Caesars: The Empire Strikes Back Slashing Sports Betting Media And Ramping Brick And Mortar Segment

Summary

• First among peers to staunch the bleed of media/marketing money fighting for sports betting market shares results in better prospects ahead for improving EBITDA on digital vertical.
• The horsepower of CZR's 65m rewards database will accelerate both digital and brick and mortar earnings growth ahead.
• Synergies, ending capex, recovering brick and mortar and rationalized digital efforts make the stock a strong buy here.
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"Out of intense complexities, intense simplicities emerge…"

Winston Churchill

Data by YCharts

No single gaming operator has faced greater complexities in its 2015 post- bankruptcy life than my own alma mater, Caesars Entertainment Inc. (NASDAQ:CZR). And since then, under the astute transformation led by Eldorado, it emerges as a company presumably overpriced by some metrics. It emerges loaded with $27b in total debt. It emerges with its post position as the nation's number #1 casino operator untouched. And above all, in our view, emerges as one of the best buys in the sector as the pandemic begins to wind down.

What has happened, as the Churchill quote above suggests, is that CZR management took the storm tossed wreckage of an otherwise worthy ship and brought it to a safe, comfortable harbor, ready to move ahead to our revised PT of $125 a share from its current $82 at writing.

It was only 7 years ago that CZR emerged from a bankruptcy filing ignited way back in 2008 when management foolishly sold itself to private equity operators Apollo Global and TPG for $27b in the teeth of the global financial collapse. The only real beneficiaries were inside options holders. Such a headwind of course wasn't on management, but what was on management was the transformation of a once great, gold standard brand of all gaming-faults and all-to the equivalent of a fallen star.

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(Above: The world flagship of gaming brands since 1966, Caesars Palace).

Its then CEO Gary Loveman, a Harvard professor unfathomably handed the CEO job in 2003 by gaming veteran Phil Satre, who had stepped down. When I called Phil to inquire about the out of the box hire, he pointed out that Loveman had been largely responsible for bringing CZR's potential to higher ground through his building of its database potential as a consultant out of Harvard.

Loveman's appointment came after the great success of his gig for Caesars that resulted in a highly sophisticated slice and dice data algorithmic system that enabled the company to drill down ever deeper on customer database motivations. He had made a prior success for MacDonald's. In an economy then roaring ahead on a wave of disposable income pouring out of home equity loans, Loveman's approach produced a great growth dynamic-for a while.

But five years later, it became apparent that as CEO, Loveman had blundered into one bad decision after another in attempting to take a business heavily dependent on customer facing contact, that destroyed much of the character than made it what it became since Caesars Palace first opened in 1966. The dream of pioneer visionary Jay Sarno, who created the Palace was not that it would always market to high end customers seeking what became years later, the town's tag line" What happens in Vegas…stays in Vegas..."

So Loveman proved, as has been the case with failed CEO's all over the public company landscape, that he was a one trick pony. Former colleagues at CZR properties told me during his tenure that a heavy corporate hand was laid over property level decision making. Much of heavy handed corporate oversight obliterated its customer facing legacy built up over decades. "It became an intolerable bureaucratic mess to be frank," one former colleague complained. "Hosts accustomed to walking the slot zones or games pits establishing customer friendly chats were confined to host desks. Imagine customers had to leave their machines, walk halfway across the floor, to reach the host deck and stand around and wait to ask for two for the buffet…" said one player development person we knew.

Carl Icahn, the ever astute activist billionaire had a particularly savvy grasp of the casino business after having made a ton scooping up cats and dogs on the Vegas and AC strips. He spotted what he thought were empty suit CEO'S. He'd do deep dive analysis of valuations. He found unpolished gems. He took over companies, installed new management, made capex improvements then resold the properties with massive gains to investors. In 2018, he saw CZR as an undervalued, tarnished fallen angel. He swooped in averaging around $9.50 to $11 a share accumulating his ultimate position of 17%.

Caesars archives

He engineered the departure of Loveman as well as his stewardship replacement, got two seats on the board and installed a solid, gaming pro to warm the CEO chair while he looked for a buyer. A few tire kickers stopped by for a cup of coffee but no cash so Icahn continued looking.

In 2019 he found a kindred spirit on Eldorado Resorts (NASDAQ:ERI). He didn't flinch, or hide behind weak offers to trade shares. The feisty hunger to grow in the Reno based Carrano family operation, was led by its CEO Tom Reeg, in the words of Icahn, "He put their money where their mouth was, the only guys to step up to the plate." A deal was made for $8.9b plus debt or $12.75 a share.

The CZR deal was the tailwind of a healthy appetite to wolf down and digest acquisitions in breakneck speed for ERI that began in 2017 when they broadened their geographic reach by acquiring Isle of Capri casinos while further adding to its home Reno footprint with Circus Circus and Silvery Legacy.

