Dirks & Company, Inc. Phone: (800) 774-0778
I8 East 53rd Street – Sixth Floor (212) 832-6700
New York, NY 10022 Fax: (212) 759-7264
RESEARCH REPORT July 11, 2002 BUY RECOMMENDATION Sal Nuccio:(212) 832-4767
Ray Dirks: (212) 832-2294
Carnegie Cooke & Company, Inc.
(OTC-PK: CGKY)
Price Range: $1.58 - $0.37 Shares Outstanding: 25,577,132
Current Price: $1.00 Fully Diluted: Same
Market Capitalization: $25,577,132
Years Ending June 30 Years Ending June 30
*Earnings Per Share: 2002 A $ 0.16 Price/Earnings Ratio: 2002 6.3x
2003 E 1.97 2003 0.5
2004 E 5.37 2004 0.2
2005 E 8.76 2005 0.1
Price Target (one year): $ 5.00 Cash Position: $308,000
Price Target (two years): 10.00 Long-term Debt: $53,800 (Mortgage)
*Assumes all earnings are repatriated to the United States, and reduced by standard Federal corporate taxes.
Recommendation
Carnegie Cooke & Company, Inc., with headquarters in Las Vegas, has been authorized by the Brazilian government to provide a range of gaming services and is an accredited collector of betting revenue in Brazil. It presents a highly speculative but potentially rewarding opportunity to capital-appreciation-seeking investors who recognize the risks of such ventures. The progress made thus far by Carnegie under government authorizations and contracts with Brazilian Jockey Clubs suggests that pre-tax earnings per share in the fiscal year ending June 30, 2003, could well exceed $3.00.
Carnegie Cooke "went public" in 2000 by merging with an existing public company, the American Environmental Corporation, and then renaming it. Its plan, now being implemented, is to generate profitable revenues by (1) mechanizing wagering at Brazilian
racetracks, (2) operating off-track betting parlors (OTB’s), (3) providing international simulcast racing at tracks and OTB’s, and (4) placing "virtual-reality” gaming machines
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No statement or expression of opinion or other matter herein contained is, or is deemed to be, directly or indirectly, an offer or a solicitation of an offer to buy or sell the security referred to above. The information contained herein is taken from sources believed to be reliable, but its accuracy cannot be guaranteed. There can be no assurance that recommendations by those sources will prove profitable or will equal the performance of past recommendations. The principals and employees of Dirks & Company, Inc. may trade in securities mentioned herein subject to self-imposed restrictions; such affiliated person may at any time hold positions in issues recommended within this publication. Dirks receives remuneration from the company under an investment-banking agreement.
in these locations and in malls, gaming arcades, bars and other busy sites throughout Brazil. The gaming machines show simulated races on which patrons could wager.
Fiscal 2001 and 2002 Were Profitable
In fiscal 2002, which ended June 30, an unaudited statement showed net income of $3.9 million, or 16 cents per share, on revenues of $4.3 million. In the previous year, net income was $1.6 million, or 7 cents a share, on revenues of $2 million.
Projected earnings, both before and after taxes, are delineated on page 5, after discussion of Carnegie Cooke's primary businesses. Income projections are made assuming non-repatriation of the income to the United States. However, when it is repatriated, it will be subject to standard Federal corporate taxes.
The company has engaged auditors. (See page 6)
Carnegie Cooke Buys a Jockey Club
In Brazil, racetracks are owned by Jockey Clubs, independent entities that are exempt from federal taxes and licensed by the government. A club must own a racetrack to qualify for licensing. The license gives a club the right to open turf-related wagering agencies throughout its state, and engage in other activities, provided that they promote the turf industry.
In June 2000, Carnegie Cooke took its first major step into this lucrative arena by acquiring a club, the Jockey Club El Dorado in Porto Alegre, for 2.1 million shares of its common stock and a commitment to invest $2 million in the club and related activities. In addition to its racetrack and land, the club has an exclusive agreement with Caliente, a Mexican corporation, to provide international simulcast gaming transmissions throughout Brazil and other South American countries. Caliente has allowed the club to assign this agreement to Carnegie Cooke directly. Thus far, Caliente is the only organization that has Brazilian government approval for such simulcast gaming.
