How Independent Research Can Add Depth to Valuations in High Visibility Sectors like Casinos
How Independent Research Can Add Depth to Valuations in High Visibility Sectors like CasinosIndependent insight posted on Smartkarma 14th November 2017
Read more of Howard’s work by clicking here!
- Investors in this expanding sector are deluged with me-too analytics that can often inhibit, rather than illuminate the road to smart price discovery driven by under the radar management moves.
- Casino stocks have their temperatures taken like flu patients every time news breaks whether it is a true catalyst or simply a vapid space filler for media outlets.
- The nature of the symbiotic relationship between standard buy and sell-side analysts and managements unavoidably is built off a process that hasn’t changed in decades but is now being challenged by sources of independent research.
Douglas Kim’s recent insight on SK Confessions of an Independent Research Analyst astutely pointed out how the role of independent research as a value added source of opinion to investors is riding on what many of us believe is a growing tide of analytics. They’re coming from new algorithms developed by quants that at times appear to be something of witches brew difficult to tease out in real-world performance. And they’re also originating from technical analysis sources that attempt to bring deeper more measurably predictive analytics to weigh in on the final investment idea. At the same time, we see investors beginning to disrupt the process by sourcing ideas and valuations from independent researchers who in a sense, have no dog in any particular fight.
Over my own career, I have been asked many times by investors what other than the standard set of data points usually applied to company performances, are the key, under the radar realities that longer term, actually drive bottom lines and by extension, casino share prices. I have developed what I call an “alternate reality” set of proprietary metrics and valuations entirely based on a view from the inside out. It’s the intellectual property of my consulting practice, but I am happy to share some its foundational principles with Sk readers. I think investors who are clients of wealth management divisions of banks, hedge funds should nudge their advisors to enhance their research beyond the standard data points that are the holy grails of the sector, to impart a keener insight to the company or idea that would normally be the case in a buy, sell or hold call.
While the casino industry shares many elements of related businesses, like lodging, entertainment, dining, and tourism, it has by any measure in my view, totally unique performance elements that can’t readily be judged by the same data sets applied to those sectors. What’s needed is a more nuanced understanding of what makes the business unique and by knowing that, bringing a depth and perspective to an investment idea in the space.
1.The casino business is probably more heavily regulated than most any other type of enterprise at a multiplicity of levels. Where governments feverishly compete for industries like manufacturing, energy, tech and retail with all kinds of tax concessions, waivers and infrastructure emoluments, they have historically needed to be nudged, or indeed pushed, by pro-legalization advocates to open the doors to casinos. Most recently we’ve seen how Japan, despite the relentless support of Prime Minister Abe and passage of the act, has resisted the process at every stage to the evolution of that nation’s Integrated Casino Resort industry.
The old fears persist: Problem gambling, corruption, entry for criminal elements, game integrity, money laundering run wild. These are not official or public objections that are ever likely to greet plans to build standard hotels, entertainment arenas, auto assembly plants, technology companies. After developers finally win over officialdom and elements of the public, they find themselves subject to high, sometimes punitive taxation percentages on gaming win, constant monitoring by massive regulatory bodies that track and let’s be frank, police, daily business on the casino floor, in its accounting departments, room towers, restaurants and dining establishments. The operating assumption to be brutally frank: We have to watch these guys. Those regulatory bureaucracies, tend to grow exponentially, every time the complications common to all cash movement businesses surface. Beijing’s junket crackdown crashed the Macau sector in 2015. It was perfectly understandable as part of a policy to curb political corruption and money laundering. And in its aftermath, stocks in the sector took a major hit. Yet, some analysts published recommendations built on doomsday scenarios. The facts as later developed, indicated that the action was clearly a baby with the bathwater situation. Offenders were indeed rooted out–by the handfuls. But VIP players stayed away by the bushel loads due to an immediate government induced paranoia. People who had nothing to hide, hid anyway or took off for the casinos of the Philippines. So the relationship between the scope of the actual problem and reality was distorted. This has subsequently been proven by the robust recovery of VIP business in Macau. related type industries, life is much simpler. You either make, distribute, buy or sell a product or service to an end user period. In casinos, skepticism accompanies daily business. Regulators, both in new and mature gaming markets tend to assume policies that fundamentally say: Look Mr. Casino operator, you exist at our pleasure so watch your step or we’ll pull the plug faster than you can roll a pair of dice. That is quite a difference than the attitude toward other related type businesses that are subject to a fairly normal set of regulations as to safety, sanitation, employment rules, and environmental impacts. In casinos, you have all that PLUS the mountain of regulations covering the dealing and administration of games of chance.
Beside the junket crackdown in Macau, we had moves on smoking that hit the sector stocks, ATM withdrawals, ad nauseum and bureaucrat decisions on the number of tables allowed for a given casino. These were not made by managements making business judgments, but by officials. And if you think officialdom in the SAD were singularly overbearing—consider this. In the early days of Atlantic City New Jersey, it required an on site inspection, and a lengthy approval process to move a sign from one zone of slots to another. As a senior level executive I was required to apply for and be cleared for, an A or Key License. The application was 130 pages long on two sides. I had to list every relative I knew up to and including second cousins including their names, addresses and phone numbers. The commission had all my bank information and by the way, escorted by enforcement officials, we were all required to go to any bank in which we maintained a vault lock box, open it and go through all the contents which were duly reported. My license, when issued, was the imprimatur of a person who easily could have walked in the next day to CIA headquarters and be immediately qualified as a field officer handling top secret information. None of this accompanies your average tech startup, movie theater, pizza parlor or two hundred room motel operator. What it tells us is that this is a business that is a creature of government more so than most others and when government sneezes, the industry, and its stock, can catch pneumonia.
