BYD Boyd Gaming
the analysis is by Randoph McDuff
It is also in the portfolio of John Paulson.
November 5, 2009
BOYD GAMING: Betting on a Cyclical Recovery
Please note: All views are expressed are solely of the author, and will generally be contrary to that of the majority of investment firms and of the investing public at large. All prices, unless indicated otherwise, are expressed in US dollars. Estimates of EBITDA are calculated using very stringent guidelines, and will therefore differ from the majority of published analyst reports. Share prices quoted herein are as of October 31st, 2009.
BOYD GAMING: Betting on a Cyclical Recovery
"When experience is not retained, infancy is perpetual. Those who cannot remember the past are doomed to repeat it" - George Santayana
Does the technical end of the US recession equal a near term bull market?
To answer that question, perhaps we should compare the current US recession to the previous recession.
According to the National Bureau of Economic Research, the US last experienced a recession that started in March 2001. An end date of November 2001 was declared but remains controversial. While the period of negative growth was described as being brief, the impacts were felt in the United States until 2003.
The previous recession was characterized by massive layoffs, outsourcing and a jobless recovery. Many formerly highly paid manufacturing and professional employees were forced into much lower paid service positions. The Dow Jones Industrial average fell from 11,722 points on January 10th 2000, to 10,367 points at the start of March 2000, the official start date of the recession. By September 2003, the DJIA fell to 7,528 points, 2.5 years after the official start date, and well into the onset of the economic recovery phase.
This equity contraction represented a broadly based decline of more than 34.5% from the economic peak. By the end of 2003, the DJIA had only rebounded back to 10,409, still down 9.5% from the previous peak.
It should be noted that in 2003, the first year in four that produced GDP growth in excess of 2%, the DJIA index was still 11.2% below the peak of 2000. It was only in October 2006 that the Dow Jones average surpassed the peak of 2000. Recovery of broadly based capital, from the prior economic peak, took more than six years.
Despite the broadly based index underperformance, if one was both patient, and had no aversion to owning cyclical stocks in the economic setback of 2000-2002, selected categories performed very well in the up cycle.
The casino industry, as a whole, provided investors with above average returns until the current recession. At the start of 2000, two months prior to the official "kick-off" of that US slowdown, investors could have purchased shares of Boyd Gaming for a price of $5.50 per share. Just six months beforehand, shares of Boyd sold for $7.375 per share. Going into that slowdown, investors at $5.50 probably would have felt that they were getting in at bargain prices.
For the fiscal year ending 2000, BYD Gaming generated revenues of $1.131 billion. EBITDA was $.27 billion, or a margin of 23.4%. The EBITDA to interest expense ratio was 3.4X.
In the year 2001, Boyd's top line reflected a slowdown in consumer spending brought on by the recession. Revenues fell to $1.1 billion and EBITDA fell to $.215 billion, a margin of 19.6%. The EBITDA to interest expense ratio fell to 2.9X.
In 2002, the first real year of moderate recovery from the recession, Boyd's revenues rebounded to $1.22 billion; EBITDA grew to $.254 billion, still below the level achieved in 2000. The EBITDA margin recovered from the trough of 2001, but at 20.8% was still below peak, despite revenues that were now above peak. EBITDA to interest expense ratio rose to 3.5X.
Investors that purchased shares of Boyd Gaming, in late 1999, immediately prior to the stock market peak, would have endured a paper loss, going into that economic turn, of more than 56%.
Boyd shares fell from $7.375 in the second quarter of 1999 (immediately prior to the economic peak), to $3.25 per share (shortly after the formal end of the recession) in 2001.
The drop occurred, based on an absolute EBITDA decline of $55 million. The EBITDA decline equalled a 3.8% lower margin, on a revenue reduction of $31 million. In the recession, expenses rose to maintain customer counts, but were inadequate to wholly maintain gaming revenues. This is consistent with cyclical businesses.
When any investment drops by 50%, individuals, particularly market timers, sometimes lose objectivity. On occasion, they might then tout the purported merits of the "50% loss" adage, in an attempt to rationalize the paper loss and opportunity cost. The saying goes like this:
"An investment that falls by 50%, will subsequently have to recover by 100%, just to break even."
This statement implies that investors should cut their losses when down, because it may take an inordinate amount of time (2X +) to get back to being ahead, when debating as to whether or not to hold a money losing stock.