To be allowed to operate in Brazil, Carnegie formed a Brazilian company, Carnegie Cooke do Brasil, LTDA, which is a limited liability corporation. Under Brazilian law, a percentage of the domestic corporation had to be owned by a Brazilian citizen. In this case, 15% of the enterprise is owned by Valdo Marques da Silva, former owner of the Jockey Club El Dorado, which remains a 100%-owned subsidiary of Carnegie Cooke & Company.
The Brazilian Association of Jockey Clubs
In December 2000, Carnegie took its next major step by entering into an agreement with the Brazilian Association of Jockey Clubs (BAJC), which allows Carnegie to:
· Mechanize the racetracks and betting systems,
· Provide international simulcast racing throughout Brazil,
· Open off-track-betting parlors, and
· Install Carnegie's virtual-reality gaming machines nationwide.
Carnegie was able to begin implementing those plans three months later, when its agreement with BAJC was approved by the Brazilian Department of Agriculture, which controls the turf industry. It also named Carnegie an "accredited collector of betting revenue." The $2 million capital investment financed those tasks, as well as some physical improvements at the tracks.
Thus far, 28 of the approximately 50 members of the jockey-club association have agreed to join in the alliance with Carnegie, under its agreement with the association, and have given the company the right to open off-track betting agencies. Under the agreement, and with the government's accreditation, Carnegie will be able to open these off-site agencies anywhere in Brazil, and retain all of the revenues.
The racetracks and betting systems of nine of the 28 clubs in the alliance have been mechanized. Carnegie has been doing this in conjunction with Caliente, which provides the hardware. In addition, Carnegie has been making physical improvements that are expected to enhance business, such as lighting for night operation.
Carnegie will receive 22% of the net revenue (after wins) from participating Jockey Clubs. That will include gaming revenue generated by simulcasts of international and Brazilian races on view at all Jockey Clubs in the alliance.
The company’s projected net-revenue share in the current fiscal year, which ends on June 30, 2003, is $8.7million, according to management. Subtracting 12%, or about $1 million in expenses, puts net income from the Jockey Clubs at $7.7 million for the year, or $0.30 per share. A conservative assumption is that Carnegie’s income from this segment will remain the same in the next two fiscal years, because of the difficulty in predicting how many Jockey Clubs will decide to mechanize their wagering operations.
Simulcasts: International and Local
Caliente provides the international signal that is broadcast into the mechanized Jockey Clubs. The Mexican company also serves as the bank for international betting at the jockey clubs and agencies that are equipped to receive the international simulcasts. Carnegie pays $30,000 a month to a satellite company through which Caliente broadcasts the signal. The monthly fee remains the same, whatever the number of clubs or agencies receiving the simulcasts. The same satellite system also is used to telecast all local racing in Brazil in real time to properly equipped Jockey Clubs and betting agencies.
Off -Track-Betting Agencies
Because management originally felt that the OTB offices would be its major source of revenue, Carnegie planned to establish many of them throughout Brazil. However, while they still are expected to produce substantial income, CEO Jay Goldberg and his associates concluded that the company's true cash cow would be the Virtual Reality Machines, which can be installed in arcades, bars, tobacco shops, hotels and anyplace else where ADSL telephone service is available. In fact, management believes revenue generated by these machines will far exceed the combined gross income from OTBs and the Jockey Clubs. That shift in focus reduced the pace of planned openings of OTB offices to a goal of 30 by the end of fiscal 2003.
As to the betting offices, each will feature 55 international events every day, along with local races, according to Mr. Goldberg. Research and betting volume on local races, he said, indicate that each office could generate more than $1 million in annual net revenue after wins. Caliente of Mexico would receive 15%-to-18% of that, and Carnegie would get the balance, less 16% for estimated operating expenses and 10% for the agency manager. Thus each OTB would net approximately $640,000 per year, or $53,333 per month, for Carnegie Cooke.
Management’s three-year projection:
· If three OTB offices were opened in each of the last ten months of the current fiscal year, the total contribution from them for the year would be $8.8 million, or $0.34 per share.
· In fiscal 2004, the 30 offices opened in 2003 would be in full operation, producing $19.2 million [30 OTB’s times $53,333 per month times 12 months]. And, if another 30 OTB’s were progressively opened during the year, they would contribute an additional $8.8 million, bringing total income for 2004 from this segment to $28 million, or $1.09 per share.
· Following the same pattern in fiscal 2005, with another 30 being progressively installed, income that year would total $47.2 million, or $1.84 per share.
