Credit: By Darren McCammon :
Eldorado Resorts (NASDAQ: ERI ) is the result of a merger between Eldorado and MTR Gaming Group followed by the subsequent purchase of two MGM properties in Reno, the Silver Legacy and Circus Circus. Altogether, the entity has trailing pro-forma annual revenue of approximately $901 million and adjusted EBITDA of $160 million.
ERI's Q4 2015 earnings report , released last week, is the first one which combines pro-forma operations for the fully merged entity and thus should improve investor visibility. The combined ERI now has locations in Reno, Nevada (Eldorado, Silver Legacy, and Circus Circus casinos all connected by a large indoor walkway); Shreveport, Louisiana (Eldorado Shreveport); Columbus, Ohio (Scioto Downs Racino); Chester, West Virginia (Mountaineer Casino Racetrack & Resort); and Erie, Pennsylvania (Presque Isle Downs & Casino). It is a somewhat geographically diversified regional gaming operation with a combined total of 4,900 hotel rooms, 300 table games, 45 restaurants, and 10,300 slot machines and video lottery terminals.
Locals and those who can reasonably drive to a resort for an extended weekend getaway are ERI's primary customers. In this respect, it differs from the large Las Vegas and Macau destination gaming resorts such as MGM (NYSE: MGM ), Caesars (NASDAQ: CZR ) and Las Vegas Sands (NYSE: LVS ) that can draw customers from all over the world.
This article is an update to an article I wrote a year ago recommending ERI . However, since I realize that article is now behind a pay-wall for many readers, here are some links to other postings on ERI.
My first blog post regarding the Eldorado/MNTG merger was made in May 2014, mylatest blog post on ERI was done last week . I have been a strong proponent of ERI during this time and have owned a significant position in it since back before the MNTG merger. Thus, I should warn you that while I try to maintain objective analysis, I am probably at least subconsciously positively biased.
- Vince Martin wrote a more cautionary article on ERI . Vince follows the entire gaming sector. He started off negative on ERI, but as the story has matured, his coverage has also evolved.
- Oliver Rheinfurth has written a number of strongly positive articles on ERI .
- Bert Hancock wrote a balanced article on ERI . Bert is a relatively new author; this is his first article on ERI.
- Jonathon Ferreira wrote this generally positive article on ERI . Jonathon is also a new author; this is only his second article.
Price activity in the sector - Eldorado Resorts has more than doubled since my article a year ago. Over that year, the price of other regional gaming companies has been more mixed: Isle of Capri (NASDAQ: ISLE ) -17%, Boyd Gaming (NYSE: BYD ) +30%, and Penn National Gaming (NASDAQ: PENN ) -10%. Eldorado's strong outperformance was primarily due to two transformative transactions identified as potential positives in that previous article which did in fact occur: a debt refinance reduced ERI's interest costs approximately $35 million annually (gains which flow directly to both the bottom line and cash flow), and the company purchased the Silver Legacy and Circus Circus casinos from MGM. This purchase both significantly increased its presence in a growing market (Reno) and opened numerous potentially synergistic opportunities. However, despite this very strong past performance, as we will see, ERI continues to trade at significantly lower multiples than its competition. Based on current projections, I believe ERI may have another 80% of upside in the next year (more on this later).
Macroeconomics - Regional gaming operations throughout the United States have seen a steady increase in traffic. Analysts say improved employment rates in the U.S. and lower gas prices have helped to drive traffic to these regional operators. Nevada visitor volume also continues to exhibit a strong and steady recovery.
Eldorado's combined year-to-date activity was not available as of this writing. However, Scioto Downs' comps have been up 7.5% or more since Brew Brothers opened, and according to the Gaming Control Board, February revenue comps at Presque Isle are up 17.9%. One can hope the rest of Eldorado's casinos, particularly those in Reno, are showing similar growth.