In a nutshell, those who subscribe to the 50% loss rule assume that stock market gains take place at exactly the speed of losses.
Such a notion represents an interesting conversation starter at a cocktail party. However, it is patently wrong. More ominously, it can produce a false dilemma for investors:
"either I sell and switch to something else after a sharp drop, or I will never recover my capital".
The dilemma is false, because it implies that just 2 logical approaches exist to addressing a money losing investment. What proponents of market timing neglect to note is a host of other possibilities that exist along the continuum. An abrupt takeover offer for an attractive price might occur. There may be a meaningful recovery of share capital based on changing market sentiment. A positive transformational change might take place at the firm in question. None of these aforementioned possibilities, to name just a few, can generally be anticipated.
There is absolutely NO fundamental reason that any stock cannot rise every bit as fast as it drops, or even faster. In the case of cyclical companies, this rule of 50% becomes even less applicable, when compared to non cyclical businesses.
To demonstrate the opportunity cost for those who endorse such views (ie market timers), consider the case of shareholders with stock in Boyd Gaming, in the year 2002. Remember that BYD shares bottomed out in 2001 at $3.25, supposedly well after the recession had technically ended.
If one had set up some sort of formal or informal stop loss program on the shares, and sold out of Boyd at any point on the way down; for example at 25% of the loss from $7.375 per share, the buyer at $7.375 would have received about $5.53 per share.
Perhaps that same investor would have steeled themselves up for further short term pain, and ultimately sold out at a 50% loss from peak purchase price, they would have received $3.68 per share.
However, from the second quarter of 2001 to the 2nd quarter of 2002, BYD shares appreciated from a low of $3.25 and hit $16.85, a gain of more than 500% off of the bottom. There was absolutely NO fundamental reason for this explosive gain to have occurred. In 2002, Boyd was still producing lower EBITDA than in 2000. All that changed during the interval was an intangible, a change in market sentiment.
For the investor who purchased BYD at the peak in 1999 and maintained patience and discipline through the bottom, Boyd would have still proved out to be a 2.2X bagger from the top. On the other hand consider the plight of the professed long term investor, who in fact turned out to be nothing more than a short term speculator; not only did he/she lose 25%-50% of their initial capital, they also missed out on the powerful run up.
Further compounding the error in judgement, resulting from adherence to the "rule of 50%" lay in the fact that Boyd Gaming's share price recovery took place while broadly based stock market indexes continued to fall. Those who DID sell BYD at that bottom, in all probability (based on index returns) would have placed their money into something "safer" (ie larger cap or less cyclical). Sadly, the majority of US stocks continued to drop for an additional year. It would have been logical to assume that the realized loss on Boyd would have turned into yet another loss, on the reinvestment. Adherence, in this case, to the 50% adage, resulted in opportunity cost in the magnitude of 400%. It seems reasonable to estimate that the total opportunity cost could have exceeded as much as 420% over four years.
In the case of Boyd Gaming, over the course of 2 years, the shares fell by slightly more than 50%. It took less than one year into the recovery for the shares to climb by 400%.
It took until 2004, for Boyd's absolute EBITDA to surpass the peak of 2000.
The company added some properties, took on additional debts to make capital improvements, and worked diligently to become a more sizeable gaming company. In 2004, EBITDA margins stalled out at 20.5%, still below the peak. Only in 2005, a full 5 years after the previous economic peak, were Boyd's EBITDA margins restored to 23.4%.
From 2004-2006, US GDP was optimal. This produced benefits for all companies in consumer discretionary industries.
The domestic casino industry in general, benefited from this period of expansion. Specific to Boyd, EBITDA margins peaked at 26.2% of revenues in 2006. The largest publicly traded casino operator in North America, MGM Grand, more than 4x Boyd's size, reported peak EBITDA margins of 33.2% in that same year.
Then the next economic contraction started, and the cycle repeats.
So called "smart money", including Kirk Kerkorian (MGM Grand), Sheldon Adelson (Las Vegas Sands) and Steve Wynn (Wynn Resorts Ltd), have each lost billions on paper in the past 24 months. Mr. Kerkorian's paper loss in MGM is estimated at $13.4 billion from peak.
finance.yahoo.com
Every one of these large casino investors understands full well the cyclical nature of the business. They take comfort from the 20%+ EBITDA margins being generated by their companies, at what is likely to be the bottom of this economic cycle. Kirkorian, Adelson and Wynn are very old hands in casino investment, having experienced decades of ups and downs.
