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Finding Fundamentals

Going back to basics in deciding which companies have the most potential

Finding Fundamentals

It has been a while since fundamentals were the major theme in investment discussions involving casinos.

For a long time, worries about debt covenants going toxic and driving companies into bankruptcies or fire sales to maintain balance sheets have driven investors.

Many investors fled stocks for the relative safety, and suddenly very-high yield and potential returns, of bonds. The way to own a casino, it seemed, was to own its bonds, because, sooner or later, bondholders would become the stockholders.

And that will almost surely be the case at several companies-perhaps some with marquee names.

Before balance sheet hysteria, investors were driven giddy by dreams of grandiose, multibillion-dollar meta resorts with financing provided by a world awash in liquidity, which itself was largely supported by the gold rush-like boom in Las Vegas real estate values and other assets.

And before that, there were the story stocks-riverboats dotting the American landscape and turning entrepreneurial enterprises into public companies, inventions like automated shufflers and slot management systems leading to more efficient and profitable operations.

Many a fortune was made in the early 1990s when riverboat stocks rocketed skyward. And many were lost when they crashed to Earth, before some-Argosy, for example-rose again to reward investors.

Now, with the nation’s banking crisis apparently behind, the casino industry’s own balance sheet issues clarified, reality having set in on starry-eyed developers, and the halcyon days of a young industry behind, it may be time to return to fundamentals.

Those fundamentals might not seem so exciting as investors settle for more realistic valuations, bankers and investors finance less grand projects that actually pencil out on more than dreams, and the North American gaming industry grows more slowly.

But the new, more sober era will still present opportunity to true investors, people buying a piece of a company that they’ve studied and understand, not a trade-based hype and hope.

We’re already seeing a turn in that regard, as evidenced by first-quarter earnings conference calls where discussion turned more to items like cost controls and business volumes.

The most popular measure of an investment’s fundamentals has been price-to-earnings, and for good reason. It’s a simple term to understand and, ultimately, stock prices are driven by earnings.

But PE has not been the favored measure for gaming companies. Debt-to-EBITDA or enterprise value-to-EBITDA have been the favorites. One reason is that cash flow is a more reliable indicator of earnings power less susceptible to accounting manipulation.

And it is the measure lenders and buyers use when valuing companies.

There is another measure, however, that has been almost discarded but may deserve something of a comeback-price-to-book value, with book value meaning the value of a company’s assets.

This measure has long seemed archaic in an age where we have fewer factories and more service companies, where software can generate far more money than its tangible constituents can possibly be worth.

 An example in a casino industry context are slot machines and participation leases.

Casinos hate participation leases. Why give $20,000 a year or more to slot machine companies as a revenue share for a box that can be bought for $12,000 or $14,000 and manufactured for a lot less, casinos have asked.

But the value, slot companies argue, is far greater than $12,000 or $14,000 if the machine can generate tens of thousands of dollars a year more than a bought machine, and do it year after year.

The value slot machine companies have arrived at in most cases is 20 percent of revenue-a bargain for both them and casinos, they say.

Thus the debate.

But casinos have more of the classic tangible value that makes price-to-book useful. They are brick-and-mortar structures. They occupy real estate in places where, generally, market value can be reliably gauged. They are populated with things-slot machines, furniture, video displays, computers, kitchen ovens-with tangible value. And they have a history of being able to crank out so many dollars of profit or cash flow per square foot, per gaming position, related to the value of those surrounding tangible items.

So, when companies as solid as Pinnacle and Boyd sell for book value or less, they may deserve a closer look.

And everyone knows the financial issues at MGM Mirage, but when the owner of such high-quality properties sells at 0.8 times book, it could give some assurance to investors, and certainly to bondholders.

And what about MTR Gaming, with solid, earning properties at Mountaineer Park and Presque Isle selling at less than 0.2 times book?

Of course, price-to-book is not a basis upon which to make an investment. But for casino companies, it might be a good measure to use in the screening process.

Frank Fantini is the editor and publisher of Fantini’s Gaming Report. A free 30-day trial subscription is available by calling, toll free, 1-866-683-4357 or online at

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