The Nevada Gaming Commission is considering an amendment to allow an institutional investor to own up to 25% of the voting stock of a gaming company without getting licensed, up from the current 15%. Las Vegas Attorney Frank Schreck proposed the amendment and we doubt he's doing it on his own. Someone is funding the cause.
In our 4/20 post, "GAMING REGIONALS: THE FALLACY OF EV/EBITDA", we "normalized" PENN's underleveraged free cash flow. We assumed PENN would make an acquisition at 6.5x EBITDA and generate a 5% net free cash flow return. PENN outlined their return metrics in the Q1 earnings call this morning and, low and behold, our projections were confirmed: 5% is the number.
The following is our calculation of a hypothetical $1.25 billion acquisition (presumably a Strip property). We chose 1.25 billion because it essentially levers the company up one turn to about 3.5x, still under the 4x target. With PENN on the record, we can "YouTube" management when they announce their next acquisition. We believe this return focused management team will not sway from their discipline.
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The Client is back and the cash register is ringing...
A core theme of our work on the Chinese Stimulus program is that as the Ox starts waking up he will be craving the basic materials that countries like Australia and Brazil provide. In the case of Brazil, data has arrived demonstrating that in the form of increasing shipments of iron ore. Total Chinese ore imports totaled over 52 million metric tons for March, with more than 22 million tons worth coming from Brazil.
Without a doubt this data is a huge shot in the arm for Brazilian exports which are concentrated so heavily on commodities and certainly explains why the Bovespa is trading up again today. Although anecdotal reports put Chinese ore stockpiles at about 1.5 months worth of imports and growing -an uptick that could signify speculative purchasing, all signs point to continued strength so far this month with expectations that it will continue.
We are long the Brazilian equity market via EWZ and remain bullish on prospects there as Chinese demand works through the global chain. In the coming days will be delving into the other half of the export equation for that nation -Agricultural commodities, as well as drivers for domestic demand, but for now the Client is the most important part of the story.
PS: Anyone out there short shipping stocks?
Fiscal 2010 top line won't grow by 10% - without providing details, management indicated that revenue growth would be similar to fiscal 2009. WMS has executed - no question. We just question their forward guidance. The bar looks like it might be set too high, and investors are trading the stock as if the guidance was conservative.
Here are our concerns:
- North American new and expansion units will fall 47% in the 4Qs ended June 30th, 2010 - Management touted that only a 1/3rd of their business is North American box sales. That's still a lot of exposure to a business that will experience a huge decline in 2010.
- Financing may have pulled sales forward - WMS ramped up its financing efforts to secure sales. We fear that this aggressive approach may have pulled sales forward and artificially inflated market share at higher prices. The company added $37 million in receivables in the quarter. We are not against using the balance sheet to fund sales. IGT and BYI do it. We are just point out that market share gains in the quarter may not be sustainable.
- No free cash flow - Despite a strong quarter, the company's free cash flow was negative in the quarter. Obviously, the aggressive financing will push out free cash flow generation. We project only $0.80 to $0.85 in free cash flow per share in fiscal 2010.
- No visibility on fiscal 2010 - WMS is no longer providing backlog for "competitive reasons" and because they believe the lead time has shortened so much that comparisons are not useful. They also indicated that the current backlog is within the normal range of the last 16 quarters - that's a big range.
- Hit driven business - More than the other slot companies, WMS's business is more reliant on generating "hit" games. Their strategy is narrowly focused on fewer game launches. Their superb execution has generated by far the highest success rate. The problem is that with their guidance, WMS is projecting success at an even higher level going forward.
- WMS doesn't have the breadth of product to permanently increase market share - Since WMS is more targeted, they don't offer the breadth of product of an IGT or BYI which makes them more reliant on hits but also could cap their market share in the mid 20s%.
- Valuation - We believe 2010 will be flat in terms of EPS growth putting the forward multiple at about 21x our $1.50. Even on the Street's aggressive $1.75 estimate, the multiple still looks full at 18x.
Every time you see a data point on housing the first thing to remember is that affordability is at all time highs. Over time, affordability and population growth will solve the US housing crisis. The only thing left to solve for here is duration.
Today the NAR reported a 3.0% decline in March sales, which was weaker than the 1.5% consensus estimate. The volatility in all housing data today suggest it's very difficult to get a read on trends looking at one month numbers. On the margin the more relevant point is that home sales, like other consumer centric companies, showed improvement from early this year, but nothing happens in a straight line. Inventory of existing homes remains elevated at 9.8 months, but is down from the worst levels seen last November at 11.0 months.
All of this remains consistent with our Macro Housing call that a housing bottom will happen in 2Q09. We continue to believe that there is stabilization in housing price declines. As seen in the chart below, we did not go below the January lows and we are now seeing a notable uptick in median sale price. A clear bottoming process!
One nagging concern is the end of the foreclosure moratorium. I continue to see anecdotal evidence to suggest that speculative cash bids for bank-owned homes have been a significant portion of existing home liquidity -particularly in harder hit markets like Florida and southern California.
As more forced sales come to market, it will place pressure on buyers seeking to capture the relative value spread between bank sellers and non-distressed owners, who have held on to higher asking prices.
Today, the WSJ ran a story on bidding wars between buyers vying for bank owned properties at these levels. Clearly, any expansion of the spread between these two types of sellers could dampen liquidity as more foreclosed homes come on the market.
Other than the MACRO implications of our housing call there are other ways to play the rebound in housing. Our Healthcare team has a very compelling way to play a housing recovery - Senior Housing.
For the Senior Housing companies, home sales are the key underlying factor. The majority of seniors own their homes free of any mortgage and have the bulk of their net worth tied up in their home. As the housing market tightened beginning in 2007, occupancy and pricing has stalled.
With a severe decline in the revenue drivers and leveraged balance sheets the equities collapsed and pose significant upside from current levels. If housing is indeed bottoming, Brookdale Senior Living (BKD) and Assisted Living Concepts (ALC) could benefit from the reversal of the same drivers to the upside.
Howard W. Penney
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