Unfortunately for many retail investors, media pundits and investment banks built up image of casinos as being recession proof, or at least recession resistant. This fallacy was carefully crafted over the last economic upswing, and promoted gaming patrons to be largely hard core junkies. In reality, casino companies are lumped into the category defined as "consumer discretionary". Most people who gamble do so as a form of entertainment, utilizing spare cash. When cash is tight, they gamble less. When cash is more plentiful, they gamble more. The casino industry, simply put, is cyclical.
After a decade of industry rollup and the taking private of many public casino operators, the US sector now has just 5 other good sized public operators, in addition to Boyd.
MGM Grand (MGM-NYSE, $9.25) sells for about 13.5X my 2009 forecast EV to EBITDA ratio. Kirk Kerkorian's Tracinda Corp. is a major shareholder. MGM is the 800 pound gorilla of the industry. 2009 revenues may exceed $5.9 billion and casino EBITDA margins, at the trough, are still better than 27.5%. MGM has rolled up much of the industry, and added significant debt in doing so.
In 2006, MGM EBITDA peaked at 33.3% of revenues. In the 4th quarter of 2007, the MGM share price peaked at $100.50 per share. Since that time, on the heels of a potential 23.4% drop in revenues (2007-2009), and a 32% drop in net EBITDA over that same period, MGM shares have fallen by more than 90.7% from the 2007 peak.
Analysts are currently uniformly bearish on MGM at present. I believe this to be consistent with "cyclical bottom thinking". Consensus expectations suggest that revenues in 2010 will fall from 2009 estimates. Shares of MGM Grand are selling for roughly the same price paid by investors in August 1993.
Las Vegas Sands (LVS-NYSE, $15.09) is the gaming vehicle of Sheldon Adelson and sells for about 16.6X my 2009 forecast EV to EBITDA ratio. 2009 Revenues could touch $4.7 billion. Consensus estimates are for 2010 revenues to average $6 billion. EBITDA margins are presently about 23%.
In 2007, revenues of Las Vegas Sands were $2.95 billion, and EBITDA was $.532 billion, or 18% of revenues. 2007 EBITDA was impacted by preopening expenses on a new casino. Peak EBITDA margins were touched in 2006, at 29.2%. So, current EBITDA margins are down by 21% from peak. In the 4th quarter of 2007, LVS shares touched $148.76. The share price is down 89.9% from the peak. LVS went public on December 15th, 2004.
Wynn Resorts (WYNN-NASDAQ, $54.22) is the creation of Steve Wynn. 2009 Revenues are forecast to be $3 billion, and EBITDA margins are roughly 22.1%. The shares sell for roughly 16X my forecast 2009 EV to EBITDA ratio.
In 2007, revenues of Wynn Resorts were $2.69 billion. EBITDA was $.649 billion, or 24.1% of revenues. Current EBITDA margins are off 8.3% from peak. Shares of Wynn are down from a high of $176.14 touched in the 4th quarter of 2007. The stock is down 69.2% from the peak.
Penn Gaming (PENN-NASDAQ, $25.13) is a widely held public casino operator operating in the US. The company does not have operations in the city of Las Vegas. 2009 revenues are forecast to be roughly $2.4 billion. EBITDA margins are currently in the range of 22.5%. The shares sell for roughly 11.9X my forecast 2009 EV to EBITDA ratio.
In 2007, revenues of Penn Gaming were $2.44 billion and EBITDA was $.636 billion, or 26% of revenues. Current margins are off 13.5% from 2007. In 2006, EBITDA margins peaked at 31.2% of revenues. In the second quarter of 2007, shares of Penn Gaming touched $63.68. The share price is down 60.5% from peak.
Isle of Capri Casinos (ISLE-NASDAQ, $7.75) is a widely held public casino operator operating in the US. No ISLE facilities exist in Las Vegas. 2009 revenues are forecast to be roughly $1 billion. EBITDA margins are presently about 19% of revenues. The shares sell for 9.1X my 2009 forecast EV to EBITDA ratio.
In 2007, ISLE revenues peaked at $1.122 billion. EBITDA (factoring out unusual charges) was $.185 billion in 2007, for a margin of 16.4%. Record EBITDA margins of 22.4% were achieved in 2004. Currently EBITDA margins are roughly 15.2% off of peak. In the first quarter of 2007, ISLE shares touched $33.01. Shares are presently down 76.5% from peak.
