Dover Downs Casino: The best bet could be the common shares

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Dover Downs Gaming & Entertainment, Inc. is a diversified gaming and entertainment company whose operations consist of the Dover Downs Hotel & Casino and Dover Downs Raceway. Dover Downs Hotel & Casino is comprised of a 165,000 square-foot video casino complex. Dover Downs Raceway is a harness racing track with pari-mutuel wagering on live and simulcast horse races. – Company Website

As of December 2012 Dover Downs operated 2,478 machines.

Most recently on January 23rd, 2013 Dover Downs cut the dividend distribution to shareholders due to the March 2013 amendment to their credit facility that prohibits the payment of dividends. In the most recent quarter (Q1, 2013) it was abysmal with a (0.01) per share loss compared to a 0.07 YOY. Top line was also fairly ugly coming in at 45.3M versus 58.4M a year earlier (22% decrease).

The Industry itself has increasing competition from both encroaching physical casinos as well as prospects of legal internet gambling becoming federally legal in the coming years (and recently legalized in a few states). Another headwind Dover Downs faces is the declining interest of out-of-state citizens to travel to the casinos and facilities due to more relaxed state tax in surrounding areas.

Currently trading at roughly 0.5 retained earnings, 3.42x cash and well below book value, it is not hard to see some value although there are reasons why. There is a strain on cash-flow to pay for future capital expenditures, 2.4M cash provided from operating activities and 569K in Capex. The depreciation charge was 2.5M for the quarter using the straight line method.

“Net cash provided by operating activities was $2,430,000 for the first three months of 2013 compared to $5,985,000 for the first three months of 2012.  The decrease was primarily due to lower pre-tax earnings, partially offset by the elimination of certain annual license fee payments on our gaming operations.  We paid an annual license fee of $1,540,000 on our gaming operations in February 2012, which related to the 12 months ended June 30, 2012, which we are no longer required to pay.” – 10-K Footnote 

As you can see the YOY decline is actually worse on an adjusted basis.

Total assets are 195M with the bulk of the weighting in property and equipment (166.9M) compared to 81.9M in liabilities, with a current ratio sitting at approximately 1.654.

Retained earnings are at 109M and as long as earnings stabilize positively, dollars are being sold for 45 cents. The bulk of the problem remains in the foot traffic decline from out-of-state visitors due to a slightly more relaxed state casino tax code, increasing competition in the Maryland area, and internet gambling legislation. The CEO recently said he will focus on four key components for company survival, maintaining bank relationships, prevent more layoffs, keep marketing and reinvesting in facilities maintenance.

Henry B. Tippie, Chairman of our Board of Directors, controls over fifty percent the voting power through direct and indirect holdings (RMT Trust).

In the first quarter 2013 there was a remaining 1.65M shares authorized for re-purchase although it was noted the credit facility will not allow them to do so.

“Additional gaming venues have recently opened in Maryland, Pennsylvania and New Jersey. These new venues — particularly a large casino at Arundel Mills Mall in Maryland which opened in June 2012 with slot machines and subsequently added table games in April 2013 — are having a significant adverse effect on our visitation numbers, our revenues and our profitability. Management has estimated that approximately 35% of our total gaming win comes from Maryland patrons and approximately 66% of our Capital Club® member gaming win comes from out of state patrons.” – 10-K Footnote.

Membership in the Capital Club currently stands at approximately 175,000 active patrons. 

5-year revenue and net income:
Revenue            Net Income

  • 2008:    239M                       19.51M
  • 2009:    233M                       11.28M
  • 2010:    238M                        6.74M
  • 2011:    240M                        5.36M
  • 2012:    226M                        4.81M

Cost of Good Sold are relatively fixed assets and costs with a 5-year average of 197.8M

10-Year Retained Earnings Growth:

  • 2003: 24.87M
  • 2004: 35.15M
  • 2005: 55.46M
  • 2006: 73.74M
  • 2007: 86.64M
  • 2008: 99.26M
  • 2009: 104M
  • 2010: 106M
  • 2011: 108M
  • 2012: 109M
  • Current Share Price $1.72 or a total price tag of 55.9M in the open market (discount the cash on hand and we are at 42M)

    Beneficial Owners

  1. Gates Capital Partners, L.P. = 2.65M shares
  2. Nordea Investment Funds S.A. = 1.447M shares
  3. Private Capital Management, L.P. (a subsidiary of LeggMason, Inc.) = 1.75M shares

(All the Above as of Feb. 15th, 2013)