In the process ERI has amassed over $27b (mrq) in long term debt which in the view of some analysts along the way, brought questionable leverage and skepticism about synergies ERI said it would produce. In his most recent earnings call, CEO Reeg proved that every single addition to the ERI portfolio by acquisition had produced dramatic increases in EBITDA under its management. The record was achieved by expertise in finding promised synergies.

Caesars archives

Above: The CZR regional map is a massive feeder machine for its Vegas properties as well as brining diverse, geography/

ERI recasted the 65m Caesars Rewards database to distribute comps better aligned to real customer value and continued the aggressive capex investment started by the prior management, but rationalized it. It also rationalized the portfolio... Above all, ERO launched an effort to t return decision making on key policies to the property level.

Today under the CZR imprimatur the combined company has 52 properties under many brands including 23,000 rooms on its Vegas strip properties including iconic Caesars Palace. (One of its properties there is in the process of being sold this year. The EBITDA jettisoned from that property, Reeg noted will be replaceable in the growth arc of Vegas over the next several years, he said.

Since the actual close of the CZR deal in early 2020, the company has endured the industry wide collapse due to Covid and is now poised to recover across the board of its verticals as we enter what is hoped to be the endgame of the pandemic. What commands our attention now is not only the post Covid re-ramp of its brick and mortar business both in Vegas and its regional properties, but its nimble pivot on sports betting.

And we believe that points up a management which has indeed boiled down complexities it has faced, to a simple, gut level grasp of how to grow its business profitably in the years ahead.

We think that is a story possibly lost on some investors and analysts who have taken what we believe to be an overly conservative stance on where they see the stock going.

Caesars Sportsbook: First mover to staunch the floodtide of marketing losses that have bedeviled the sector from day one

Since the US Supreme Court striking down the PASPA law that opened the floodgates to sports betting in 2018, CZR, like all peers, had before it, faced the same decision tree:

Go at it from scratch and build one's own platform-where would that lead? Partner up with an existing leader in the space without US conflicts? MGM Resorts International (MGM) pursued that structure with the UK's Entain, giant. Where did that lead? To a good place for certain, but perhaps a merger after a failed buyout? Or buy an existing top brand to eventually acquire?

CZR took the last route, bought legacy William Hill last April for $3.7b, rebranded the platform to Caesars Sports Book to align its name with its powerhouse Rewards database. And then in a virtuoso swing, sold off the Hill UK and international business to 888 Holdings Plc. (888)(OTCPK:EIHDF) for $3b by September 2021. The deal will close this year. So CZR hits the ground running with a net cost of landing in a fast moving, mature sports betting operating business for a net $700m.

Getty Images

Above: The William Hill acquisition was a smart solution to a complex set of options CZR faced in deciding which route to take on sports betting.

Now compare that entry price to the cost of a start from scratch CZR sports book which would a) Yield it no existing customer data base l b) the need to find, appoint and develop a home grown platform, with a tech stack pick and shovel supplier to run the site-big bucks there. So from the jump the clear message from the sector was this: be prepared to shovel a ton of money into customer acquisition and eat loss after loss with no relief in sight as everyone else was doing the same thing. The battle for market share would be bloody.

To support its rebranding, CZR launched a huge media blitz with comedian J. B. Smoove as Caesar and actress Halie Berry as Cleopatra gagging it up between a sign up pitch with other big names. The ancient Rome roaring crowd background noise was distracting and perhaps the message got somewhat lost.

(Note: When I ran marketing at CZR I used late comedian Buddy Hackett in my TV ads dressed in a toga as a decadent jolly Caesar gagging up the message from a sedan chair in ancient Rome. It had been part of a cartoon part of the CZR logo of a Roman eating grapes. So the idea thematically still flowed after many decades).

The current version was of course aimed at rapidly building CZR brand ID awareness. The message however was a bit muddled, delivered as it were both on radio and TV against the roar of a crowd. But the core message managed to wobble through the heavy production of the commercials: Bet with CZR on sports, build points toward trips to brick and mortar CZR properties. A simple, customer value message delivered nonetheless.

If we assume the launch of the CZR brand effectively began with the brand change last spring, that means that the company had been pumping the gas on promotions and media advertising for nearly a year.

With its 4Q21 earnings release, CZR indicated it had generated $472m in sports betting revenue for the year showing an adjusted EBITDA loss on the business of ($476m). Changing dollars is clearly a dead end strategy. It also reported that it believed its overall current share of market nationally was projected at ~30%--an average between its power states and its laggard states. That share is expected to drop and stabilize profitability at 21% margin thereafter.

What's the magic sauce here?