Boyd Gaming (BYD-NYSE, $7.36) is a widely held public casino operator in the US. The Boyd family controls 36% of the shares. The majority of facilities exist in Las Vegas, although the firm does have some regional exposure. Boyd Gaming and MGM Grand also operate a joint venture in Atlantic City which owns the "Borgata" Casino.
2009 revenues are forecast to be $1.62 billion. Excluding all joint venture contributions from Borgata, I forecast EBITDA to be in the range of $.340 billion, or 21% of revenues. The shares sell for about 11.6X my 2009 forecast EV to EBITDA ratio.
In 2007, BYD revenues were $1.98 billion. EBITDA was $.437 billion (excluding the contribution from Borgata), or 22% of revenues.
Record EBITDA margins of 23.4% were touched in 2006. These peak margins were also demonstrated by other casino operators.
In the 3rd quarter of 2007, shares of Boyd touched $54.22. On a 19% decline in revenues, a 10% decline in EBITDA margins and an absolute 23% decline in EBITDA, shares have fallen by 86% from the peak.
Of the 6 publicly traded operators in my peer sample, I have chosen BYD to be my cyclical recovery vehicle.
Boyd Gaming shares have fallen almost in line with the two most highly leveraged operators, MGM and Las Vegas Sands.
Boyd receives my investment attention, over MGM or LVS, for the following reasons.
1. Boyd's balance sheet is stronger, by far, than MGM or LVS. BYD's EBITDA is currently more than 1.96X annual interest charges. This excludes the sizeable contribution from Borgata. If the 50% Borgata EBITDA was consolidated, EBITDA coverage would rise to more than 2.5X. Boyd has completed the majority of its capital expenditures for the foreseeable future. Absent an acquisition of operating assets, free cash flow should gradually reduce total liabilities. I do not add Borgata's EBITDA in Boyd's income statement, as the firm lacks the ability to readily access Borgata cash.
In comparison to BYD, MGM's EBITDA to interest coverage was just 1.5X in Q2. MGM's EBITDA coverage includes the contribution from Borgata, and excludes a very sizeable interest charge presently being capitalized.
LVS' EBITDA to interest and preferred share coverage was 1.88X in Q3. LVS also capitalizes a considerable interest amount. If reflected on the income statement, the interest and dividend coverage ratio would be reduced considerably.
Not only is the balance sheet at BYD better than the two most depressed casino equities, the quality of the balance sheet and income reporting at Boyd, in my view, is heads and tails above the two peers noted. While MGM and LVS are throwing in everything but the kitchen sink to improve their debt coverage ratios, BYD's interest coverage, at what may be the bottom of the market, appears to be more than adequate to ride out further economic malaise, without straining the boundaries of credulity.
Wynn Resorts currently has the strongest balance sheet among the 4 large publicly traded Las Vegas operators. The EBITDA to interest coverage ratio, by my calculation, is currently 3.5X. This ratio makes Wynn one of the few casino operators that have garnished the praise of Wall Street.
2. Boyd is prepared to make acquisitions during a time of depressed valuations. It is now cheaper to buy an existing casino, than it is to build a "greenfield" operation. Management has made offers to purchase some or all of the facilities operated by Station Casinos. Station, presently in reorganization, has rebuffed the proposal. However, the willingness of BYD to come up with a cash offer of $950 million for Station properties, and without requiring a major equity underwriting to come up with cash, provides me with confidence that management is prepared to make accretive acquisitions for the benefit of existing shareholders.
reuters.com
A potential purchase price of producing assets would be funded through a $2 billion standby revolving line of credit, now unused, that was provided for Echelon development. This revolver comes up for renewal in 2012. The interest rate is no more than LIBOR +1.625% (2.86% currently).
If management could add existing assets with EBITDA margins similar to existing properties, ANY purchase could prove to be highly accretive for existing shareholders.
For example, let us assume that the Station Casino properties produce similar returns as Boyd. Station's problems arose from an inability to service $6 billion + dollars in high cost debt, not based on the quality of the portfolio. If Boyd was to buy existing operations, for a cost of $950 million, producing EBITDA margins of perhaps 18%-20%, and was to finance the purchase from the revolver; net EBITDA accretion would be roughly $143 million to $163 million per annum. Allowing for an 8.9X to 11.9X EV/EBITDA multiple on a $950 million potential acquisition, and the net result is a potential market cap swing of $3.70 per share to $11.37 per share.
