The Importance Of Capital Intensity And Thoughts From Einhorn

It seems as though there has been a recent debate on going within the value investing community pertaining to ROE, ROIC and net-nets. At one hand of the spectrum we have the argument that value investors are throwing in the towel and buying anything with a high ROE while using 20+ years discounted cash flows to support their thesis. The central argument is, there is no margin of safety if one pays more than NCAV or liquidation value. At the other end of the spectrum we hear that the most profitable way to invest over the long-term is continually buying and selling assets trading below NCAV, P/B or low P/E. I do agree that assets available below NCAV, low P/B or low P/E can be profitable but we must ask ourselves why is Mr. Market willing to offer us a business at a price that values the business higher dead than alive?

According to Buffett “the risk in buying poor businesses is that much of the bargain element of the initial purchase discount may well be dissipated by the time a catalyst comes along to unlock what appeared to be the initial excess value.”

This is because 1) the market has discounted the asset for a reason, likely because the expectation is for the business to continue to destroy value as it is capital intensive in a declining industry where business metrics are deteriorating 2) The economic value the business earns is not enough to cover the cost of the capital used to generate it and 3) The company has poor corporate governance, questionable management practices and bad capital allocation.

Take a textile manufacturer as an example. This is a very simplistic example ignoring depreciation tax saving among other things. The company is currently earning $1,000 while revenues are declining (or stagnant) at $10,000 and the NCAV is $10,000.

Cash: $8000

Accounts Receivable: $5000

Inventory: $2000

Long-Term Debt: $4000

Accounts Payable: $1000

The company is selling for $7,000 or a 30% discount from NCAV and a P/E of 7. Sounds like a good deal right? Not so fast.

We need to examine the capital needs of the business. What if the company requires $1,500 a year to remain competitive in terms of maintenance capital expenditures? Simply stated, the company needs new machines and equipment to remain productive and keep costs low or face losing market share to competitors who do. Now the company has negative $500 free cash flow a year and you get your equity in the form of machinery. Keeping all variables constant in 5 years the company will have NCAV of $7,500, cash will be $5500, sales will be $10,000 (or less) and income will be $1000 (or less).

Assuming the market revalued the company along the way (@ a 30% discount to NCAV), it will now be worth $5250. The company would experience cash burn and have to make the difference through a secondary offering, debt or both in the long-term. Is this adequate margin of safety?

So what is the point? Context matters and it is imprudent to invest blindly in anything.   

ROE and ROIC arguably don’t matter nearly as much if the company is not capital intensive. The most important variables are how long the competitive advantage will continue and the rate of growth on unit volumes. Here is what Einhorn had
to say about the matter.

“I believe that it is irrelevant to worry about ROE or marginal return on capital in non-capital intensive businesses. If Coke or Pfizer had twice as many manufacturing plants, the incremental sales would be minimal. If Greenlight Capital – and here I mean the management company that receives the fees, and not the funds themselves – had twice as many computers and conference room tables we wouldn’t earn twice the fees…in fact, they probably wouldn’t increase at all. When the capital doesn’t add to the returns, then ROE doesn’t matter. It follows from this that in non-capital intensive businesses the price-to-book value ratio is irrelevant. The equity of the company in the form of intellectual property, human capital or brand equity is not reflected on the balance sheet. All that matters is how long, sustainable or even improvable the company’s competitive advantage is, whether it is intellectual property, human resources or market position.”

The place to find value in non-capital intensive companies is the earnings power. Think of Microsoft or another software company. The marginal cost associated with growing revenues are minimal, as the core infrastructure (the software) only requires small adjustments and tweaks overtime and costs pennies to duplicate. Each additional customer added or sold to actually costs less overall. Think if you could develop software for $100,000 total and sell each copy for $101 at a cost of $1. Once you achieve the break-even point of 1,000 customers, each additional customer sold to will only cost $1 or a hypothetical 10,000% ROE.

