities.
1. Coverage. The company's current coverage stands at 1.76x and as CC reports is stable. And it's entirely fair to suggest that it borders on the thin side. Yet if we project a going forward earnings profile that percentage-wise is no better than current performance in a down drafted Macau market and a stable but not spectacular Las Vegas market, that coverage ratio seems to us to be safe.
Going forward it's going to improve as pipeline projects begin producing EBITDA.
2. Maturities. We checked Morningstar for a peek at Wynn debt and the nearest maturities the company will face.
Nearest: $1.32 billion of 7.75% notes due in 2020. This chunk currently shows a yield to maturity of 6.65% - not bad.
Long term the big kahuna of Wynn debt is a $1.8 billion baby due in 2025. Those notes bear a 5.5% coupon. All of Wynn's debt maturities fall between 2020 and 2025.
Here's what will impact both the interest coverage as well as the refinancing costs:
1. By 2020, when the first tranche is due, all three present pipeline projects will be up and running: Wynn Palace will have established a four-year EBITDA profile and any further capex that property will need will fall within normal ranges of property improvements and maintenance.
2. By 2025, all of Wynn's current debt load will have been transformed into operating properties contributing EBITDA.
By 2020, Wynn Everett in Boston will have been open around two years and will be contributing EBITDA.
So the interest coverage between now and 2025 (save a total recessionary disaster that could devastate everyone, both in Macau and Las Vegas) should continue to move favorably back above median for its peers due to the unique earnings potential of pipeline projects.
So the question is raised: Suppose the persistent rumors that Japan will legalize gaming within the next three years turn out to be true and Wynn, among its peers, is standing up, waving its renderings along with other supplicants for a license there? Would the company's track record, leverage and reputation position it to succeed? And if so, could it finance it, either solo or in partnership with a big name Japanese company?
To get some perspective on these questions we contacted four investment banking people we have known through the years who have at one time or another worked on financings for casino properties. We asked them to take a quick look at Wynn debt and give us an opinion. We asked them two questions:
1. Interest coverage. Given the schedule of maturities and current performance of the company, plus the operating assumption that the pipeline properties would perform no better nor worse than present Wynn resorts, do they see a financing or refinancing problem?
All four answered: No, they did not. All agreed Wynn would have little trouble meeting maturities at present coverage ratios sprung out of property performance. However, all also agreed that ratios would rapidly improve as new product came on the market.
"The only contingency I see that could be a close run thing is if there's a free fall recession in gaming around the world due to factors we can't yet see. Black swans are rare," said our source, "but they do appear."
2. Would Wynn be positioned to finance a possible entry into the potential $20 billion Japanese gaming market should it succeed in winning a license? All agreed they saw no structural financial problem based on present numbers, for the company to freely bid, develop and open a major integrated gaming resort in Japan.
The takeaway: By all means investors need to arm themselves with as much ammo as possible before they make their moves. The problem I have seen, and continue to see, is the herd mentality often surrounding recommendations, especially on stocks like Wynn, which as I have written, are long distance runners. Going by tight sets of technical or metrics alone produces tunnel vision.
Most recently JPM downgraded Wynn, followed two weeks later by UBS, and now we further have this valuation by CC. Going from buy to neutral is no big deal - yet it should flag an amber caution signal to investors when it happens. Too many investors assume that the downgrades are based on knowledge their authors possess that they don't. That's faulty logic. Investors by all means should pay attention to changes in grading on shares they hold or decide to move on long or short. Yet they shouldn't allow themselves to fall victim to tunnel vision by seeing a given downgrade as gospel.
There are just some companies through performance over time, superior management focus and keener understanding of the markets they serve whose shares are recognized as worth a premium in good times and bad. And that premium doesn't just spring out of blind faith. But deeper understanding of a company's business and how it goes about making its money year in and year out.
About the author: Howard Jay Klein is a 25+year c-level veteran of the gaming industry and a consultant. He is the author of Mastering the Art of Casino Management and publisher of the SA marketplace site The House Edge. His own gaming portfolio is managed in a blind trust for his family to avoid conflicts of interest with clients past, present and future.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.