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Thursday, August 6, 2009

UBET Slides, What Gives? Actually, Positive News

Small-cap stocks can move quickly, up or down. Just one week ago, shares of Youbet.com (UBET, $3.15) touched $3.79 intra-day and now the stock is down 17% from that level. Meanwhile, the S&P 500 is actually up 2% over the last week. We note that the decline occurred on volume lower than the average three-month trading volume of 332 thousand shares per day.

DateOpenHighLowCloseVolumeAdj Close*

What happened? Hard to say, but appears that someone either decided to book a gain after the share price recovery in recent months and/or became frightened by economic data that shows consumers remain in hibernation. In addition, specific to horse racing, Equibase reported on 8/5/09 that US wagers for the month of July were down 13.4% Y/Y, with YTD wagers down 10.9% Y/Y.

However, the Daily Racing Form highlighted that the Y/Y comparison isn't apples to apples because Saratoga and Del Mar, two major racetracks, started their meets one week later this year (thus, making July 2009 look worse Y/Y). Even so, the reported Y/Y decline in July was at least a moderation from the 17% decline reported by Equibase for the month of June. Our point: the incremental news was actually a slight positive for the industry and for Youbet.com.

Also, surprisingly, the Market seems to have missed Churchill Downs 2Q09 report last Wednesday after market close. Churchill's headlines:
  • Company’s Second-Quarter Net Revenues, Net Earnings and EBITDA From Continuing Operations Increase Year-Over-Year Despite Tough Economy
  • Slot-Machine Gaming and Online Businesses Continue to Fuel Company’s Growth
And key point in first paragraph:
  • "The primary drivers for the year-over-year increases in both net earnings and EBITDA from continuing operations were the continued growth of the Company’s online business – including the advance-deposit wagering (“ADW”) platform, TwinSpires.com, which posted gains in net revenues from continuing operations of 35 percent compared to the prior period – and the growth of the Company’s gaming business in Louisiana, which improved its quarter-over-quarter net revenues from continuing operations by 31 percent."
One the back of industry content agreements with ADW players like Youbet, Churchill realized meaningful Y/Y growth in online revenue and cash flow. Online revenue increased 35% Y/Y to $21 million while EBITDA increased more than 200% to $5.2 million (25% margin).

We expect Youbet to also benefit from the new content arrangements, albeit with lower margins relative to legacy content. In our view, this remains the one unknown headed into next week's earnings report. We're also curious to learn more about Youbet's strategy to enter the European market (see this 7/30/09 article from EGamingReview), although we suspect management is not yet in a position to share details. Plus, any European initiatives will likely take time to scale.

Bottom-line: contrary to the decline in the share price, the Equibase numbers show slight moderation in the Y/Y pace of decline and results from Churchill Downs bode well for Youbet.com. Other than that, nothing has changed since our 7/18/09 post: we already know/knew the consumer/gaming market is under duress, yet Youbet is one of only a handful of companies actually growing in the current environment. Not only that, the company has a solid balance sheet and should generate meaningful excess cash flow this year, next year, and the year after, assuming no strategic blunders. With the share price decline this week, the 2009E free cash flow yield is back to 10.7%, which we find very attractive relative to many alternatives.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long UBET.

© 2009 Jeffrey Walkenhorst
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  1. Excluding the 6/25 pre Russell 2000 small cap index announcement trading as an abberation in volume, since this article was posted on 8/6, the share price has lost almost another 25% in value on increased average daily trading volume of almost 15%.

    It's clear that at least in the short term, the market does not share your sentiment with respect to UBET; but that is potentially okay, and perhaps even advantageous to me (us) in the long haul; assuming that you now perceive that this is trading today at an even greater discount to what you believe to be its fair market value.

    Assuming that your market analysis and estimates of future earnings and free cash flow did not include additional growth from being able to openly market for business in Illinois, with the Governor's signature on the Advanced Deposit Wagering Legislation (SB 1298- PUBLIC ACT 96-0762: http://www.ilga.gov/legislation/publicacts/96/096-0762.htm)

    this seems to be an incredibly opportune time to have jumped in, and perhaps even continue jumping based on Friday's ongoing slide, and perhaps marginal .01 bounce off the bottom.