There are two main risks for non-capital intensive businesses, reinvestment risk and risk the competitive advantage will be lost. Do they return cash to shareholders? Do they attempt to diversify their revenue stream? More often than not the capital is squandered by investing in capital-intensive businesses after generating more cash than they know to do with. The blessing becomes the burden.

Let us circle back to Einhorn.

I believe it is very important to analyze ROE and marginal returns on capital…but only in capital intensive businesses. It may surprise you, but I prefer at the right price capital intensive businesses with low ROEs, where I think the ROE will improve, to high-, or at least medium-ROE businesses.

The problem with high ROEs in capital intensive businesses is that it is hard to sustain the ROEs. Here, high returns attract competition both from new entrants that come with new capital and existing competitors that try to see what the better performing competitor is doing to copy it. The new capital and the copycats often succeed in driving down the superior ROEs. Really bad things happen to earnings when a 25% ROE turns into a 10% ROE.

This is why I prefer the low ROEs. Great things happen to earnings when a 10% ROE becomes a 15% ROE.”

ROE can improve three ways: 1) better asset turns, 2) better margins and 3) by adding leverage. This analysis can be performed further in depth with the Dupont method. Now is there really no margin of safety in earnings power? If you and I were to agree to a deal where you lend me money ($X) for 10-years in return for $100, how much would you lend me?

I assume it wouldn’t be $100 or even $90. It would of course depend on the opportunity cost of your $100 during the next 10-years… but is everyone’s opportunity cost the same?

If I were in your situation I wouldn’t take less than $25 representing a 15% discount rate. If you were now to offer me $80 upfront for $100 in 10-years, I would take it and think of this as a margin of safety. Here is why. First the $80 represents a 2.25% discount rate or an ability to borrow at 1% less than the current prime rate. I would then invest the money during the next 10-years and collect the difference depending on the IRR.

Discount Rate Capitalization Factor Cash Flow Net Return Break Even Borrowing
6% 1.79 $143.27 $43.27 $55.84
7% 1.97 $157.37 $57.37 $50.83
8% 2.16 $172.71 $72.71 $46.32
9% 2.37 $189.39 $89.39 $42.24
10% 2.59 $207.50 $107.50 $38.55
11% 2.84 $227.15 $127.15 $35.22
12% 3.11 $248.47 $148.47 $32.20
13% 3.39 $271.57 $171.57 $29.46
14% 3.71 $296.58 $196.58 $26.97
15% 4.05 $323.64 $223.64 $24.72

Depending on my discount rate, for every $0.01 above the breakeven borrowing rate you offer me, I will be adding to my edge or margin of safety. Because the future is uncertain, and hard to predict we demand a higher margin of safety from intrinsic value and likely blend a range of values. I would rather be approximately right instead of precisely wrong.

“Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”

This brings us to the Triple play. What is a triple play? Most baseball fans will understand the sports reference but how does it relate to investing?

There are three ways to earn an investment return.

1) Revenue growth

2) Margin or inventory turn expansion leading to higher net income

3) Multiple expansion

I like to invest in companies that I think are capable of all three to maximize my overall expected return. The point of the post is there is many different ways to build wealth each with its own risks. It is up to the individual investor’s style and personality to determine which strategy (or combination of strategies) he or she pursues.


Warren Buffett on Value & Growth: The Two Approaches Are Joined At The Hip

“Learn from the mistakes of others, you can not live long enough to make them all yourself.” – Eleanor Roosevelt

In the Chairman’s Letter of 1992 from Warren Buffet I found this small excerpt on his view about value, growth and using discounted cash-flow analysis. I felt like the writing must have light shed on it and be shared with others as it resinated with me, as does most of Buffett’s writings and insight. I was not entirely sure how to paraphrase and interpret each paragraph as Warren does an amazing job teaching in a basic manner, so I decided to just share it all!

Warren Buffett:
But how, you will ask, does one decide what’s “attractive”? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

In addition, we think the very term “value investing” is
redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).

Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase.

Similarly, business growth, per se, tells us little about value. It’s true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.

In The Theory of Investment Value, written over 50 years ago, John Burr Williams set forth the equation for value, which we condense here:

The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset. Note that the formula is the same for stocks as for bonds. Even so, there is an important, and difficult to deal with, difference between the two: A bond has a coupon and maturity date that define future cash flows; but in the case of equities, the investment analyst must himself estimate the future “coupons.” Furthermore, the quality of management affects the bond coupon only rarely – chiefly when management is so inept or dishonest that payment of interest is suspended. In contrast, the ability of management can dramatically affect the equity “coupons.”

The investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase – irrespective of whether the business grows or doesn’t, displays volatility or smoothness in its earnings, or carries a high price or low in relation to its current earnings and book value. Moreover, though the value equation has usually shown equities to be cheaper than bonds, that result is not inevitable: When bonds are calculated to be the more attractive investment, they should be bought.

Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite – that is, consistently employ ever-greater amounts of capital at very low rates of return. Unfortunately, the first type of business is very hard to find: Most high-return businesses need relatively little capital. Shareholders of such a business usually will benefit if it pays out most of its earnings in dividends or makes significant stock repurchases.

Though the mathematical calculations required to evaluate equities are not difficult, an analyst – even one who is experienced and intelligent – can easily go wrong in estimating future “coupons.” At Berkshire, we attempt to deal with this problem in two ways. First, we try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we’re not smart enough to predict future cash flows. Incidentally, that shortcoming doesn’t bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he or she avoids big mistakes.

Second, and equally important, we insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we’re not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success.

1992 Chairman’s Letter

A Canadian Media Company Warren Buffett Would Love


It was actually quite ironic when I was recently reading a companies 2012 annual report that came up in a Canadian value oriented screen I went through, (using only TSX issues) eliminating prospects that did not meet the cut. From an original search return of 68 I was able to narrow it down to two companies I found intriguing and worth further research. One of the following companies was Glacier Media (TSE:GVC) an information technology company focused on print & digital media. Now the ironic part was that in the 2012 annual report the president quotes Berkshire Hathaway (“Berkshire will probably purchase more papers in the next few years. We will favour towns and cities with a strong sense of community, comparable to the 26 in which we will soon operate. If a citizenry cares little about its community, it will eventually care little about its newspaper. In a very general way, strong interest in community affairs varies inversely with population size and directly with the number of years a community’s population has been in residence. Therefore, we will focus on small and mid-sized papers in long-established communities.”) and also indicates “Glaciers view aligns with that of Warren Buffett, whose Berkshire Hathaway now counts nearly 270 community media properties in its portfolio.”

“Glacier has two segments: the newspaper and trade information markets and the business and professional information markets. The operations in the newspaper and trade information group include the Western Producer Publications and Farm Business Communications agricultural information group, Business In Vancouver Media Group, the JuneWarren-Nickle’s Energy Group, the Business Information Group, and the Glacier Newspaper Group. Its operations in the business and professional information group include Specialty Technical Publishers, CD-Pharma, Eco Log and a joint venture interest in Fundata. In November 2011, the Company acquired a 50% interest in InfoMine Inc. In November 2011, the Company acquired Canada’s Outdoor Shows Limited. In December 2011, it acquired Postmedia Network Inc.’s community newspapers in British Columbia.” – Thompson Reuters

The company has a great interactive timeline of acquisitions from 1999 in chronological order HERE. 

