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Wednesday, October 28, 2009

Online Gambling and Youbet.com + Las Vegas Still Reeling (Should be No Surprise)

First, a WSJ/Dow Jones article is reporting that a bill to lift online gambling is making progress in Congress and viewed as a means to help fill empty government coffers:
  • Online gaming could "raise nearly $42 billion for the U.S. Treasury over the next decade, according to an analysis conducted by a non-partisan congressional scorekeeper."
Along with other gaming companies, Youbet.com (UBET, $2.08) supports the measure as a means to expand the company's Internet platform (and clearly valuable, apt domain name) into new areas beyond horse racing. While some investors are concerned about potential cannibalization for Youbet's core horse racing business, we see somewhat distinct market opportunities that should lead to a much larger addressable market for the company. Thus, any news on this front could prove a positive catalyst for the stock, although timing/ execution related to potential new business lines remain unknown and, therefore, not factored into our valuation.

We'll come back to Youbet. We want to touch on an AP article that summarized recent results/ commentary from Wynn (WYNN, $54.00), Boyd (BYD, $7.91), and Harrah's (private), highlighting negative industry trends. The key message was as follows:
  • Gamblers are wagering less than a year ago, visiting casinos less often and holding back on extras when they do, continuing trends that left the industry struggling in the third quarter.
Other points:
  • Industry leader Harrah's Entertainment Inc. lost $1.6 billion, including a $1.33 billion drop in the value of its assets. Harrah's said its revenue fell abroad and in each U.S. market where it operates. Overall revenue dropped 13.7 percent to $2.28 billion from $2.65 billion a year earlier.
  • Boyd Gaming Corp. said its profit fell and will wait at least three years before finishing building its $4.8 billion Echelon casino, which looms empty over the Las Vegas Strip.
  • At Wynn Resorts Ltd., where lower spending by leisure travelers and businesses pushed down profit for the second quarter in a row, billionaire CEO Steve Wynn said his company won't expand in the U.S. until the business environment improves. "The landscape in Las Vegas is troubling and it's rife with uncertainty," said Wynn, whose company is based across the Strip from the Echelon. "It's tough to understand what's going on; my 40 years in Las Vegas is not serving me very well at the moment."
Not surprisingly, the still negative operating fundamentals and commentary are pressuring shares just as the Market digests renewed economic fears and numerous pundits warn investors (or traders) to "go to cash" because the Market has gone too far too fast.

The sudden shift in gaming sector sentiment follows the impressive hope driven rally that was especially kind to cyclical, asset heavy companies over the past nine months (magnified by the bounce off of oversold lows). Giving some credit to the pundits, we agree that selective stock sales might make sense for holdings in this category.

We scratch our head over valuations realized by certain of the gaming companies (no doubt short covering / trading driven), including Wynn. We understand that some well-known value investors place great emphasis on the franchise, management, normalized earnings power, and growth potential in Macau. Still, even giving credit for "normalized" earnings of $2.00 (versus consensus 2010E EPS of $0.89) , shares are trading at 27 times a non-discounted $2.00 estimate. Even if the number is an even more generous $3.00, we're looking at 18 times.

Below, we include a six month stock chart for the companies also including Las Vegas Sands (LVS, $13.17), MGM (MGM, $8.91), and Youbet.

Unfortunately, shares of Youbet (illustrated by gray colored line) are also being thrown out the window despite largely not participating in the recent hope rally and staying profitable. Moreover, Youbet operates an asset-light business model unlike the asset heavy hotel/casino companies that have tremendous negative operating leverage in tough times given huge fixed cost structures.

Nonetheless, gambling on horse racing is also discretionary and the weak consumer is impacting the sector. Churchill Downs (CHDN, $34.60) reported an earnings miss today (Wednesday), with revenue of $101 million versus a consensus expectation of $104 million and a net loss versus an expectation of $0.25 (the loss was related to income tax provisions resulting from an IRS audit). Churchill's President and CEO Robert Evans stated:
  • “Total pari-mutuel handle for the U.S. thoroughbred industry, according to figures published by Equibase, declined 10 percent during the third quarter compared to the same period in 2008. While we outperformed the industry, with our total pari-mutuel handle down only 3 percent during the third quarter, gains in our other business segments didn’t offset the decline in racing."
However, the company's online segment delivered Y/Y revenue and EBITDA growth of 33% and 31%, respectively (slight margin compression). As discussed previously, new industry content arrangements are improving 2009 results for advance deposit wagering (ADW) players such as Churchill and Youbet.

Within the next week, we may share a bit more on Youbet. For now, suffice to say that we believe our core thesis remains intact: the company owns an established, asset light business model with a leading online wagering franchise – brand, customers, platform, marketing partners, and track relationships – that is difficult to replicate. With an implied 2009E free cash flow yield of 12% (assuming FCF of $11 million), we believe shares are trading well below the value an informed private market buyer would pay for the entire company.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long UBET.

© 2009 Jeffrey Walkenhorst
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1 comment:

  1. Thanks for posting a short update...I'm looking forward to your bit next week, and to Youbet's earnings.

    At Twinspires, their handle increased 43% over 3Q 2008. Apparently this was partly driven by new content, but also by an increase in customers and wagering per customer. Could be indicative of youbet...



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