- Distributed gaming operator Accel can go a number of different ways depending on political movement in Illinois and the company's plans for expansion.
- Fundamental analysis is difficult given significant uncertainty and a lack of comparables; ACEL looks like an 'eye of the beholder' stock.
- But Accel has some levers to pull, and a growing, asset-light business should have upside in a normalized scenario.
- After a bounce, valuation isn't perfect, and political risk seems elevated in the near- to mid-term.
Even heading into 2020, pinning down valuation for VGT (video gaming terminal) distributor Accel Entertainment (NYSE:ACEL) was a difficult task. Public comparables are essentially non-existent, as ACEL's model has important distinctions from those of slot machine manufacturers and traditional casinos. In a presentation last year ahead of its merger with SPAC (special purpose acquisition corporation) TPG Pace, Accel even called out "route-based service peers" which included Waste Management (WM) and Iron Mountain (IRM). The comparison wasn't necessarily outlandish, particularly by roadshow standards.
The expansion of gaming in Illinois promised to change the business — likely for the better, though the impact was difficult to gauge. A higher gaming tax rate was a negative, as was increased competition from new casinos, but seemed likely to be offset by an increase in the number of VGTs allowed per license and a doubling of the maximum bet. But the fiscal problems in the state — the only state in which Accel operates at the moment — are well-known, and added another potential wrinkle.
To top it off, the business hadn't been tested by any sort of recessionary environment: VGTs only launched in Illinois in 2012. Add in net leverage at year-end of ~2x EBITDA and ACEL promised a big dose of the "garbage in, garbage out" problem.
Five months later, the problem is even more pronounced. The coronavirus crisis has hit Illinois hard. The VGT business in the state remains closed, and likely is several weeks away from reopening. High unemployment could dent bar visitation and spend — or the industry could prove defensive or even benefit from lower consumer spending on travel.
A resulting budget crunch in Illinois, potentially as much as $3 billion in fiscal 2021, raises the possibility of further regulatory and/or political moves after last year's expansion. Similar problems in other states, however, could open new markets for a company that already planned to expand beyond Illinois.
This is a story that can play out any number of ways. Right now, reasonable investors can see ACEL very differently. Back at $10, I lean toward the bullish side. But I'd like to see the stock cheaper to be compelling — and future developments certainly could change my opinion.
The Pre-Crisis Case for ACEL
As a route operator, Accel acts as a conduit between VGT manufacturers and licensed establishments in Illinois. The manufacturers include IGT (IGT) and units of Scientific Games (SGMS), along with a few smaller providers. The establishments usually are bars and restaurants, but VGTs are available at truck stops as well. In addition, a few chains have set up shop in Illinois as basically slot parlors: they build a 'bar' which gets little or no use in order to qualify for a license, then advertise the slots side of the business. (A grocery store near our home on the Wisconsin side of the border managed to get VGTs in a similar fashion.)
It's been a good business for Accel since VGTs launched in 2012. Per its merger presentation last year, Adjusted EBITDA was $5 million in 2013. Pro forma for two recent acquisitions, it cleared $90 million six years later.
The growth has had several drivers. Through both organic increases and acquisitions, Accel has built up market share. According to the 10-K, the company now operates in 32% of licensed establishments, the largest such figure in the state. Churn is low, and at the end of 2019 the average contract still had a length of nearly seven years.
Location growth (as new bars and restaurants are built) adds to the market size. Higher win per unit ($130 in 2019 versus $115 in 2017) has further boosted the top line.
Those drivers should remain intact. Consolidation will continue. Per Illinois Gaming Board figures cited in the Accel 10-K, there were 52 route operators in the state, down from 80 in 2015. The top 10 operators control 71% of the market. (It's worth noting that the third-largest operator, Gold Rush Gaming, is embroiled in a legal battle with state regulators that could result in its license being revoked.) Location growth could see a short-term hit, but the longer-term outlook seems at least stable.
