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I like Dale Black’s answer to The Question we posed to gaming companies a few weeks ago. As a reminder The Question was (and still is):

Cost of capital is rising across the globe and returns on investment in the gaming sector appear to be falling. How does this impact your long term view of the industry? If this is the new paradigm what are your long term options for capital allocation?

  • Rather than dismiss the current difficult environment, Mr. Black acknowledges higher cost of capital is here to stay. Future projects will be judged assuming a higher borrowing cost than those prevailing during last few years of easy money. ISLE’s recent goals have included improving financial flexibility and matching future expenditures with the flexibility afforded the company in the new credit facility. The focus will be on improving operations of existing properties while reducing the leverage ratio one to two turns over the next 18 months. Mr. Black’s assertions are borne out in the numbers in the first chart. I calculate ISLE could reduce leverage to 5x in 2 years.
  • This sounds a lot like the Argosy plan from the late 1990s. For the younger folks, ISLE’s current management team successfully turned around Argosy Gaming at that time. They are off to a solid start with ISLE, despite the difficult environment. Mr. Black has to be one of the most underrated CFOs in gaming as he restructured the balance sheet to effectively provide liquidity until fiscal 2013. Despite the very high leverage, ISLE has no significant debt maturities until that time. Leverage should consistently decline as capex is curtailed. See chart #2. Operationally, ISLE just reported its FQ1 ended July 31st which was the first decent quarter in some time. Margins were clearly a focus and it showed.
  • Management seems to be saying and doing the right things. Moreover, there actually could be some upside to the EPS estimates due to continued margin improvement. I see only downside EPS possibilities for most of the other gaming operators. While the ISLE story certainly has some potential, I’m not sure the stock does over the near term. Forward EV/EBITDA is around 7.5x which, while not expensive, historical precedent shows could go as low as 5x. At that multiple, I could buy PENN which maintains an underleveraged balance sheet at 2.5x versus ISLE at 7x.
ISLE's goal is to deleverage by 1-2 turns in 18 months. This looks attainable
CapEx story looks promising