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I have written about Boyd Gaming (BYD) a couple of times recently. First, I wrote about how it was the best way to play the pending legalization of online gambling, primarily because it already has licenses in New Jersey and Nevada in place and it owns 50% of the Borgata, which generates roughly ¼ of gambling revenues for Atlantic City. And I then wrote about how on a relative valuation basis, it looks very cheap.
Yesterday, BYD released its earnings report for Q4 2012 and while the headline figures look weak, there are quite a few silver linings in this report.
Management is hell bent on paring down non-performing assets and focusing on core performing assets. Its strategy is centered around stronger economies in the Midwest and South and on capitalizing on the online gambling movement. To this end, in just the past week they have sold off two assets:
(1) Dania Jai-Alai for $66 million
(2) Echelon site on the Las Vegas strip to the Genting Group for $350 million in cash
The sale of this property includes the 87-acre land lot as well as any improvements to the site. BYD will take a non-cash impairment charge of $994 million as a result of this sale and they will increase cash by $157 million after paying a portion of their proceeds to LVE Energy Partners. On the conference call the company projected annual savings of $16 million associated with storage costs, insurance costs, and property taxes that they will no longer have to incur. This should boost EPS $0.20 going forward.
Acquired Property - Peninsula Gaming
In November, BYD completed its acquisition of five Peninsula Gaming properties, which generated $57 million in revenues and $21.2 million in adjusted EBIDTA in just the short period from November 20 to December 31, 2012 that it was under BYD's control. Annualized these properties should contribute $400 million in revenues and $150 million in adjusted EBIDTA and significantly boost free cash flow.
Boyd is now very well positioned to take advantage of the onlinegambling market, because of its nationwide assortment of properties, and because it now has legislative approval in New Jersey and Nevada. Through a partnership with bwin.party (PYGMF), BYD has an advanced technology platform tailored for online gambling and it also has name recognition in New Jersey with the Borgata. Because the state of New Jersey is only allowing online gambling to those users with an established account with companies that have a casino license and who are physically present in their state, it gives the Borgata a huge advantage over competition because it is by far the largest player and the most well recognized brand in Atlantic City.
The Borgata is synonymous with Atlantic City and given how the rules are set up, it is natural to assume that the Borgata will grab a significant share of the accounts set up for online gambling. Logically if online gambling plays out like it did with the online poker market in the US (where the leader grabbed roughly 40% of the market), then the Borgata could grab well in excess of its current market share of 25% of the market. Dennis Farrell at Wells Fargo estimates the state of New Jersey to generate $1.5 billion in annual revenues from online gambling by 2015. I think this is reasonable given New Jersey's demographics and the expected popularity it will have with smartphone users.
If the NJ market plays out like the US online poker market in the mid 2000's, then it is reasonable to assume that the Borgata could generate up to $600 million in annual revenues from online gambling (or 40% of Dennis Farrell's estimate of $1.5 billion). Half of that would go to BYD, which means a potential boost of up to $300 million in annual revenues, assuming Mr. Farrell is correct (at the end of this article, however, I use a lower estimate to be conservative). Keep in mind the margins that online gambling possesses are far greater than traditional casinos, so a large chunk of these revenues will flow to the bottom line. For example, in 2009 Pokerstars was producing an estimated 35% net profit margin. The passage of online gambling in New Jersey could be quite a shot in the arm for BYD, as I detail at the end of this article.
Pokerstars Facing Potential Ban in U.S.
Yesterday, the US casino industry asked the state of New Jersey to ban Pokerstars.com from returning to the U.S. market. Pokerstars and FullTilt, now under the same parent company, own roughly 50% of the online poker market. Both companies were sued by the Justice Department in 2011 for fraud. The Justice Department claimed they used false billing codes to process bets by US residents after online gambling was barred by Congress in 2006.
The combined entity is significantly larger than their competition, including PartyPoker.com, which is owned by bwin.party and which owns a rough 7% market share. Should Pokerstars be banned from the online gambling market in the US, this would be a huge win for PartyPoker.com. Bwin is a partner with BYD and MGM, whereby BYD would receive 10% ownership of the partnership in the event of passage of online gambling in the US. The online poker market in the mid 2000's was roughly $7 to $8 billion per year and could conceivably grow to $10 billion annually if passed into law in the next couple of years. It could potentially be even larger if you consider the proliferation of smartphones, which were almost non-existent in the mid 2000's.