Some current key valuation metrics I would like to highlight are:

  • P/B = 0.35 or 397M in equity (48.4M is derived from ownership in non-controlling interest)
  • P/S = 0.42
  • Price to Cashflow = 3.17
  • Current Ratio: 1.18
  • Quick Ratio: 1.065
  • P/E = 13x or 7.69% earnings yield
  • Current Market Cap: 140M or 1.56 per share
  •  2012 Gross Margin: 33.03%
  • 2.77x Price to EBITDA
  • 5.12% Dividend Yield or 50% pay-out ratio on 2012 earnings (recently increased 33% from 0.03 semi-annually to 0.02 quarterly)

Madison Venture Corporation owns 33% of Glacier Media, with CEO & president Jonathon J.L Kennedy as a principal. It is always great to find management with “skin in the game” and values aligned with that of shareholders. 

I have attached an Excel file for important financial statement components on a 10-year interval under the following link. Glacier Media

Using earnings intrinsic value where G is equal to 11.3%
V = EPS x (8.5+ (2G)
V= 0.12 x 31.1
IV = $3.72

Discounted Cashflow Model:

Intrinsic Value = (Initial Cashflow x Growth Rate + Initial Cashflow) / (Discount Rate – Growth Rate)
(43,969,000 x 0.043) + 43,969,000 / (15-4)
IV = $4.80

IV = (4.80+3.72)/2
IV = 4.26

“The Company has recognized non-capital tax loss and other deductions of approximately $ nil (2011 – $23.2 million) that can be carried forward and may be used to reduce future year’s net income for tax purposes from the Canadian tax jurisdictions.”

The net interest expense in 2012 was 6.093M (12% of cash-flow or 8.3x) – Liquidity Risk is almost non-existent. On a side note a 100 basis point increase would have approximately 1.3M impact on pre-tax net income.

I would assume two major reasons for the depressed share value over the recent years would be first the subsequent event brought forth by CRA (Canadian Revenue Agency) in regards to non-capital losses of an affiliate (line 31 of annual report) as well as industry headwinds (declining print/ad revenue) and the entrance/expansion of multiple digital media companies in recent years. Cash-flow, retained earnings and sales have all been growing since the recession, led by M&A activity and organic growth. The industry as a whole is littered with value opportunities as newspaper distribution is having extinction priced in, an outcome small communities and larger media players will not allow, even if that means expanding and focusing on digital distribution in the future years.

Goodwill of small community newspapers surpasses that of large urban areas as loyalty, trust, heritage and character have been built up over time, the longer the community has existed, the stronger the goodwill of the community newspaper. If you have ever lived in a small town or read a small community newspaper you will understand the concept.

As management actively pays down debt (23.6M in 2012), continues to pay a dividend, and eventually a large share buyback will be authorized if price continues to decline as cash-flow grows. In 2015 long-term debt of 103.31M will be coming due (or 77%) further freeing up cash-flow servicing interest and debt.

YEAR Diluted EPS Retained Earnings (in Millions) Long-Term Debt Cashflow Goodwill/Intangible Assets Sales
2002 0.01 -0.03 6.66 4.5 35.16 27.39
2003 0.11 2.42 3.04 5.86 48.45 28.89
2004 0.09 4.63 17.79 6.45 54.52 41.24
2005 0.16 9.96 16.34 10.01 99.44 62.57
2006 0.18 22.93 128.36 27.42 352.01 186.17
2007 0.33 53.51 110.72 38.55 359.43 216.4
2008 0.3 81.78 109.84 38.09 392.2 249.09
2009 0.15 95.71 93.69 28.44 386.28 229.13
2010 0.15 118.06 85.63 36.15 363.26 242.6
2011 0.29 132.85 129.27 42.24 373.35 267.39
2012 0.12 140.76 118.11 43.97 395.79 330.02
10-Year Avg. YOY % Change 113.1051028 874.8389217 111.2736197 33.15249962 39.92554918 36.03360983
5-Year Avg. YOY % Change -4.875653083 22.33963096 3.645902473 4.304766514 2.087288505 9.322611601
10-Year Total Growth % 1100 5716.528926 1673.423423 877.1111111 1025.682594 1104.892296
YOY % Change Diluted EPS Retained Earnings Long-Term Debt Cashflow Goodwill/Intangible Assets Sales
2002-2003 1000 8166.666667 -54.35435435 30.22222222 37.79863481 5.47645126
2003-2004 -18.18181818 91.32231405 485.1973684 10.06825939 12.52837977 42.74835583
2004-2005 77.77777778 115.1187905 -8.150646431 55.19379845 82.39178283 51.72162949
2005-2006 12.5 130.2208835 685.5569155 173.9260739 253.9923572 197.5387566
2006-2007 83.33333333 133.3624073 -13.74259894 40.59080963 2.107894662 16.23784713
2007-2008 -9.090909091 52.8312465 -0.794797688 -1.193255512 9.117213366 15.10628466
2008-2009 -50 17.03350452 -14.70320466 -25.33473353 -1.509433962 -8.013167931
2009-2010 0 23.35179187 -8.60283915 27.10970464 -5.959407684 5.878758783
2010-2011 93.33333333 12.52752838 50.96344739 16.84647303 2.777624842 10.21846661
2011-2012 -58.62068966 5.954083553 -8.633093525 4.095643939 6.010445962 23.42271588

