Goepel Report!!! (Sorry about the fixed font. It's the only way I could get the tables to line up O.K.)
GOEPEL MCDERMID: PRIVATE CLIENT RESEARCH
LAKE CITY GAMING CORP.(LCG-V, $3.50) 'Let the Games Begin'
December 7, 1998
Recommendation: Speculative Buy
12-Month Target Price: $5.00
Scot Atkinson, CFA
604.661.1805
Stock Data
52-Week Hi/Lo $4.00-$2.25
Shares Outstanding
Basic 11.4 mln
Fully-Diluted 13.3 mln
Company Data
Market Capitalization
$40.5 mln
Fiscal Year End June 30
LCG-V
HIGHLIGHTS
 Lake City Gaming Corp. (Lake City) is a casino manager with three locations in British Columbia operating a total of 519 slot machines and 36 gaming tables. By the end of F1999, Lake City expects to expand and upgrade its operations to 753 slot machines and 48 tables.
 Lake City recently reported Q1/F99 results. Record net revenues of $4.7 mln and net income of $933,000 or $0.08 per share were reported. These results almost matched the income level for the full year in F1998.
 The Company is waiting for final government approval to begin construction of a new facility in Penticton which would add 250 slot machines and 16 tables.
 Our EPS estimates are $0.31 for F1999 and $0.54 for F2000. We expect Lake City to generate EBITDA of $14 mln in F2000. Based on these estimates and the uncertain growth beyond Penticton, we rate Lake City shares a Speculative Buy with a target price of $5.00.
The Company
Lake City Gaming Corp. is a casino management company which, through its wholly owned subsidiary, Lake City Casinos Ltd., currently operates casinos in Kamloops, Vernon and Kelowna, British Columbia. Lake City completed its IPO on September 10, 1998. The Company has been in the casino operating business since its incorporation in 1986 and was renamed Lake City in 1992 when the current Chairman, Fred Glasgow, acquired the assets from Great Canadian Casino Company Ltd. (which he co-founded in 1982). Lake City was well positioned to capitalize on new gaming policies introduced by the BC government in May 1997. In addition to extending operating hours, increasing bet limits and permitting new table games, the government made the controversial decision to authorize slot machines. The impact of slot machines was evidenced by an increase in Lake City's gross revenues by over 600% from $5.1 million in F1997 to $31.1 million in F1998, with most slot machines operational only during the second half of the year. The government has delegated primary responsibility for gaming control to the BC Lotteries Commission (BCLC) pursuant to subsection 207(1)(a) of the Code. BCLC essentially owns the casinos in the province (it owns the slot machines and most gaming equipment) while companies such as Lake City are the operators and are required to remit 75% of slot revenues and 60% of table revenues to the provincial government. Lake City receives non-taxable income of 3% of gross revenues (forecast at $115 mln in F2000) to apply towards facility development. Management, headed up by Steve Kumpf, President & CEO, has significant experience in the gaming industry and has created a profitable organization.
Lake City recently reported results for the first quarter of fiscal 1999 ending September 30, 1998. Starting with this quarter, the Company will report revenues net of government disbursements. Lake City reported net revenue of $4.7 mln after BCLC disbursements of $12.4 mln from gross revenues. Net income for the first quarter was $933,000 or $0.08 per share, almost matching the Company's entire income for the prior fiscal year.
Relocations and Expansion
Table 1 below outlines the relative size of Lake City's various locations as well as its planned expansions. Relocating and expanding the Kamloops facility within the city on April 1, 1998 was very successful and this casino currently generates approximately $2 mln in quarterly revenues. Preparations are underway for the Company's December 15, 1998 grand opening of the new 12,400 sq.ft. casino in Vernon. Expanding from 89 slots to 177 and from 8 gaming tables to 12 will allow Lake City to market aggressively to bus and tour operators. In May 1999, Lake City will move its existing Kelowna operation to the newly renovated Grand Okanagan Resort. Construction is ongoing and this site is expected to become BC's premier casino. Following the province's request for proposals in November 1997, Lake City was one of two applicants to be approved in principle for a casino in Penticton. The Company is awaiting final approval from BCLC and the success of this facility remains uncertain given the possibility of a competing casino. A Penticton facility has the potential to add up to $0.18 to EPS annually. Lake City is actively seeking opportunities for expansion. Adding properties in BC is dependent on BCLC approvals; Expansion outside of BC is subject to local regulatory frameworks and challenges specific to each province.