According to the latest economic brief provided by the firm Applied Analysis, Nevada's initial unemployment claims are down 19.8%, retail sales are up 6.2%, and new business creations are up a whopping 282%. Additionally, the Reno Development Agency (EDAWN) has indicated it has recently assisted more than 60 companies representing over 16,000 new jobs to relocate to the Reno area (population 380,000). It would be hard to believe these, in some cases, startling good numbers did not also translate into increased gaming revenues, particularly for those casinos like Eldorado which see a high proportion of business from locals. In short, Nevada's tourism is improving, Reno's locals have more money in their pockets, improved employment figures are helping gaming countrywide, and low gas prices continue to encourage trips to regional operators. ERI is probably having a good quarter.
Sector Multiples - Despite doubling over the last year, ERI remains one of the more attractively valued gaming operators. Considering its past performance, leverage, growth, risks, and opportunities (further outlined below), I believe ERI deserves multiples at least near the average of its peers. As you will see at the bottom of this article, I have chosen to model ERI at a 9x EV/EBITDA valuation. A figure below the average of the casinos shown in the diagram but above regional operators ISLE and PENN.
Opportunities - ERI's biggest opportunity at this point may be just to continue to take advantage of the synergies inherent in the MNTG, Silver Legacy and Circus Circus purchases. Basically, the company needs to continue to duplicate what works and stop doing what doesn't at the various casinos under its umbrella. Having already achieved its initial goal of $10 million in synergistic savings a quarter ahead of plan, Eldorado believes there are additional potential synergies and opportunities to reduce the approximately $750 million in combined expenses it has annually. The $15 million the company mentioned by the end of this year seems very achievable. In fact, I note with interest that so far management has shown a distinct tendency to under-promise, I assume to purposely set-up situations where it can over-deliver.
An example of how ERI tends to under-promise is in the latest pro forma it provided. I estimate there were roughly $8 million in MGM corporate management expenses left in it; these expenses obviously will not continue going forward, however, management did not openly point that out. While I understand why one would keep those expenses in the pro forma, they did exist during the period referenced, that ERI management did not point them out is particularly conservative. In effect, it was leaving this gain "in its back pocket" only disclosing it in response to a direct question from an analyst.
Another obvious synergy the company seems to be downplaying is the Reno tri-properties. For example, there are currently 24 separate restaurants leftover from when the tri-properties were three separately owned casinos. Most of these are located in a large, second floor skyway which connects the three properties. This skyway is integrated to the point that from within you don't always know when you have left one building and entered the other. In many cases, you can actually see one or even two restaurants in the skyway from the front of a third. These restaurants are not only located very close together, many of them also offer essentially the same thing: three steakhouses, three coffee shops, three buffets, etc. There is obviously some redundancy here that can be improved upon, yet management as far as I can tell has never pointed this out, only making some vague general references to synergies at the Reno tri-casino complex. And these potentially significant synergies are not just on the cost side.
When Eldorado Reno had only 948 rooms to fill, a top-notch act like Carry Underwood was probably not economically viable to book. However, now that it has 4,442 essentially contiguous rooms in the downtown area to fill, bringing high-end acts with greater draws make more sense. Mrs. Underwood is scheduled to perform in April, and I fully expect Eldorado, working with the Reno mayor office, will continue to promote more and larger events in the downtown area.
New synergies which increase the revenue are also available on a smaller more simple scale; Eldorado typically has an ongoing act in its showroom similar to the current Footloose Dance Productions. When ERI only owned the Eldorado, advertising for the "house" show would of course only be contained within that one casino. However, now that it owns all three properties, properties again which are right next to each other and connected by a skyway, it only makes sense to have advertising for that show in all three casinos. It's also not hard to see the company extending its standard deal, 50% off dinner when you buy a show to all restaurants in any of the three casinos.
These are just a few obvious examples of the significant potential synergies which ERI is likely to take advantage of. Others include the duplication of the successful Brew Brothers restaurant at Scioto Downs (and probably eventually other clubs), the duplication of the already successful smoking patio in other casinos, reducing duplicative overhead expenses, collective purchasing power (not just food and drinks but for instance deals with slot machine providers), the merging and cross marketing of customer retention and frequent player databases, and a general sharing of best practices in regional casino operations.