If the Station assets are not purchased, a number of other prime properties could be available. MGM might be persuaded, in its current financial state, to part with the remaining 50% of Borgata. Perhaps another strategic casino might have to go on the chopping block. LBO firms were also keen purchasers of casinos in recent years, and may need to rationalize certain properties.
A $2 billion credit line buys a WHOLE lot of casino revenue in the current environment. Boyd Gaming is one of the few casino firms in business with access to low cost credit. In a credit challenged environment, firms with credit are king.
Many are praying for a speedy economic rebound in Las Vegas. I would argue that the Boyd family might be hoping for things to get just a bit worse, and for a little while longer. Only then might recalcitrant creditors, or competitors on shaky footing, perhaps currently holding out for high dollars, be more easily persuaded to part with good assets for fire sale prices.
3. Boyd's drop in revenue and EBITDA, from peak levels in 2006, is almost entirely due to the sale and closure of 3 Las Vegas properties.
The Stardust Casino and Hotel, across from the Steve Wynn's flagship resorts, was long considered to be an underdeveloped property on the Las Vegas Strip. Boyd engaged in a feasibility study to determine the most appropriate use for the acreage. Ultimately, the decision was made to close and demolish the Stardust. The Stardust entered into runoff mode in 2005, was closed on November 1st, 2006, and was demolished in March 2007. In order to secure the land adjacent to the Stardust and maintain an adequate balance sheet for the potential building of a mega property, to be named "Echelon", Boyd sold a casino for $401 million cash plus 3.4 million common shares. They further exchanged a smaller casino for the 24 acres of land adjacent to the Stardust.
With these disposals, 192,000 square feet of casino floor and 2460 hotel rooms, carrying average rack rates of $61 per night, ceased to make contributions to the BYD's top and bottom lines in 2006. In aggregate, $387.8 million of annualized revenues, and $76 million of annualized EBITDA was removed from the portfolio.
At the conclusion of the sales, demolitions and swaps, Boyd owned a total of 87 acres of raw land on Las Vegas Boulevard, one of the largest continuous holdings on the strip.
4. The deferral of Echelon removed a substantial amount of value from the company, but also removed project execution risk. On August 1st, 2008, management placed construction of Echelon on hold, until such time as Las Vegas conditions recover. Boyd executives have recently indicated that they don't envision restarting the project for a minimum of 3-5 years. Capital costs, initially envisioned to be about $3 billion dollars, had escalated to a potential $4.8 billion. These increased costs would have certainly reduced the EBITDA potential of the project. I'm comfortable waiting until a later date, if it improves the economics of the project.
In the meantime, the 87 acres sit idle, earning zero return for shareholders. In addition to the foregone revenues on the casinos sold and bulldozed, Boyd has thus expensed about $125 million of cash on the project. This is also generating a return of zero. The delay is expensive, but one that I don't dispute as unnecessary. At a total projected capital outlay of up to $4.8 billion, Echelon would have been one of the most ambitious projects in Las Vegas. Going ahead with construction would have certainly placed Boyd on precipitous financial footing, in a US recession.
This acreage won't remain idle forever. It sits across the street from 2 of Las Vegas' most attractive properties (Wynn and Encore). In a normalized Las Vegas real estate market, a project with piles in the ground, architectural plans drawn up and approvals granted, might suggest that this property is still worth the land value of up to $1.2 billion. Should Boyd fail to develop this project in an economic upswing, their hand may be forced. To put the potential value of the raw land into perspective, keep in mind that the entire market cap of BYD is currently just $635 million.
5. The Borgata joint venture with MGM, represents, in my view, an extremely undervalued asset. Since inception, BYD has made investments and advances of $405.9 million to the partnership, equalling $4.67 per share.