Virtual Reality Machines
These machines were not part of Carnegie's plan until the spring of last year, when an Argentinean company specializing in such equipment made a proposal to enter into a joint venture to distribute the machines in Brazil. However, the joint venture foundered when the producer could not provide the type of sophisticated equipment Carnegie wanted. A subsequent deal was made with a Brazilian hardware company, Microman, which began delivering machines last March to Porto Alegre, where they are being installed in arcades, bingo halls and other well-trafficked locations.
The virtual reality machines are programmed to return 65% of revenue in wins, because that is the Brazilian government's mandate. In addition, 3% of gross revenue is set aside for weekly jumbo giveaways. That leaves 32% to Carnegie Cooke as net income after wins, and 10% of that amount goes to the location owner or manager, and about 6% goes to pay local taxes. That leaves the company with about 27% of the gross.
Gross revenue per machine per day is calculated by multiplying 144 (the number of betting events per day) by the average betting per event. A conservative assumption of $15 in average betting per event, therefore, would generate $2,160 in daily gross revenue per machine ($15 x 144 events), and Carnegie’s 27% net share would be $583 per machine per day.
Continuing in this conservative bent, management bases its three-year projection on the assumption that only 50 machines will be installed each month for the entire period, for an ultimate total of 1,800 units. As with the OTB’s, the calculation must reflect the incremental increase in monthly revenue as new machines are installed. For example, in the first month, 50 machines will generate $870,000 in income for Carnegie (50 x $583 a day x 30 days). In the second month, 100 machines would generate $1.7 million (100 x $583 x 30 days), and so on, bringing total Carnegie income for the year from this segment to $67.9 million, or $2.65 per share.
Following the same mathematical path in years two and three would bring total income to $193.1 million, or $7.55 per share, in fiscal 2004, and $318.4 million, or $12.45 per share, in 2005.
Summary of Income From All Sources
(Years Ending June 30)
Net income figures assume all earnings are repatriated to the United States,
and reduced by standard Federal corporate taxes.
2003
Jockey Clubs: $ 7,685,436
OTB’s: 8,799,945
Virtual Reality: 67,860,000
Pre-Tax Total: $84,345,381 Earnings Per Share: $3.29
Net After-Tax Income: $50,607,228 Earnings Per Share: $1.97
2004
Jockey Clubs: $ 7,685,436
OTB’s: 27,999,345
Virtual Reality: 193,140,000
Pre-Tax Total: $228,824,781 Earnings Per Share: $8.94
Net After-Tax Income: $137,294,868 Earnings Per Share: $5.37
2005
Jockey Clubs: $ 7,685, 436
OTB’s: 47,199,705
Virtual Reality: 318,420,000
Pre-Tax Total: $373,305,141 Earnings Per Share: $14.59
Net After-Tax Income: $223,983,084 Earnings Per Share: $ 8.76
Private Placement
Last year, Carnegie Cooke raised $2 million in a private placement of 8 million common shares. The proceeds were used primarily to finalize its purchase of the Jockey Club El Dorado and augment working capital.
Carnegie Cooke Engages Accounting Firm
The company engaged a major Brazilian accounting firm, Consultim Servicos Contabeis Tributarious Empresariais Ltda, CNP (Accounting, Auditing, Tax and Business Consulting Group, Ltd.), to perform the following essential tasks:
· Audit all transactions from the point of acquisition of El Dorado (June 2000) through the end of fiscal 2002, producing audited statements for the periods ending Dec. 31,2000; June 30, 2001; Dec. 31, 2001, and June 30, 2002.
· Establish accounting controls, including an internal audit division, by designing the necessary systems of internal control and overseeing their installation, as evidenced by a standard engagement letter.
· As of June 30, 2002, the accounting firm will review and audit the monthly closings, produce quarterly review reports and prepare an audited statement for the entire fiscal year 2003.
Top priority, according to Mr. Goldberg, the chief executive, is the installation of an internal control system that will assure that all accounting and auditing work is in accordance with standards acceptable to a domestic accounting firm.
In addition, Carnegie Cooke engaged a much smaller accounting firm, the Geraldo F. R. Lima CRC/RS 40914, to provide specific services, independent of the primary auditing firm. Those services are:
· Perform daily, on-site reviews of cash deposits and withdrawals.
· Prepare all books and ledgers, and create trial balances on a monthly basis.
· Prepare fiscal yearend trial balances for the auditors.
· Prepare calendar yearend financial statements to be used in preparation of reports to the Brazilian Government. |