So there's a nice case for growth here. Revenue can expand thanks to both same-store and inorganic efforts. There may be some margin benefits to scale, though Adjusted EBITDA margins in recent years have stayed flattish at just below 19%. Scale can also drive growth, as data from a growing bank of VGTs, along with better analytics, can inform improved game choices at other locations. Accel is weighing the rollout of a rewards program as well.
All told, there's an attractive argument for ACEL. Valuation seems high by gaming standards at ~10x EBITDA — but capex is dramatically lower than it is for more traditional operators. Understanding that case at the moment, however, requires an understanding of several key external factors.
Illinois Gaming Expansion
After years of effort, the Illinois government last year expanded gambling in its state. It contained three positives for Accel's business. The first is that the expansion allows licensees to have six VGTs, up from a previous five. Second, the maximum bet was doubled to $4. Third, the maximum payout was increased to $1,199 from a previous $500.
Ahead of last year's merger, Acel expected the changes to boost same-store revenue by as much as 12%:
There are two potential drawbacks, however. The more significant issue is that gaming taxes are rising, from 30% before July of last year to 33% now to 34% on July 1, 2020. Accel receives 50% of win after gaming taxes and a 0.8513% administrative fee paid to Scientific Games for systems management. The higher taxes thus have a nearly 6% impact on win relative to 1H 2019 levels, which in turn offsets ~half of the projected revenue increase.
The second impact is less clear, though likely less significant. As part of the deal Illinois is getting new casinos, with six new locations throughout the state. One will be a so-called 'megacasino' in Chicago, whose prospects are much brighter after the licensing fees and tax rates were reworked last month. Racetracks also will get slots as well. In some markets, those new casinos may draw gamblers away from tavern VGTs.
That said, the Chicago casino in particular seems a more minimal risk — because there are no VGTs in the city. Accel does have a significant presence in the rest of Cook County (almost 5% of locations), but a downtown casino is unlikely to take much business away from local establishments.
Net/net, the expansion does look like a positive for Accel, given the boost to same-store growth from both more units and higher bets. But competition needs to be watched closely once it begins to arrive in force, likely in 2022.
The Coronavirus Impact
The case for ACEL in November, when it traded just above $10 after the SPAC merger, was that the stock was reasonably cheap pro forma for the VGT expansion in Illinois. The case in May, at roughly the same price, is muddied somewhat by the impact of the coronavirus in the interim.
The effects of the pandemic create a significant number of material, and at the moment unanswerable, questions. Obviously, the mid-term economic impact of the coronavirus is a key concern. Do we see a V-shaped recovery, as the market seems to be pricing in? Whatever form that recovery takes, how does bar/restaurant visitation and VGT spending hold up?
I do think it's reasonable to assume that, at some point in the not-terribly-distant future, demand and revenue at least return to 2019 levels. But I'm also less bullish on the mid-term economy than the market seems to be. Weaker-than-expected economic news, or a "second wave" of cases, could send ACEL down in a hurry, which makes me personally wonder if a cheaper price might be available at some point in 2020. Readers may well see it differently.
The other worry is that the coronavirus may further pressure population in Illinois — which already had the biggest drop of any state in the Union during the 2020s. If a recession accelerates flight, particularly from the more-well-off Chicago metro, that could create a mid- to long-term headwind for Accel.
Broader macro issues aside, the political impact could be significant. Again, Illinois' budget woes are well-known: the state went more than two years without a budget at all. The response to the coronavirus is going to add further pressure. It would hardly be stunning if Illinois legislators saw VGTs as a potential, if relatively small, way to cover up holes elsewhere.
The attractiveness of the industry as a target for higher taxation isn't just a matter of the need for cash. As ProPublica detailed in a report early last year, the industry vastly underperformed initial projections. Legislators well could make the case that route operators should share in the burden of disappointment. That's an easier case to make given that, as ProPublica noted, VGTs in Illinois still have a reasonably low tax rate. Pennsylvania takes 52%, and Oregon 73% (though those terminals are operated by the state lottery).
