Thoroughbred racehorse I'll Have Another has made headlines by winning the Kentucky Derby and Preakness, which sets him up for a run at the Triple Crown in the Belmont Stakes on June 9th, mere miles from Wall Street. Thus, it's an apt time for investors to consider whether there are any attractive equity investments related to horse racing. Although there are relatively few public companies in this industry, Churchill Downs (CHDN) is the most representative and largest market capitalization firm in the industry, and deserves a strong look from investors.
Churchill Downs offers a compelling story as the pre-eminent integrated firm in the horse racing industry, with operating segments that cover the broad scope of the industry. Horse racing, which according to the New York Times once comprised nearly all legal wagering in the United States, now accounts for only $3 billion compared to $31 billion in casino wagering in the United States in 2011. This decline in wagering market share to other forms of gambling in the United States has led to consolidation and failures of major operators. This has provided the opportunity for Churchill Downs to go on an acquisition spree in recent years, adding a number of racetracks to their portfolio. Churchill Downs has a portfolio of high-end racing operations facilities, which include Churchill Downs Racetrack (home of the Kentucky Derby, the first leg of the horse racing triple crown), Arlington Park Racecourse, Calder Race Course, and Fair Grounds Race Course.
Technology has been introduced in the horse racing industry to increase internet and other forms of remote wagering on racetracks (known as simulcasting or off-track wagering). Churchill Downs operates a significant online business segment, which includes internet gaming sites TwinSpires and Youbet.com, a supplier of horse race data, Bloodstock Research Information Services, and a major equity investment in HRTV, LLC (Horse Racing Television). They have taken a foray into non-racing gambling with their acquisition in February 2012 of Bluff Media, a poker news and information site. While initially this acquisition would be expected to mesh with their other gambling resource sites, it may also position them for what many expect will eventually be a regulated and taxed internet gambling industry.
Government regulations have also allowed firms in the horse racing industry to diversify their operations by including casino gaming at racetracks. These joint racetrack and casino developments, dubbed "racinos" have allowed racetrack operators to increase profits and greatly expand margins. The gaming segment includes "racino" operations including video poker and gaming operations at Fair Grounds Slots, Calder Casino, Harlow's Casino Resort.
Firms in the horse racing industry traditionally have volatile revenue and profit streams coinciding with the seasonal nature of racing meetings. However, Churchill Downs swung to a profit in their 1st quarter results for 2012, which is particularly noteworthy considering their 1st quarter is typically challenging due to seasonality. The results from the 1st quarter of 2012 provide evidence that their investments in tracks, internet wagering sites, and racino operations have helped to smooth their quarterly earnings results. Investors have largely cheered their results, with shares during May flat versus a major loss of 8% for the S&P 500 index.
In terms of financial performance, EBIDTA growth and balance sheet strength are two attractive elements of CHDN. Total EBIDTA across all segments for CHDN grew by upwards of 55% percent to $17 million from $11 million in the year-earlier period (Q1 2011) and a loss in Q1 2010. By operating category, racing operations EBIDTA grew 24%, technology grew 119%, and gaming grew 100%. These results speak to their effective diversification of the business across platforms.
CHDN has greatly reduced their financial leverage, taking their level of long-term debt on the balance sheet from $238 million in 2011 to $107 million in Q1 2012. For a firm that has taken on a large number of acquisitions in terms of physical racetracks and internet gaming acquisitions to so quickly extinguish debt shows the strength of financial management stewardship at the firm. The reduction of debt is an extremely positive development from a long term perspective, as CHDN positions itself with ample resources available for further opportunities in a space likely to experience further consolidation.
In terms of valuation, CHDN offers opportunity for investors looking for an acquisitive firm in a stable and consolidating industry. At a price of $58.83 as of June 4, 2012, CHDN has a market capitalization of $994 million, is valued at just 1.4 times sales, and has a trailing price-to-earnings ratio of 15. With strong EBIDTA growth and a robust and diverse business, CHDN offers value as a best-of-breed play in the horse racing industry.