The Borgata is a 140,000 square foot casino and 2000 room hotel in Atlantic City. Opened in 2003, the project has made continuous investments to build on its status as the pre-eminent casino in AC. The venture has completed an 800 hotel room expansion in late 2008, named the Water Club, which carried a capital investment of more than $400 million. Boyd's share of the total joint venture presently carries total long term debt of $595 million, which includes $200 million recently invested in the Water Club. With 2009 forecast revenues in the range of $800 million, and EBITDA of as much as $228 million, Borgata generates EBITDA margins in the range of 28.5%, the highest in the Boyd portfolio. As this is a private joint venture, it is my view that the market is attributing little real value for Boyd shareholders. If one assumes that Borgata is worth a 20% discount to the publicly traded firm with the lowest EV/EBITDA ratio in the peer group (ISLE), this would imply a value, net to BYD, of $2.50 per share in value. Such a discount seems excessive, considering that Borgata generates EBITDA margins 50% above ISLE, has the leading market share in Atlantic City and has recently opened a hotel property offering accretion potential as it matures. Borgata remains a prize, even in an increasingly competitive region.
A more appropriate valuation, in my view, is to price Borgata at 10X EV/EBITDA in a private transaction. This produces a value, net to Boyd, of $6.30 per share, or 85% of BYD's current market value.
On a "sum of parts" basis, Boyd Gaming looks to be quite undervalued at the current price.
If Borgata is truly worth somewhere in the range of $2.50 per share to $6.30 per share for Boyd, and the 87 acres of raw land on Las Vegas Boulevard retain a value of $7.5 million per acre ($7.50 per BYD share), this implies a potential value of $10 to $13.8 per share, for just these two assets. If the raw land ever does command a value of $15 million per acre and Borgata can be unlocked at my $6.30 per share estimated value, these two assets become worth as much as $21.3 per share.
Then, one must estimate a value for the remaining 808,200 square feet of gaming space and 7250 hotel rooms in the Boyd portfolio. They appear to be fully capable of generating $340 million of EBITDA in an adverse time. BYD generates EBITDA margins roughly in line with PENN, despite having thrown away $125 million in the last several years on preconstruction costs at Echelon; to value the casino assets at 11.9X EV/EBITDA seems reasonable. This produces a value of $8.27 per share.
Since 2000, Boyd has made capital investments of $1.23 billion, net of write downs, on its portfolio of properties. This represents an investment, on existing properties, of roughly $14.15 US per share.
An addition source of potential accretion lies on the balance sheet. On September 30th, 2009, Boyd's total long term debts were recorded on the balance sheet at their full carrying amount of $2.65 billion. However, the estimated fair market value of this debt might be a full $519 million, or $5.97 per share, below the carrying amount. In the first 9 months of 2009, Boyd repurchased $82.4 million face value, at a total cost of $70.14 million, or 85.2% of par value. Over the next several years, should Boyd prove opportunistic, management may be able to add further shareholder value, via discounted debt purchases. With only sustaining capital expenditures planned for the short term, BYD would appear to have an ability to accelerate such purchases over the next year or so.
In total, my sum of parts estimated value for BYD, without a revenue producing Echelon casino, is approximately $18.27 to $29.57 per share. Whatever discounted debt purchases may be made could be incremental to my estimate.
In an economic recovery, it could seem reasonable to suggest that BYD's EBITDA may rise, potentially enhancing the value. Please do NOT assume that a sum of parts calculation represents my future share price estimate. It is merely an expression of potential value, under certain conditions, should a motivated party seek to bust up the firm.
Finally, all of this assumes the Echelon remains on hold. Should the project be revived, such a mega project could prove to be a game changer.
Does Boyd's 23% decline in EBITDA justify an 86% decline in share price?
I think not. However, the decline appears to be wholly consistent with the pessimism experienced by casino operators, off the previous economic low of 2001. The market reaction was extreme then, and appears to be more so now. Admittedly, the current US economic malaise is more severe than the 2000-2002 period. In my view, a portion of the BYD share price decline is likely a sympathetic reaction to the current woes of MGM and LVS.
Differing from all three of the major casino peers in Las Vegas, (WYNN, LVS and MGM) Boyd has felt little need to dilute shareholders with equity underwritings. In fact, a modest open market repurchase program recently took place. I would NOT anticipate more stock purchases. Management has stated their willingness to pay up to $950 million in cash for some or all of the Station Casino assets. Such a cash deal, through a court appointed reorganization, produces nothing in the way of M&A revenues for Wall Street. In short, the business model of Boyd has little appeal to Wall Street. BYD is a self financing, fully funded casino operator. They have finished several years of major capex and are presently using excess cash to retire debt at discounts. The company is, frankly, a terrible investment banking prospect.
