Iao Kun Group Holding Company Limited: A Possible Turn-Around Candidate

| About: LiNiu Technology (LINU)

Summary

Iao Kun Group has hit bottom but may come roaring back.

Iao Kun Group is in the process of restructuring its operations.

Iao Kun Group's strong balance sheet should help it weather the storm.

Introduction:

Iao Kun Group (IKGH) is a holding company which operates through its subsidiaries and related promotion entities that act as VIP room gaming promoters and a collaborator, and is entitled to receive all of the profits. When it comes to penny stocks, I usually take a pass. When it comes to management that is not well known and may at times be "misinterpreted", I surely would want to stay away. But when I do come across a situation where the downside risk is its current price, i.e. $0.30 and its upside, if only some positive events were to occur, is $1.00-$2.00 per share, then I am willing to risk some money, if not my reputation and will share it with those who may not be too faint hearted and who may be willing to "place a bet on the house."

Background:

I was first introduced to IKGH about three years ago by who I consider to be one of the best stock pickers in our business. At that time, the stock was around $3.00 per share and the story was quite intriguing. The company was incorporated on September 24, 2007 as a holding company that operates through its subsidiaries and related promotion entities that act as very important person (VIP) room gaming promoters. Until recently, the company conducted a VIP gaming promotion business at five VIP gaming rooms located in five casinos in Macau, China and two casinos in Australia through the Promotion Entities, which include the Promoter Companies, the Collaborator in Macau and Junket Operator in Australia. The Company was and still is to receive all of the profits of the VIP gaming promoters from VIP gaming rooms. The Company's VIP rooms are focused on high stakes baccarat (slot machine players need not apply).

As an aside, Macau dwarfs Las Vegas is gaming revenues. However, what has changed within the last 12-18 months is China's involvement in cracking down on any and all gaming irregularities and improprieties, real or perceived. This has greatly reduced the ability and willingness of China's high rollers to venture on high stakes gaming trips to Macau. The result is that IKGH has shut down four out of five gaming room operations in Macau forcing it to focus on its operations in Australia and undertake other ventures. The one remaining VIP gaming room is at the City of Dreams Macau in Cotai.

One of the initiatives was announced on June 23, 2016 when its indirect wholly-owned subsidiary Iao Kun Jeju Hotel Company Ltd had entered into a share purchase agreement with Golden and Luxury Company Ltd (a Philippine Company) to acquire the JejuSun Hotel and Casino in Jeju, Korea for approximately $101.8 million. While the written agreement has expired, both sides are still said to be negotiating because both sides want to close this transaction. No other bidder has come in as of today and even if someone does, IKGH would still be in the advantageous position of having the necessary gaming licenses to operate in Korea. The problem is to come up with the cash since issuing additional shares at these levels is not an option.

Looking at the company's June 30, 2016 balance sheet, which was restated on October 7, 2016, we see that current assets are over $146 million against current and total liabilities of $58.3 million. $14,228,500 of the total liabilities is in connection with the purchase of the City of Dreams VIP gaming room. This liability may be partially contingent on achieving certain performance hurdles related to this acquisition.

At first sight, a strong balance sheet. However, a disproportionate amount, $137.8 million of the current assets amount, are Markers Receivable. (This amount represents the restated amount as of October 7 after $21.5 million were written off as uncollectable). The company is using all legal means to collect as much of this amount as possible but whether it can be successful to collect the $100 million to close the acquisition of the JejuSun Hotel is certainly not assured.

At this point, we need to assume some worst case scenarios. Worst Case scenario #1-IKGH is unable to collect at least $100 million of its markers receivable, which will force it to walk away from the acquisition. Worst Case scenario #2 would be that they do collect an amount sufficient to close the transaction but another bidder has stepped up in the interim and is acquiring Jeju Sun. And worst case scenario #3 would be that the hotel-casino acquisition does not close and IKGH collects only a fraction of the Markers Receivable, and that another $50 million will have to be written off in the weeks and months to come.

Financials:

As of June 30, 2016, the restated shareholders equity was $87.6 million or $1.39 per share. After writing off another $50 million of the markers receivable, equity would decline to about $37.5 million or $0.60 per share. IKGH would then hold cash in bank of over $87 million or about $1.39 per share. Cash after all liabilities are paid would still amount to $28 million or about $0.45 per share.

The company would then be able to focus on its Australian operations and be in a position to pursue a more modest acquisition that would still transform it into an operating company. Another cloud overhanging IKGH is a communication from NASDQ stating that the Company is in violation of the $1.00 minimum price necessary to maintain its NASDQ listing. In March 2017, it will be granted another six months period during which, unless the price per share recovers, it will have to consider a reverse stock split or risk delisting in September 2017.

Conclusion:

As explained at the outset, IKGH is an extremely high risk speculation where the invested principal may well be at risk. However, the risk reward ratio is at least a favorable 3:1 and may be higher if the above worst case scenarios turn out to be less ominous. First, having closed four VIP gaming rooms in Macau will save the company at least $75 million annually. If managed prudently, the balance sheet, even with additional write-offs, is in decent shape. Also, the possibility of closing on the Jeju Sun Hotel would be a game changer and even the pursuit of a smaller property would force short sellers to begin covering their shorts. I am projecting that one or two positive development within the next few weeks will stop the hemorrhaging of the stock and return it to a more reasonable level of $1.00. Beyond the six to twelve months time horizon, the shares will, given only one or two positive developments, i.e. the purchase of the Jeju Sun or other property, advance to the $2.00 a share level.

Disclosure: I am/we are long IKGH.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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