But far more important was the announcement by Reeg that CZR would" dramatically curtail media spend" as it had reached branding goal, a competitive share of market across its footprint and will only use a prudent media buy in new states for limited introductory times. Additionally expect to see a reduction in the madhouse CZR promotional deals across the industry both in new and established states.

CZR data miners have found that a disproportionately large number of new sports betting customers, over 20%, ($160m) had come from the CZR Rewards database.

Clearly CZR management had unwound the complexities of the sports betting frenzy unleashed by the Supreme Court in 2018 i.e., how do you grow without buying the business till you bled your cash coffers dry? How do you make money in a business with essentially a 7% margin? The answers are simple: you don't make money in sports betting unless you can cross market the generally younger demo to make that walk across the casino floor and drop a few shekels on the blackjack table or in the slot machines.

Thus far it seems to be working. Rather than continuing the race to the poor house, CZR has learned that blending its inherited Hill database with its existing CZR Rewards 65m souls, the net here is this:

Over time, when the frenzy dies and we are looking, at a sports betting vertical with perhaps 5 or 6 surviving leaders, wrought out of a series of mergers and takeovers we see coming in the years between now and 2023.

CZR Digital is expected to accumulate a total loss of $1b until 2023, beginning with the just announced major cut in marketing and media and eventually produce a 50% EBITDA accretion against a share of market they see as sustaining 21%,

So going forward sports betting will be part of a highly bullish expansion of digital gaming verticals while at the same time, CZR will keep its focus on recovery of its brick and mortar business. Here are a few key numbers for context:

Revenue (ttm) $9.57b

Pre-tax income (ttm): ($1.070b) nearly all of which is attributable to the lingering Covid issues like the omicron variant which hit 4Q21 earnings with a miss of 16%.

Financial outlook

At writing CZR is sitting on $27.3b (mrq) in debt, accumulated over time linked to both its acquisitive strategy and of course massive revenue hits from the pandemic.

Cash and cash equivalents (mrq) $1.10b down substantially from pre-Covid early 2020 of $1.7b. Against this, CZR expects proceeds from the Hill sale to hit this year's balance sheet. Its capex programs across the system will be rapidly reducing toward the end of this year. CZR's current ratio sits at 1.13%. Levered FCF is $2,56b.

So overall, CZR's balance sheet is nowhere as pristine as some of its peers, part of which I believe is why Mr. Market may find it pricey even at $82. No matter how you calculate the re-ramp in its brick and mortar segment, the sharp reduction in sports betting media, incremental debt repayments out of growing cash flow in the second half of this year and the dwindling and end of capex by year's end, you have this kind of bet on CZR right now:

Its Las Vegas group business segment will begin to speed ramp between the last half of this year and 2023 as the long awaited return of the convention and mass tourist business occurs. With what I believe will be exponential leaps in revenues as the pandemic finally wanes, CZR will turn profitable very fast. EBITDA will accelerate fast. Proceeds from both the Hill global sale and the completed but as yet official sale of one of its Vegas properties will fall into this current fiscal year. Management is committed to debt reduction with no further long term capex in mind, no covetous eyes on new acquisitions. Sports betting bleed staunching is already in motion. Never underestimate the immense power of the CZR 65m database to produce the perfect circle of customer rewards earned in the regionals, circulated to Vegas properties, which in turn re-circulate to other CZR properties. It is the one high valued legacy of Loveman. CZR has inherited the customer friendly management ethos of Eldorado instilled decades ago by the Carrano ownership in Reno. This has been clear since the business model that created the core success of Eldorado, is already showing results at CZR properties as they slowly emerge out of the pandemic.

Key to this of course is the pursuit of the return of the keystone customer segment of the casino business often lost in the media shuffle which constantly bemoans the absence of millennials in casinos. What CZR understands all too well that the age 55+ customer is the bread and butter of the casino business. That customer, clearly absent due to Covid, is beginning to stir and return. CZR is rebranding its Ballys four corners Vegas property to the Horseshoe name as well as its St. Louis Luminiere property. Under the Horseshoe name it will better reflect its segmentation of mass market, pure gambler appeal created by its founder and original owner legendary Benny Binion. So it is a three tiered company: Caesars on the higher end, Harrah's in the middle and Horseshoe catering to budget no frills tourist gamblers.

At its present market cap of $18b I believe a speedy re-ramp of revenue to CZR, the biggest guy on the casino block, remains unrecognized on the pace of recovery ahead.

Analyst PT are averaging ~ $112. My calculations see a faster turnaround both in Vegas and in the regions, a fattened cash position by year's end, and a well rationalized cost to revenue ratio of sports betting going forward.

For that reason I am now putting a revised PT of $125 on CZR to be reached sometime late inQ3 or early 4Q2022.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.