  • If the company can continue to assume a growth rate of retained earnings conservatively at 2% and aggressively at 5%+ in the next 5-10 years an estimate of 125-140M would be produced. That of course uses one massive assumption that Dover Downs remains profitable on an annual basis. I believe they will remain profitable in fiscal year 2013 with a conservative estimate of  0.05 to a better case scenario of 0.13. This will be a turn around story but can also be approached as a “cigar butt” depending on your time frame. Monitoring results will be key in the next 4-8 quarters as earnings need to stabilize or begin to increase or Dover Downs and nearly 1400 full and part-time employees will be in trouble. If and when the turn around is complete retained earnings and asset value will more than likely be realized at fair value if not a premium (if earnings are growing). The 10-year average EPS is 0.464 and if we assign a 10-16 multiple we will get 4.50-7.50 PPS in the coming years (not accounting for the past retained earnings of the business) provided earnings improve. I would be comfortable buying under $2.00 with a strategy of selling over retained earning value and closer to 125% of BV.dde
  • Now if business can turn around through increased foot traffic the casino is a license to print money with spreads similar to the banking industry but with no lending risk. A weakness could be viewed as the commodity type business Dover Downs is involved in, where deeper pockets and lower operating expenses prevail.
  • A wild card in the investment analysis is future tax rates as implications could both be disastrous and serendipitous
  • Effective income tax rate was 43.2% in 2012 as compared to 41.6% in 2011.
  • American Gaming Association survey of Casino Entertainment indicates industry trends are actually increasing with revenue growth likely to continue in 2013. They also break each state down individually starting with Colorado on page 11. Delaware has revenue retained by the operator of roughly 43.77%, one of the toughest casino state taxes in the country, compared to directly boarding states New Jersey (with 8% state tax on gross gaming revenue), Pennsylvania (55% tax on slot machines, table games 16%) and Maryland (33% retained by operator). The industry as a whole contributed 8.6B in direct gaming taxes as well as earned 37.34B in gross gaming revenue in 2012 said the AGA. Essentially consumer spending is fuelling the increase of about 4.8% YOY, the complete table provided below.
  • STATE 2011 2012 % Change
    Colorado $750.11 million $766.25 million +2.2%
    Delaware $552.37 million $526.67 million -4.7%
    Florida $381.72 million $427.89 million +12.1%
    Illinois $1.48 billion $1.64 billion +10.9%
    Indiana $2.72 billion $2.61 billion -4.0%
    Iowa $1.42 billion $1.47 billion +3.5%
    Kansas $48.48 million $341.15 million +603.7%
    Louisiana $2.37 billion $2.40 billion +1.3%
    Maine $59.45 million $99.22 million +66.9%
    Maryland $155.71 million $377.81 million +142.6%
    Michigan $1.42 billion $1.42 billion -0.5%
    Mississippi $2.24 billion $2.25 billion +0.5%
    Missouri $1.81 billion $1.77 billion -2.2%
    Nevada $10.70 billion $10.86 billion +1.5%
    New Jersey $3.32 billion $3.05 billion -8.0%
    New Mexico $248.92 million $241.48 million -3.0%
    New York $1.26 billion $1.80 billion +43.1%
    Ohio NA $429.83 million NA
    Oklahoma $106.23 million $113.06 million +6.4%
    Pennsylvania $3.02 billion $3.16 billion +4.6%
    Rhode Island $512.86 million $527.96 million +2.9%
    South Dakota $100.90 million $107.36 million +6.4%
    West Virginia $958.70 million $948.81 million -1.0%

    Source: State Gaming Regulatory Agencies

dover_downs_hotel_and_casino_meetings_l

Finally as of March 29th, 2013 Church hill downs entered into an agreement to buy Oxford Casino for 160M in cash or roughly 7.5x estimated 2013 EBITDA. The property included 25,000 square feet of property, 790 slot machines, and 22 game tables. Now if we were to use the trailing 12 month operating earnings + depreciation as a proxy we would obtain (10.27M + 10.29M = 20.56M (not including the factor of more equipment and property, 165,000 square feet and 2,478 machines)

20.56M x 7.5  = 154.2M

Current Price: 55.9M

Now I would never invest in a company for the sole reason of a take-out candidate or possibility of a merger/acquisition. Combined with compelling fundamentals and lacklustre industry head winds I believe Dover Downs is moderately miss priced by Mr. Market.

Dover Downs Gaming & Entertainment, Inc. 2012 Annual Report 

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