Subscribers to our premium site, The House Edge, got a 24-hour advance look at this research. In this article covering Eldorado Resorts (NASDAQ:ERI), we are extremely bullish and allude to the possibility that it is well positioned for acquisitions. We take the position that it has the appetite and the financial heft to expand.
Just after posting our article to our subscribers, the news broke that the company had indeed made a deal to acquire Isle of Capri Casinos (NASDAQ:ISLE) for $1.7 billion or $23 a share. In brief, we see this as a strong positive for both companies. The article is presented here without alteration in the light of yesterday's news.
Also note that back on May 13, in an article headlined "Isle of Capri A Transaction Waiting To Happen…," we saw this possibility given the background of Isle's new CEO as a former Wall Streeter. Our analysis of the company's prospects focused on just such a possibility. As we forecast, this potential development posed an upside for the shares.
Here's our track record on the call for the record:
Price at our Isle writing on SA last May 13: $15.99
Price of Isle at close yesterday after news of Eldorado acquisition: $22.04
Net gain to readers who acted on my call: $7.05 a share or over 33%.
Also note that we likewise express the view in the following article that ERI is a solid buy at its current trade and it too would be on the lookout for acquisitions. However, the focus on the article remains on ERI and we stress our bullish outlook for the shares not taking into account the accretive value the Isle buy will add. We'll do that after we analyze the full implications of this move and will pass our research on to our subscribers first.
"Your diamonds are not in far distant mountains or in yonder sea; they are in your own backyard, if you but dig for them…"
Russell H. Conwell
Let's start with the premise that I'm a strong believer that more than most other sectors gaming is a business where dominant family or individual entrepreneurial ownership and continuing financial and management skin in the game are the sina qua non of a company worth investor attention.
The track records of casino operators with either active management from founders or continuing board representation have as a group done better for public shareholders over time than have many managements comprised only of corporate hires.
Here are just a few: Steve Wynn (NASDAQ:WYNN). Boyd family members are still active in Boyd Gaming (NYSE:BYD). Founder of Las Vegas Sands Corporation (NYSE:LVS), Sheldon Adelson, remains an operating CEO. Members of the founding Goldstein family are still large holders in Isle of Capri Casinos.
The Farahi family continues active in ownership and day-to-day management of Monarch Casinos (NASDAQ:MCRI). Over the long term, shareholders in these companies have been handsomely rewarded as "partners" in a true sense with founding families.
And somewhat less visible, but no less active is the public gaming company with the most members in day-to-day management - Eldorado Resorts, Inc. I've observed this company over time as both an industry insider as well as an analyst and consultant. (Note: ERI is not now, nor ever been, a consulting client of my company.) And over time, I have come to feel strongly that they epitomize the kind of management DNA ethos that makes for a continuity of performance over time and worthy of investor notice. The timing at this moment at its trading range seems to warrant a good hard look.
I think as a result of lower general visibility among investors, ERI is undervalued.
For context, let me start anecdotally. Back in the day, I had the occasion to travel to Reno to review a new line of slot machines built by the then industry leader Bally Gaming, a division of the then Chicago parent Bally Manufacturing, long defunct. A close friend ran the division and arranged my hotel reservation.
Although at the time Harrah's was the signature property in town, he deliberately booked a room for me at the Eldorado Casino Hotel downtown. "I want you to see something," he said. "It's an education in how great places are run under the radar screen of many investors."
The next day, before visiting the plant, we met for lunch at the Eldorado and walked the casino floor together. The place was spotless, shiny clean, well laid out. It was obvious that floor personnel were visible and on the move in all the slot zones interfacing with customers. In the pits, the dealers smiled, were friendly, exchanged niceties with players.
As we walked the floor, my colleague pointed out a young man perched up on a platform inside a carousel of slot machines who was selling change. In those days before voucher technology, change people wearing pocketed aprons loaded down with rolls of quarters, halves and dollars either roamed the casino floor or worked at strategic positions in carousels changing bills for coins.