Should Pokerstars' past transgressions prevent it from entering the US market, PartyPoker.com could conceivable gobble up a large chunk of the 50% market share owned by Pokerstars and Full Tilt…possibly boosting their market share to 25% of the overall market.
While the outcome of passage of online gambling in the US is still uncertain, the movement amongst several states to offer it is gaining momentum and I believe it would be a mistake to ignore this potential in assessing the valuation of BYD. Under a reasonable assumption that PokerStars and Full Tilt are barred from entering the market, if only temporarily, there is the potential for PartyPoker to grab up to $2.5 billion in annual revenues, of which $250 million would fall to BYD.
The Icing on the Cake - Further Asset Sales
As BYD continues to do a complete makeover of its company, additional assets sales are to be expected…or so management would have you believe. On the Q4 2012 conference call, in response to a question about what other things the company is targeting to reduce debt, COO Paul Chakmak stated:
"I think we're not going to lay out the specific plans just like we would on a historical basis do that. I think we continue to be very focused on improving the balance sheet; we have a lot of initiatives that we are considering implementing over the near-term future that will accomplish that. And so that's what we're going to really focus on and we'll let you guys know as we kind of accomplish those rather than lay them out today."
Undergoing a Major Overhaul
Management continues to do an overhaul of its company. It has gotten rid of two albatrosses that should boost EPS by at least $0.25 annually in Echelon and Dania Jai Alai. It has brought on a highly profitable group of properties in the Peninsula Gaming acquisition, and it expects to sell off more non-performing assets in the near future. Additionally, in my opinion, it is in line to benefit the most out of any other casino operator, including Caesar's (CZR), MGM Grand (MGM), or Zynga (ZNGA), from legalization of online gambling in New Jersey. I expect the lion's share of revenues from online gambling to fall to the Borgata and as a result, to BYD. While MGM owns the same 50% stake as BYD does in the Borgata, MGM is valued at almost 10X the valuation of BYD so the impact is far less.
On top of this should Pokerstars.com and Full Tilt receive unfavorable rulings from the U.S. regarding their desire to re-enter the online gambling market, and should online gambling be legalized in the US, then there is a good chance that PartyPoker.com and as a result, BYD, would be a significant beneficiary.
Valuation is Very Compelling
In my prior article I valued BYD on a price to free cash flow basis and showed just how cheap it was compared to other casino operators. Namely, it trades at 3.5 times free cash flow. Isle of Capri Casinos (ISLE) and Penn Gaming (PENN) trade at 6.2X and 13.8X, respectively, and Ameristar Casinos (ASCA) was recently purchased for 5X free cash flow. And my calculation did not take into account the benefit from Peninsula Gaming because their financials were not available at the time. Nor did it take into account any benefit from online gambling.
I believe the market is also grossly underestimating the benefit that legalization of online gambling will have on BYD. If we assume that the Borgata garners a 30% market share and the overall market grows to $1 billion by 2015 (33% less than what Dennis Farrell is estimating) then BYD would get 1/2 of $300 million in revenues or $150 million in revenues. Assuming slightly lower net margins than what PokerStars experienced in 2009 of 30%, BYD could generate $45 million in net profits from online gambling in New Jersey alone. On its current share count, that would result in $0.52 EPS. Add this to the current estimate of $0.65 EPS for 2014 and adjust for some modest growth and its easy to see how BYD could be generating $1.25 to $1.50 EPS in 2015.
I would highly recommend purchasing BYD at any price below $8. I think it is undergoing an overhaul that will make it much more profitable and I believe they are the most poised to immediately take advantage of online gambling in New Jersey and Nevada. I do not think the market currently appreciates how much of a transformation this company is undergoing and how much of an impact the approval of online gambling in New Jersey will have on the company. If my projections of $1.40 EPS are accurate, BYD could trade well into the 20's by 2015.
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