    Given the fact that they have already been operating in IL on the fringes for some time, and that CHDN-TWIN SPIRES could have a perceived marketing advantage due to their ownership and operation of AP, have you made any estimates for increased revenue, net income, and free cash flow as a result of the legalization for UBET'S service in Illinois?

    While overall handle in Illinois was down 12% year over year from 2007 to 2008, Illinois OTB's still generated $460MM in handle in 2008 by themselves so this is not an insignificant sum. On-Track and Inter-Track wagering also added another $360MM in parimutuel wagering activity, so the fish may still be plentiful there for them to add to the top and bottom lines from Illinois with some proactive marketing.

    Based on the experience in CA, the legalization of ADW has little to no impact on marginal growth for overall parimutuel wagering handle, however there is demonstrable evidence that legalization of ADW results in substantial migration in wagering handle from OTB's; and to a somewhat lesser extent from the live track, to the electronic platform.

    Despite the fact that overall handle in Illinois; like elsewhere, seems to be continuing to fall in 2009, any migration from OTB's and live track to ADW; and specifically to UBET represents an incremental year over year growth opportunity, and could help to mitigate the impact of falling revenue from other more mature states.

    Has your confidence been shaken at all with the nationwide decline in 2009 parimutuel wagering handle?

    How; if at all do you perceive this to effect your assessment of the current trading price as an estimate of fair value? Have you adjusted your estimate of fair value downward due to declining revenues, or do you now feel that this is trading at an even greater discount?

    What; if any effect do you think that the revenue opportunities in Illinois may yield for the current year (assuming marketing and operating under emergency rules established for September)?

  2. Dear Anonymous,

    Thank you for your insightful comments and questions. I'm planning to provide an update on UBET as the stock appears WAY oversold, but other near-term obligations are keeping me busy for now. I did speak with management the other week.

    In brief, my positive view has not changed, even with slightly lower forward estimates. I believe franchise value remains significantly higher than current levels and is supported by current and expected free cash flows. Please stay tuned and let me know if you've other questions.


  3. JW,

    I find it interesting that under the auspices of the new law in Illinois; Fairmount Park (Collinsville, IL -Metro St. Louis, which I believe was previously alligned with Hawthorne, and Maywood/Balmoral ownerships in a deal with Youbet, is now touting a new promptional partner-TVG. I find this disconcerting; in that UBET has not yet issued a PR on Illinois, even though they pruportedly inked a deal with Hawthorne-Maywood/Balmoral more than a year ago, so they should easily be ready to roll out the news and their plans. The fact that they haven't leaves me wondering if the deal still actually exists.

    UBET was deep rooted in IL long before Duchisois and Twin Spires even existed, and long before JB Pritzker and Brodsky even appeared on the scene, with Edgar and Chiparoni on the BOD going way back. If they somehow managed to blow this in their own backyard, that will be baffling to say the least.

    I'll look forward to your update.

  4. JW;

    P.S. The Youbet deal I was referring to was previously noted here:


    and the Fairmount aspect of this I referenced is here:


    Given the dramatic discrepancy between the two; at least with regard to Fairmount, it certainly appears as though something is rotten in Denmark.

    The fact that Youbet has remained silent on IL only throws gas on the fire of uncertainty

  5. Hi Anonymous, hard to say exactly what is happening with regard to Illinois legislation. I'm not sure about Youbet's relations with Fairmount Park, which - like many other tracks in the industry - is wrestling with tough issues. Youbet does offer Hawthorne and Balmoral content and Youbet banners are present on the home pages of these tracks. Fairmount's handle is small relative to other tracks. Please see
    http://www.state.il.us/agency/irb/racing/pdf/Mutuels%20Monthly%20Reports/2009%20June%20Monthly%20Handles.pdf .

    Either way, Youbet has plenty of tracks/content to offer customers.