"See that guy," my friend said, pointing to the young man, enthusiastically changing a twenty dollar bill for a customer. "That's one of the Carano family sons. All five of Don Carano's kids, in one capacity or another, will work in the business. Not one of them will begin sitting behind a desk, all will literally be hands on from the casino floor throughout the property. This place makes a fortune. Someday, it will go public, but it won't ever change into a stuffy, corporate bureaucracy."
Since the 1970s, the bulk of the Carano family wealth and management know-how have become invested in the business. The four sons and one daughter are now preparing interested members of the next generation of 11 grandchildren to continue in the business.
Nepotism can be especially dangerous in a company when family ties don't always work to the benefit of public shareholders.
Plenty of family businesses have their share of unproductive, parasitic bozos. To the contrary, in this company, we see it as a big plus. It's a line item unlisted on the ERI balance sheet, but a strong asset. The Caranos are smart, savvy and hardworking. And worth an investor bet on the future of their company.
Don Carano, a Reno lawyer, bought the Eldorado in 1973 against advice of friends in the business. It's become an inter-generational family enterprise with public shareholders. All five of Carano's children, now into middle age, are active in the day-to-day running of the company. And the generation after them is on tap to continue that involvement.
The reason is this: DNA in gaming companies tends to instill a strong management culture that is passed down through every level of management down to line employees. And that in turn, when it's positive, translates into cash flow and earnings. Apart from the standard analysis metrics we use to value stocks, in casinos, investors need to understand this:
Gaming is a 24/7 business. It is demanding of management time, it can move through five crises a day, it often needs fast decisions made by individuals who bring a gut level understanding of customer dynamics to problems. Executives poring over computer screens alone can't run casinos from the flight deck of the Starship Enterprise.
As technology and numbers crunching MBAs have transformed much of the industry, it's still not a business for just anyone. The singular type of personality it takes to succeed in gaming management isn't always to be found on a resume, flushed out in a series of interviews or even from a battery of psychological tests.
Hard day-to-day slogging, dealing with masses of people you are there to entertain, service and make happy is not a business for everyone. It brings long hours, lots of wear and tear on mind, body and often spirit and demands a thick skin.
You have to be a believer in the property culture to succeed. And when the business is in your blood that's a good thing for customers. Whether real or perceived, the idea that "the boss is in the house" resonates with customers. And that's good for shareholders over the long run.
For certain it can't insulate shareholders from family woes, such as those that dogged the once great Horseshoe properties of the Binion family (long part of Caesars (NASDAQ:CZR)). But what does count is the management commitment to a high intensity service ethic that often had begun with the vision of its founding family that began life fighting for every single customer every single day.
Eldorado is just such a company. Its founding patriarch Don Carano, 84, remains chairman and also devotes his time to a vineyard in Sonoma California. But the business model he crafted in the 1970s remains in place today.
It is beginning with that core element that we spread out to a quick look at ERI's recent performance, earnings outlook and why we now feel it offers a higher than targeted upside for investors who agree with our assessment of its current valuation as being low.
Eldorado Resorts Inc.
Price at writing: $14.25.
52-wk. trading range: $8.47-$15.60.
1-year target est.: $17.33.
Market Cap: $670m.
P/E ratio vs. industry: 21.39 vs. industry 18.10.
Average daily volume: 200,000 shares.
Institutional holdings: 46.53%. We think this will grow significantly as coverage on the stock increases spurred by earnings beats.
Annual 2015 revenue: $719m.
Gross Profit: $273m.
Net income applicable to common shares: $114m.
Q2 2016 earnings: 23c on revenue of $231m. Up yoy 32%.
Through Q2 of this year ERI paid down $736m and I committed to continuing to ease the gross leverage ratio of 4.9X.
ERI operates seven casino/racino properties in five states: Nevada, Ohio, West Virginia, Louisiana and Pennsylvania. The crown jewels of the business are its three signature downtown Reno properties: The Eldorado, The Silver Legacy and Circus Circus. The last two of these were the 50% share they did not own but acquired from their now former partner MGM for $72.5 million. The operating results here include the acquisitions counted from Q1 2015.