2012 Annual Report

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


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


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 

6 Quotes from Warren Buffett: 1982 Berkshire Hathaway Shareholder Letter

WarrenThe first quote and simplest to understand pertaining to business management and the decisions that are made that are not beneficial to the acquiring shareholders is the following: “Managers and directors might sharpen their thinking by asking themselves if they would sell 100% of their business on the same basis they are being asked to sell part of it.  And if it isn’t smart to sell all on such a basis, they should ask themselves why it is smart to sell a portion.” But we constantly see dilutive equity offerings executed for the sole purpose of acquiring a less attractive (not at the time) business at the expense of the shareholders. As Warren explains in the letter he would never offer part of his ownership stake for less than intrinsic value. Ask yourself does it make sense to sell $1 for 0.50 cents ?

“Don’t ask the barber whether you need a haircut.”  Making sure interests align is key, being aware of the biases that are produced by so many of us constantly is essential in navigating the world of individualistic societies, where everyone is trying to get one step further ahead at the expense of a fellow human.

“The thrill of the chase blinded the pursuers to the consequences of the catch.” As seen to often by dilutive, value destroying management, in it for a bigger bonus or a larger slice of gluttony pie. Management is a key component of any business and it is best to make sure their interest align with yours (maximizing shareholder value not employee compensation)

Acquiring a business or a portion of the ownership is very exciting especially when bargains are littered in a non-effiecient market, produced by more often than not, buyers forced to sell at an unpleasant time due to urgency, liquidity, or usually the case, leverage and can be had by any individual willing to pay the requested price at the time sought. “Fractional-interest purchases can be made in an auction market where prices are set by participants with behaviour patterns that sometimes resemble those of an army of manic-depressive lemmings.” For clearer clarification of the quote please see the definition of a lemming below.
1) “any of various small, mouselike rodents of the genera (Lemmus,Myopus,  and Dicrostonyx,)  of far northern regions, (as L. lemmus,  ofNorway, Sweden, etc.,) noted for periodic mass migrations thatsometimes result in mass drownings.” – 

A very humorous analogy of goals, business benchmarking, business performance and management execution can be summed up in the following quote from Warren. “Just shoot the arrow of business performance into a blank canvas and then carefully draw the bullseye around the implanted arrow.” As we see too often today obscure comparisons and fictional benchmark standards are implemented just in time, as the drum of the old benchmark beats a loud thump of failure and is swept under the rug. It is casually replaced by a “new” “better” and “more accurate” benchmark, only to be changed again at the first sign of defeat.

The last quote is in regards to valuation of a business using accounting statements and how investors and management often put to much focus and labor into the analysis of these numbers, which more often than not, are implemented in a questionable (liberal) manner. “It’s simply to say that managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.”

1982 Berkshire Hathaway Annual Shareholder Letter (HERE)