    Seems imprudent for Youbet to issue a press release when the law is not yet official given ongoing appeals process. We've no real news as yet.


  6. JW,

    The ADW legislation linked above passed both chambers of the legislature by veto proof margins and was signed by the Governor and became law. While there is lengthy and ongoing litigation with respect to the casino set aside money payable directly to the tracks, unless you know something that I don't yet, this ADW statute is not being challenged in court by anyone and this law is unrelated to the other ongoing litigation.

    As a consequence, this is substantive material information, and while already generally public there is limited awareness of it and its potential impact as an opportunity for new revenue. There is no reason not to issue a PR about Illinois, since it is a new state market which has enacted a law expressly permitting ADW.

    I know that the handle for Fairmount Park is neglible in the big picture as well. The purpose for my mentioning it however was; because in the aritcle linked above, they were quoted as being a party/partner to the deal between Youbet and Hawthorne/Maywood-Balmoral. Since there has been no PR; and yet Fairmount is actively promotiing a deal with TVG, it calls into question whether a deal still exists between Hawthorne/Maywood- Balmoral.

    While UBET is carrying the signal for Hawthorne-Maywood/Balmoral the banner adds on their sites could only be promoting the UBET wagering platform to out of state customers, since prior to the enactment of this law on August 26th, ADW was ruled illegal in Illinois by virtue of an opinion issued by the Attorney General to the Illinois Racing Board, dating back to 1998 I believe.

    The "new market" which they can now expressly market to, are Illinois residents, who are now allowed to legally wager via ADW on content emanating from both out of state, as well as from within state from live tracks operating in Illinois.

    The ADW experience in CA strongly suggests that ADW is the only growth market for parimutuel wagering, and under further scrutiny the substantial majority of that comes from the current OTB clients migrating to the electronic platform.

    If 15% of the overall handle for next year in Illinois is derived via ADW; and UBET handles half of that, this represents $60MM of new handle for UBET with little to no incremental expense for expansion of the operating system platform which has sufficient scalable capacity already. The only added expense to attain some of this handle will be marketing; and the fact that the law is new, would allow for securing some free media, simply by issuing a PR, since the enactment of the new law has not been widely publicized at all.

  7. Hi Anonymous,
    Thanks for the follow-up. I understand that the legislation is re: enabling online wagering for in-state residents and should be an incremental positive for YB and other participants. I imagine all online players are angling for market position despite the 2008 news that YB reached an exclusive deal with tracks -- we need to see what happens.

    According to the below Bloodhorse article, sounds like ADWs remain in limbo until the Racing Board issues guidelines:

    "Now that the legislation has been signed by Quinn, the Illinois Racing Board will draft and adopt regulations to implement the law. The Internet gambling sites with which the state’s tracks will partner will then be eligible to be licensed by the Illinois Racing Board and accept wagers from Illinois residents."

    I prefer my companies to issue PR only when they have something on which to truly hang their hat. To issue a release now still seems premature, in my view. I am fairly certain that the company is focused on happenings in Illinois.


  8. Anonymous - other news from DRF.com (you probably already saw this, but just in case):

    Headlines | Posted 8/26/2009, 5:29 pm
    Illinois account bets made legal
    By Matt Hegarty

    Gov. Pat Quinn of Illinois signed a bill on Tuesday that legalizes online and telephone betting in the state, a move that will put a stamp of approval on a practice that many account-wagering companies had conducted even without explicit authorization.

    The legislation will significantly affect only one large national account-wagering company, Television Games Network, which had previously refrained from taking bets from Illinois residents because of its reluctance to test the legality of the practice. The other three major account-wagering companies - Twinspires.com, XpressBet, and Youbet.com - were already accepting bets from Illinois residents.

    Horse racing interests have been pushing for legislation authorizing account wagering in Illinois for years, in the hopes of legally exploiting one of the biggest racing markets in the country, Chicago. The city is home to Hawthorne Racecourse and Arlington Park, which is owned by Churchill Downs Inc. Twinspires.com is owned by Churchill.


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