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Looking Ahead

Investors are beginning to recognize that many gaming stocks are undervalued

Looking Ahead

Caesars Entertainment’s and Penn Entertainment’s stocks have jumped up from recent lows thanks to Carl Icahn and Donerail Group.

Icahn and Donerail, each in their own way, brought attention to the fact that the stocks of both companies are way undervalued, with Caesars down 70 percent over the past three years and Penn a stunning 82 percent.

And what is true for Caesars and Penn is largely true for other casino operators. The Big Four—Caesars, Las Vegas Sands, MGM Resorts and Wynn Resorts—are down an average of more than 33 percent over the past three years, Deutsche Bank analyst Carlo Santarelli calculated. Regional operator stocks that he tracks are off 40.6 percent, with only Red Rock Resorts in the green, and it is up a merely modest 10 percent against a broader stock market that has soared during that time.

Icahn, in his fashion, highlighted Caesars’ undervaluation by buying a big position in the company. Icahn’s message is clear: The stock is undervalued and should go up from here. For example, Santarelli projects Caesars’ free cash flow per share next year at $6.41. That suggests a stock price more like double its current mid-$30s.

Donerail, on the other hand, has taken the activist investor route—sending an excoriating letter from Managing Partner Will Wyatt to Penn Chairman David Handler urging the sale of the company to realize the value of its network of 43 regional casinos.

In his letter, Wyatt accuses Penn of throwing good money after bad by:

  1. spending $551 million to purchase Barstool Sports, losing money on it and then selling it back for $1;
  2. spending $2 billion to purchase $25 million annual revenue generator theScore; and,
  3. signing its current deal with ESPN for ESPN BET. Combine the acquisition costs and operating losses and Penn has bled nearly $4 million in shareholder value.

The result, Wyatt says, is to so alienate investors that the stock price gives no credit for Penn’s solid and profitable brick-and-mortar casino business.

Even at just seven times EBITDA, the casinos by themselves are worth $6.9 billion compared to Penn’s current enterprise value of $4.1 billion, he said. Thus, there is a case for investors buying Penn’s stock today knowing that someday it will be worth much more, either because the expensive efforts to build a digital business will finally pay off, or because the company will jettison that effort and realize the value of its brick-and-mortar business.

As mentioned, Caesars and Penn may be the most extreme examples, but the underappreciation of casinos by investors extends throughout the industry.

Let’s use lodging as a close cousin to gaming. While the Big Four casino companies sell at 7.8 times next year’s EBITDA, according to Santarelli’s estimates, major lodging companies sell at 12.7 times. In other words, the casinos’ average stock price would have to rise 62 percent just to match their lodging counterparts.

Here’s another example: MGM Resorts and Marriott International both practice an asset-light model of operating, but not owning, their properties. MGM has a new and, by their reports, highly successful marketing relationship with Marriott. Both cater to affluent customers.

Marriott operates hotels. MGM operates hotels with money-making casinos attached. Both are profitable and are growing those profits. All else being equal, one would think that MGM stock is higher than Marriott’s. One would be wrong. Marriott is selling at 14.8 times Santarelli’s 2025 projected EBITDA. MGM is selling at 5.8 times.

Even Wynn Resorts, the Tiffany of the gaming industry, sells at just 9.3 times.

Regional stocks are even cheaper. Boyd sells at just 6.7 times next year’s EBITDA. Golden Entertainment is a paltry 6.4 times; and Boyd owns much of its real estate and Golden owns all of its land.

Bottom line: The casino industry as a whole is now a value play. The question is how all of this plays out, and how are fair values to be realized?

As Donerail suggests, it partly could come in companies being sold. And just as private capital has moved in to buy gaming suppliers like AGS and Scientific Games, perhaps private investors will step in to scoop up casinos at bargain prices. If so, that could lead to them spinning off individual properties, opening opportunities for public companies with strong balance sheets like Golden Entertainment and Monarch Casino. Even Penn Entertainment could be a buyer of select properties if the company regains its brick-and-mortar focus for investing growth capital.

It also could come through growing the businesses. Certainly, Churchill Downs and Red Rock Resorts demonstrate that investors will pay more than seven or eight times EBITDA for regional operators that have clear and successful growth strategies. However, growth opportunities are fewer every day as the industry comes closer to being fully built out.

The preferred way would be for investors to begin recognizing the inherent profitability of the business and begin paying for gaming’s predictable and considerable cash flows.

That means changing investor sentiment, which so far is proving to be the tricky part.

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