Normalized EBITDA actually, according to my methodology, surprised to the upside. I was not anticipating normalized EBITDA to exceed $320 million in 2009. With stringent cost controls in place, even a mild US economic recovery could restore lustre to the Boyd and for that matter the sector in general.
Each casino operator has some knock against it from Wall Street, save for Wynn. I acknowledge the validity of each bear thesis on each and every stock in this sector. However, Wynn is currently selling for a forward EV/EBITDA ratio that makes my nose bleed, and has nothing that I would consider to be a hidden asset on the books. This is not to imply that Wynn shares won't produce excellent performance in the next up cycle. I believe that all of the casino companies in my peer sample, should the US economy recover even modestly, may prove to be cyclical darlings once again.
The contrarian's argument on US equity allocation, at this time, can best by summed up with my own views.
I'm a global bull, but a US bear. On a relative basis, it is my view that many developed global markets offer far greater return potential in the long term. In contrast, I consider the US economy to be somewhat past the plateau of a generational bull market. Few important US driven secular trends benefit the entire economy. The one notable trend, a move from cash to non cash payments, is already represented in my account, through holdings in Mastercard.
Those who disagree with such a view have little support in the form of economic data. In the last 9 years and 10 months, the US economy will now have produced more months of negative or subpar GDP growth (below 2%) than optimum GDP growth (3% or higher). The US is now clearly a cyclical market. Accordingly, so as to obtain maximum potential benefit from a US recovery, I must, by default, consider owning a cyclical investment. It makes me uncomfortable to do so.
And THAT is exactly the reason that I'm going all in on Boyd Gaming, with a view to build up an equal portfolio weight. As a global "everyman", I must discount my bias and consider a middle ground, as being possible, for the US economy. My emotional responses to current negative investor sentiment, are attempting to override, what should be considered a logical and rational investment for small cap cyclical accounts, in a potentially improving economic cycle.
Off the bottom of every cyclical market, investors can come up with thousands of reasons NOT to own a well run firm that has been beaten up. When these same cyclical investments rise fivefold, tenfold or twentyfold, everybody suddenly wants in.
As for those who have written off Boyd completely (hence the washout), I wonder why they no longer consider BYD to be capable of outperforming in a potential economic advance. After all, from US economic "peak to peak" (1999-2006), BYD represented a 7.3 bagger. Those who patiently purchased the shares off the bottom of the last economic cycle, when the cycle had already turned for the better, generated a 16.6 bagger going into economic high. Certainly, the shares are nowhere near that today. However, we are now comparing "peak to trough" performance. Appraise ANY cyclical sector or stock on peak to trough, and you will almost always feel queasy.
The company now sells for a discount to other Las Vegas peers on a trailing EV/EBITDA ratio. Considering that Boyd has a stronger balance sheet than all save Wynn Resorts, has suffered minimal EBITDA contraction as compared to peers, and is deleveraging its balance sheet without diluting existing shareholders, this seems unwarranted.
While ISLE and PENN have been proposed by some as being the better "values" in the market, this appears to have been arrived at largely based upon their lower degrees of share price decline. If the global economy is improving, and the US economy will continue to be the weak link among developed nations, a relatively weak US dollar might result in an international tourism "pick up" in the mid term. Regional casino operators will not benefit from an influx of foreign tourists, despite their vociferous protests to the contrary. Las Vegas remains a world class tourist destination, and I want to participate in any potential recovery of that market. Unless ISLE and PENN establish a meaningful presence in Las Vegas, I will continue to have limited interest in their businesses.
RMG1 made an initial underweight purchase of Boyd Gaming at an price of $36 + dollars in 2006, based upon the EBITDA prospects for a completed Echelon casino. Based upon my mid term view for recovery in Las Vegas casino operators, I am delighted that an opportunity exists to buy additional shares at the current price of $7.36. In my view, this price represents a capitulation value.
RMG2 VC recently opened a brand new investment position, based upon cap weight.
The shares may continue to be volatile from here. Perhaps I may even be presented with a further opportunity to buy more shares below this price. So long as my total allocation to Boyd remains underweight in the portfolio, the possibility of averaging down further does not present me with undue concern. As dividends flow through to the account, further purchases may be reported. I am NOT investing in Boyd for the potential of earning a mere 20%-30% return on my cyclical capital. |