The Reno story and consolidation of US regionals coming
Last July 14, we posted on Monarch Casinos & Resorts, a Reno-based casino operator with a similar profile to Eldorado. Though much smaller (2015 revenue $202m) Monarch shared many common attributes to ERI: It has inter-generational family management that translated to a strong service ethic and relentless hands-on cost controls.
At that writing, the shares were at $23.03 and have moved little since. At this writing, the last trade was at $22.90. (See our Monarch post in your House Edge archive). We still remain bullish long term on the shares because the company is heavily invested in two growing markets - Reno and Cripple Creek, Colorado.
Our take on that company was similar in that we saw the growth of the Reno/Sparks gaming market as a key trigger to its forward earnings profile as well as its entry into the Colorado market as a first step outside Nevada. We saw an upside longer term strongly sprung out of a demographic dynamic that has been forming in Reno/Sparks with a quickening pace over the last five years.
The Caranos and the Farahis are both sending a message about Reno that should perk investor confidence in both companies - namely they both doubled down on their bets in that market.
Monarch acquired its Atlantis property in 1996 and since has invested over $60 million in a program of constant upgrade, renovation and expansion. At the same time, it acquired a property in Colorado as part of a diversification. Eldorado follows a similar game plan on a larger scale: Expansion in Reno, diversification with acquisitions in regional markets outside of Nevada. ERI acquired Sliver Legacy and Circus Circus in late 2015 and connected the three with walkways so customers can avoid the downtown streets.
These guys know their business and know their market. In an era when many legacy Reno properties dating back to the 1930s and '40s have long gone the way of the dodo bird, others with the staying power like Harrah's invested in that consolidation, seeing a propulsive growth curve forming in Reno. Ditto for Eldorado and Monarch.
Meanwhile, Reno's big cousin down south, Las Vegas, has long evidenced strong conviction investing by large gaming operators. They point to recovery of gaming revenues, though modest, rising non-gaming business, sustained growth of visitation and a strong, diversifying local economy as the basis of their increasing Vegas investments. And it is justified. Yet in the blizzard of that growth, the Reno story has become an afterthought. And because of it, our take is that stocks like ERI are undervalued.
So what do the Caranos know that the market may or may not really understand yet? There has been occasional perked interest on ERI from time to time on SA posts as well as those found on other financial sites. What we shall attempt to do here is provide a deeper dive into what we are convinced is the rationale behind the decision by Eldorado to increase its Reno bets and by that confidence provide investors with a reason to take a serious look at the stock now.
1. Reno's 26 casinos with revenues of $1 million* or more posted annual revenues of $1.3 billion, of which $674m was gaming, or roughly over 50% of the grand total. During the same period, Las Vegas strip gaming accounted for $6.3 billion or 34% of the total $15b in total revenues. So while Reno also is experiencing a rise in non-gaming revenue it remains, percentage-wise, a superior generator of pure gaming than does its southern cousin.
Gaming margins, particularly slots, are still the best money machines margin-wise in any US regional casino hotel. This reflects a different customer dynamic between both markets. Percentage-wise more people still visit Reno to gamble as a primary driver than do visitors to Las Vegas. For the first six months of 2016, Reno gaming was up 5.3% while the Strip was up 2.32%. (The strip has since posted better numbers mostly attributable to the baccarat business. The wide swings in Strip gaming revenue ride the fate each month of the hold percentage on baccarat. This is not the case in Reno.)
*Metric of the UNLV standard gaming research tables.