It's possible that another grand bargain could be struck around gaming after last year's deal, which would increase adoption in exchange for the higher tax rate. But that seems highly unlikely any time soon. The new casinos authorized by last year's expansion haven't been approved yet, let alone opened. Existing operators will fight tooth and nail against any further expansion of VGTs, which pressured casino win in the years after their release.
Even an expansion might not be much of a plus. The incremental revenue created by increasing the amount of units per establishment could be relatively minimal, given utilization: Accel's own projections last year suggested just a 5% boost to win from a 20% increase in placements. The boost to operator profits might be even lower, as they might wind up buying or leasing VGTs that see very little usage.
Between macro and political risks, Accel's home state seems like a worry. The question is if it can find a new one in which to operate.
Do New Markets Open Up?
Illinois won't be the only state looking for near-term tax revenue. That might create an opportunity.
Accel is considering entering new markets. It has a license in Pennsylvania, for instance. It's floated the idea of moving into Georgia as well, which offers "coin-operated amusement machines".
But the nature of the business makes it exceedingly difficult to enter existing markets. Multi-year contracts mean only a small percentage of establishments can change operators in any given year. The same data advantage Accel holds in Illinois is a detriment elsewhere. Indeed, Golden Entertainment (GDEN), who operates routes in Nevada, Montana, and Pennsylvania, hasn't moved in Illinois despite procuring a license in 2017.
That leaves states that might authorize VGTs going forward. Missouri seems one promising target. The state already has an issue with so-called "gray market" machines, and Accel's 10-K cites lobbying expense in that state. Accel presumably could enter Missouri relatively quickly given an existing base in southern Illinois. Indiana represents another potential target for similar reasons.
One big issue in both states is the presence of existing casinos — who, like their Illinois counterparts, will fight intensely to protect their proverbial turf. But budgetary needs may build some momentum behind VGT expansion in those states, or elsewhere.
Leaning Cautious on ACEL Stock
Again, there are a number of moving parts here, and many different ways the story can play out. But there are two core worries that keep me on the sidelines.
The first is the general state of the Illinois macroeconomic and fiscal environments. There are potential headwinds to demand in terms of both employment and demographics, while state legislators will at least be tempted to wring a few more dollars out of the industry. Even if a tax hike doesn't happen (and the gridlock at the state level suggests that it won't), there's a potential overhang to the story. And we're still a long ways off from real movement in other states.
The second is valuation. Again, comparisons are imperfect. But the data points we have suggest a double-digit EV/EBITDA multiple might be too high. Accel itself, according to commentary at the time of the merger, paid ~8x EBITDA for Grand River Jackpot. Penn, based on commentary from filings, appears to have paid less for Prairie State. (I don't believe the company disclosed the actual purchase price.) And GDEN trades at less than 8x EBITDA (though most of its profits come from casinos, not distributed gaming).
Accel probably deserves a premium to even those acquisition multiples, given its size. (Prairie State, for instance, generated less than $10 million in annual EBITDA in its last year as an independent company.) But it's difficult to argue that ~10x 2019 EBITDA is all that compelling, particularly assuming that the benefit from gaming expansion is somewhat neutralized by 2020 losses and mid-term macro worries.
Still, Accel does have levers to pull. Near-term losses are going to be manageable: the company said in a recent prospectus that monthly cash expenses were declining to just $2-3 million per month. Weakened rivals may allow further consolidation in Illinois, or open an opportunity to make a cheap acquisition in a new state. State governments probably start looking at gaming expansion in the second half.
And valuation, given free cash flow potential (Accel originally thought it could get to ~$70 million in 2020), is not terribly onerous. Of course, that's not quite the same as compelling. And the risks here seem like they might create a better opportunity at some point. In the meantime, ACEL should be a story worth watching.
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