So the lesson here is this: Government moves, sudden or planned are not all very good reasons to sell off a stock position in an otherwise strong performing casino operator unless of course, you see options play or are a day trader looking for a quick in and out on a sudden dip. But the government isn’t the only culprit per se, in the movement of casino shares. The other is the news cycle. This is a high visibility business. People are interested in happenings in a casino venue. The media know this and when anything happens, big or small, reporters call up analysts for comment. Most recently we’ve seen how tragedies in Las Vegas, Manila have hit gaming shares in the short term when analysts weighed in on the impacts. November’s early numbers in Macau indicate a robust 28% YoY increase during the first twelve days of this month. Yet, when asked to comment, several analysts also pointed out the start of the imminent Grand Prix event that “could dampen” Novembers strong start. Why? Because historically that has been the case. Whether that happens or not, its a slender reed for sure. This is a business where played delayed is usually mortgaged to the following month: It does not disappear.
To give some color on this issue I have studied the relationship between regulatory and force maejure elements in both Macau and Las Vegas. Early this year., associates spooked by news asked my opinion on a group of gaming stocks. “No knee shaking or knee jerking. Just stay long,” I said. I am no oracle. I merely based these picks on a broad lens view of how the industry tends to move over time and my understanding of the management dynamics that always play into results. Here are the results of my calls to date:
Wynn Resorts Ltd Wynn Resorts Ltd (WYNN US) up 22.5% and going higher IMHO.
Las Vegas Sands Las Vegas Sands Corp (LVS US) UP 22.5%
MGM MGM Resorts International (MGM US) up 3.8%
Monarch Casino Resorts Inc. Monarch Casino & Resort Inc (MCRI US) up 47%.
Note: Monarch is a US regional casino, relatively low cap, low visibility company with properties in Reno and Colorado only. Buried just below the surface of its usually strong performances in EBITDA over time was a pattern of management skills that in my view displayed themselves in strict fiscal discipline, excellent margins and a know-how employed in creating a customer mix–most critical of all, that added a valuation far above the market price. The alpha here lay in the longtime family management linked to a pattern that suggested the company was entering the next scale-up of its base which could be added to by development or acquisition.
As the year unfolded, it would appear support for the stock began to heavy up. And the single most valuable standard metric in valuing this sector is EV/EBITDA. This is a very Capex intensive business to the debt to equity ratios will always reveal more leverage than what many standard analysts may find comfortable. But Capex is the mother’s milk of the casino business. In the right hands, it produces great returns. Secondly, investors, I believe, always need to ask themselves this key question no matter what the standard metrics like P/E, PEG, 50 day moving averages, PTs–all part of a decision to be sure. But none them alone can answer this question: Do I want to be in business with these guys? Don’t think like someone buying a blip on a trading screen, think of yourself a buying into a business–mainly a management. And the extension of that is this: What does the EV/EBITDA ratio tell me about what this business is worth if someone showed up with a fistful of money and wanted to buy in. And think of yourself as a selling shareholder.
The Symbiotic relationship between standard buy and sell side analysis and independent research.
Over a long career, I have participated both as a corporate executive answering the questions of analysts gathered for earnings calls as well as a consultant on the asking end of the conference. As a result, I came to know many from major houses and found them to provide good guidance on fundamentals based on their inquiries. But at the same time, I limned a distinct proclivity in them to keep questions in the safety zone that avoided asking about tough issues lest they injure ongoing relationships with corporate contacts they need to do their jobs. This is entirely understandable. But the downside is that the process tends to produce far too many softball questions in order to maintain a general air of civility and nurse relationships. Enter the estimable Chinese Wall of old financial institutions who made it almost a fetish to insist that there existed an unbreachable wall between the interests of their investment banking departments and their security analysis people.
There was, to an extent, a separation that presumably was enforced but facts are facts. It has never been lost on me that institutions that raised billions over time for large and small cap casino operators, generally got rave reviews from their analyst departments. Was security analysis a tacit marketing arm of investment banking? Is it now? Let’s leap closer in time to think this out. During the 2007/8 financial crisis, many of us learned that bond rating services now and again pegged their calls on tranches of mortgage bonds on rather exotic formulations of the bundles of gold-plated obligations, so-so ones and an uncomfortable bulge of downright garbage. And at the same time, the same rating services worked with issuers for fees becoming symbiotic partners if you will, in the total transaction. There are pitfalls that are avoidable and those to be perfectly frank, that are not. And that is where in my view, the role of independent analysis comes powerfully to the front as representing a source of investing ideas and recommendations to a large extent, not in thrall to the confirmation bias, the proclivity that Doug’s insight alluded to. Its root can be in a corporate goal that finds its way into a data set and analysis of the numbers that reinforce those goals, ending up in a less than valuable piece of research for the investor. And that is where I believe, particularly in sectors with action elements that apply to no other businesses, independent analysis will continue to grow exponentially. It is not merely the disruptive technology of the delivery system, but the extent to which the work itself is free of institution biases and favor exchanges.
Next: In our next insight this month, we will look at how to value management performance outside of standard indices and metrics to bring out insights that lead to alphas not readily apparent in the casino space.
How Independent Research Can Add Depth to Valuations in High Visibility Sectors like Casinos
Independent insight posted on Smartkarma 14th November 2017
Read more of Howard’s work by clicking here!