2. Reno market dynamic.
a) Metro Reno itself has a population of 425,417 which, according to the Nevada Economic Planning Indicator's Committee, is expected to rise to 630,000 by 2019, a 7% increase. The US census indicates virtually no population growth in most states.
b) New jobs are expected to grow by 50,000, much of it fueled by the oncoming Tesla (NASDAQ:TSLA) battery gigafactory, Switch and other technology industries. While today the bulk of the Reno workforce is employed in education, health and government services, that will change dramatically as more private sector jobs in technology, gaming and housing are expected to spike. The committee estimated that currently Reno will need a projected 9,000 new homes built to accommodate the inflow of new jobs.
c) The ever-valuable migration of retirees, a prime source of gaming patronage, also is increasing. By 2019, residents 60 or older are expected to comprise 24.3%, or 155,000 individuals of the metro area population total. The pace is accelerating as ever larger numbers of Californians of all ages, fleeing high taxes and facing growing quality of life issues in most of that state's metro areas, are finding Reno a better option.
Surveys indicate the lifestyle quality, which was so key a part of California's lure, has diminished while they see Reno as to its smaller scale, climate, outdoor and recreational options and above all cost of living as strong financial incentives to move to the area.
"We're getting bigger and better business every year from our northern California base," said one Reno gaming executive from a mid-sized property. "The technology people, the young people, many of them have sort of discovered us. There are a certain number of them who don't like Las Vegas, the heavy clubbing, and all that kind of thing. We deliver on excitement without the crazy prices or the hassle and we're a lot closer to home for many," he said.
Two of Reno's key feeder markets are Sacramento, with its 2.1 million-population base lying around a 2.5-hour drive from Reno or via a 45-minute flight. And the San Francisco metro area with 7 million people, which is also a 45-minute flight and around a 3.5-hour drive to Reno. (it's four hours by car between Las Vegas and Los Angeles).
"We position our marketing in a way against two ends of the age spectrum," the executive pointed out. "You have the young millennials and GenX-ers coming from SanFran and the Silicon Valley and at the other end the growing numbers of senior locals who fled California and make up a strong component of our slot business."
All this points to a part of the underlying thesis, I believe that has driven ERI to place an ever bigger bet on Reno.
d) The demographics of the Reno metro area are not empty statistical Chamber of Commerce prattle. They represent a projected future paradigm for a strong casino operator that justifies the investments made today. And at the current trade, we think ERI presents a strong value equation for investors who can stay long on the stock over the next two years. Given the entry point of the price now, we see that value conferring rewards that are better than many other regional operators.
ERI's racinos outside of Nevada present a mixed bag of results. It is for example hurting in West Virginia where its Mountaineer racino property turned in a 4% revenue decline due to competition from the new Horseshoe Baltimore property and a smoking ban. It also feeds off Pittsburgh where competition is likewise growing. This will worsen by the end of the year as MGM prepares to debut its powerful new entry at National Harbor Maryland.
Yet ERI's racino in Ohio is up slightly. A 118-room Hampton Inn is expected to open at the property by the end of Q4 this year. We think the saturation issue looms large in many regional jurisdictions, and as such, we see ERI's racinos just about holding their own going forward.
At the same time, we don't think ERI is done with growing the business outside of Nevada. Its Louisiana property in Shreveport is down 7% for the Q2 period, battered by the downdraft in the energy sector as well as a low hold percentage.
Overall, we think the racino component of ERI will be spotty unless there is a spurt in economic growth we don't yet see in the offing. Meanwhile other than the Mountaineer racino, the properties will hold their own. We also believe ERI will continue to keep its eyes on the regional markets looking for expansion possibilities. They can finance such moves easily. Overall the core elements of the ERI story are very strong in our view:
1. A well-managed family company with skin in the game and a long track record of success.
2. A growing Reno/Sparks metro area base with a demo favorable to gaming patronage.
3. A trade that given the company's recent performance posting an Adjusted EBITDA of $46.7 million for Q2 and a determined policy of deleveraging its balance sheet, ERI is an undervalued trade at $14.25 a share.
If you believe in the Reno revival story as a ground floor opportunity at current trades for both ERI and Monarch, I see a bet on both as offering a solid risk/reward ratio in comparison with many other US regionals.
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.