Slot Game Casino Employees Square
Machines Tables Full-Time Part-Time Footage
Kamloops 275 16 91 61 14,400
Vernon 89 8 36 41 3,000
Kelowna 155 12 66 79 7,000
Current
Total 519 36 193 181 24,400
Vernon
Expansion 177 12 65 53 12,400
Kelowna
Expansion 300 20 89 94 21,000
Operations
in June 99 753 48 245 208 47,800
Penticton
Addition 250 16 78 28 16,500
Post
Penticton 1003 64 323 236 64,300
(Source: Lake City Gaming Corp.)
The Market
BC currently has 17 charitable casinos with six destination casinos tentatively approved, including two in Penticton. BCLC considers applications for new casino licenses based on the extent of local government support and the impact on the operations of existing neighbouring casinos. The approval process represents a significant barrier to entry and therefore competition to Lake City's current operations is minimal. Each province is regulated separately and growth for Lake City beyond BC is both limited and uncertain. The Company's current and proposed casinos are ideally located in BC's Thompson Okanagan region, a growing area which attracts over four million tourists each year. We have forecast that summer revenues for Lake City will be 10%-15% higher than winter revenues as the majority of tourist visits occur between May and October. Per capita spending on gambling is higher and growing faster in most other provinces, possibly because BC has not allowed video lottery terminals (VLTs) or any dice games such as Craps. We anticipate that upgraded facilities in Vernon and Kelowna will attract new customers.
Risks
The provincial government controls the casino industry in BC according to strict guidelines and regulations. Lake City is bound by any changes in legislation and BCLC has the authority to close down any casino. As well, public sentiment can prevent casino operations from going ahead, as seen last year when some groups lobbied successfully against the installation of slot machines in certain municipalities, i.e. Vancouver, Surrey and Victoria. The Company will face this challenge as it searches for new locations and current operations are not immune from public and government pressure. Although Lake City has proven itself as a successful casino operator and has developed excellent relationships with BCLC, there is no guarantee the Company will be granted additional licenses.
Of the 11.5 mln shares outstanding, management and insiders hold more than 76%. This same group also owns one million options exercisable at $1.50 per share. Mr. Glasgow, with almost 8.4 mln shares and 320,000 options, is aligned with shareholder goals in terms of maximizing shareholder wealth but today's float is less than 2.5 mln shares. A prospectus has been filed to qualify for the sale of up to 1.0 mln shares owned by Mr. Glasgow, however the illiquidity issue and concerns of majority voting control remain unresolved.
Table 2 (below)
Summary of US Small Cap P/E Ratios
Company Sym 99E P/E
Boyd BYD 6.5
Aztar AZR 29.8
Hollywood HWCC 23.8
Players PLAY 15.1
Hlywd Park HPK 13.8
Station STN 17.8
Harveys HVY 15.3
Grand GND 10.5(1)
Primadonna PRMA 12.7(2)
Anchor SLOT 7.8
_______________________________
US Average 15.3
(1) Hilton recently acquired Grand for 10.5x 99E EPS.
(2) MGM recently acquired Primadonna for 12.7x 99E EPS.
Source: Goepel McDermid Research
Valuation
We have researched a number of public gaming companies in the US, which have an average 1999E P/E of 15.3x, but most do not represent a direct comparison to Lake City as industry regulations are substantially different, the market is larger, the industry is highly competitive and most of the casino owners are also hotel and restaurant operators. Average 1999E EV/EBITDA multiples in the US range between 5.0x and 6.0x. We believe Lake City should trade at a discount to these multiples given its smaller market and the uncertainty of future growth prospects. Great Canadian Gaming Corp. (GCD-V, $2.01) with seven casinos in BC is perhaps the best comparable although six of its seven casinos operate in municipalities which have prohibited slot machines. Based on Great Canadian's recent quarter and its new Nanaimo casino, we believe it is trading close to 6.0x the expected 1998 EPS of $0.35 (f.d.). An EPS multiple of 9.0x and an EV/EBITDA multiple of 4.0x-5.0x is warranted for Lake City given the Company's number of slot machines, growth from relocations and the potential of the Penticton site. Our F1999 fully-diluted EPS estimate (for the year ending June 30, 1999) for Lake City is $0.31, including only one month of operations from the new Kelowna facility. Our estimate for F2000 jumps to $0.54 and assumes the Company has a new casino open in Penticton by December 1999. We estimate Lake City will generate EBITDA of $14 mln in F2000. Based on our estimates and the uncertain growth beyond Penticton, we rate Lake City shares a Speculative Buy with a target price of $5.00.
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