Knowing what works and what doesn't at regional gaming operations is no small success; it can add a lot to the bottom line.
Were ERI able to eventually reduce expenses by 5% through redundancies and optimization, it would result in a savings of $37.5 million annually, savings which goes directly to the bottom line.
Risks - Gaming operations are typically tied to the strength of the economy. Eldorado is not different. Should a recession occur, all gaming operations, including ERI, would be negatively affected. Regional gaming operations are also tied to the specific economics and competition in the regions they serve. Mountaineer for instance recently suffered from increased competition (Mahoney) and a smoking ban in the area (Thankfully however, there are not currently any further indications of new casinos to be built near existing ERI properties). Eldorado Shreveport is near oilfields which are likely suffering from low oil prices and subsequent high unemployment. So far this does not seem to be affecting Shreveport too severely; however, were more oil companies in the area go bankrupt, one needs to be concerned the negative effect could become greater.
Regulation is always a major risk in gaming. Were additional controls to be placed on gaming, it would negatively impact ERI. However, this risk can work both ways, for instance, if sports betting is legalized throughout the U.S., it would likely benefit ERI.
Lastly, I have assumed a fair amount of synergies on both the expense and revenue side in my model below, particularly in Reno. Were these not to occur, it would make a big difference to the bottom line. Between the high fixed costs inherent to running casino hotels, and ERI's current high debt level, there is a lot of leverage built into this model that can work either for or against the stockholder.
Insider Activity - Most recent inside activity includes open market purchases made in December by Reeg (President), Hawkins (Director), and Pegram (Director), totaling approximately 26,000 shares in the $9.62-10.14 range. They and other insiders have been steadily buying all year long, with no corresponding insider sales. 13Gs showing greater than 5% ownership have been filed by Park West Asset Management, PAR Investments, Laffitte Capital, and NGA Holdco, a management owned (Carano/Reeg) investment vehicle.
The Carano family started, holds key positions in, and remains a major shareholder of Eldorado. In my opinion, ERI should be considered a family business that just happens to also be publicly traded. Those who think ERI may one day be bought by some other entity are probably mistaken:
- Founder - Don Carano
- CEO - Gary Carano
- VP and General Counsel - Anthony Carano
- VP Operations - Gene Carano
- VP Marketing - Rhonda Carano
- VP Food & Beverage - Gregg Carano
- Director Hotel Operations - Cindy Carano
- Director of Marketing, Silver Legacy - Glenn Carano
- Food & Beverage Coordinator - Lisa Carano
- Culinary/Management Intern - Donald Carano
In other words, if you live in Reno and your last name is Carano, you probably start working at the Eldorado about the same time you learn to walk. This multi-generation ownership generally aligns well with shareholder interests, probably causing longer-term thinking than typical in most publicly-traded firms.
Target Price -Investors are either unaware or seriously under-estimating the EBITDA and cash flow producing power of the new and much larger Eldorado Resorts. Now that ERI has started to show pro-forma combined financials and will be showing combined figures for future quarters, I expect this situation to rectify. Comparing ERI to other gaming entities (particularly regional gaming companies), I come up with a target valuation of $20 per share by this time next year. The target is derived from the model below by taking my 9x EV/EBITDA multiple (slightly below industry average) times the expected 2016 EBITDA of $185 million, then subtracting out expected debt (after significant pay-downs during 2016) of $773 million and adding back $50 million in cash. This gives us the expected market cap of the company of $942 million, divided by 47 million shares equals approximately $20 per share. The model assumes both a reasonable level of synergies are achieved from the merger and a 9x EV/EBITDA multiple is eventually assigned by the market. The $20 per share represents an 80% increase from ERI's last closing price.
Where to go for more information - In addition to the sources I linked at the beginning of this article, ERI's latest slide deck dated March 2016 is a great resource. Additionally, one can find annual and quarterly reports (10-K and 10-Q), insider ownership (Form 4), major shareholders (13G), etc. at either sec.gov or the company's website.
See also Maxwell Technologies Appears Conservatively Priced on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
