The Return on Equity (ROE) and Return on Invested Capital (ROIC) trends shown in the chart below are scary enough. Throw in the fact that ROE is actually declining at a faster rate than ROIC and the situation is downright frightening. We estimate ASCA’s cost of borrowing will go up by 2% in 2009 as the company either refinances its entire credit facility, raises subordinated debt to shore up its senior leverage ratio, or negotiates a higher leverage restriction in exchange for a higher rate. A borrowing cost increase of 2% is probably a best case scenario for ASCA, especially considering a likely covenant bust by Q2 2009 (see my 8/14/08 post, “ASCA: TOEING THE COVENANT LINE”).

I’ve also been generous with my calculations as it relates to “non-recurring” items. All have been excluded resulting in higher ROE and ROIC than the standard measures.

This simple analysis hits on several themes I’ve been focused on: liquidity, escalating costs of capital (although you wouldn’t pick this up from the analysts’ models), over earning, and lower ROI’s. ASCA’s liquidity issues will force the company into a higher borrowing cost capital structure. Risk premiums are escalating, also forcing up interest rates. Finally, on the return side ASCA is not helping itself. The company made one of the worst acquisitions ever in gaming, buying Resorts East Chicago at the top (11x a declining EBITDA figure), ahead of a huge expansion, renovation, and rebrand at nearby Harrah’s. This poor decision is a major driver of declining returns.

Most gaming operators have been over earning (see 8/10/08 post) due to unsustainably low interest rates on credit facilities. No situation has been more egregious than ASCA. All good things must come to an end and so has the era of cheap money.

ROE declining at a faster rate than ROIC