Gamehost: Operator of 3 “Local Monopoly” Type Casinos in Alberta, Canada – Spending the Minimum on Cap-Ex and Paying the Maximum in Dividends
Today’s initial interest write-up is a lot like yesterday’s. Yesterday, I wrote about an Alberta based company paying out roughly 100% of its free cash flow as dividends. In fact, that company was paying almost nothing in cap-ex. Today’s company is doing the same. It pays almost everything out in dividends. And it doesn’t spend much on cap-ex. So, cash flow from operations translates pretty cleanly into dividends. And like yesterday’s stock being written up (Vitreous Glass) – today’s stock being written-up (Gamehost) probably attracts a lot of investors with its high dividend yield. As I write this, Gamehost’s dividend yield is a bit over 8%. Like the dividend yield on Vitreous Glass – that sounds high. But, you need to be careful. If a stock is paying almost all of its free cash flow – and, in fact, almost all of its cash flow from operations in this case – out as a dividend, then you might need a much higher dividend yield than you’d think. There are three reasons for this. One, if the company pays everything out in dividends then it’s obviously not paying down debt or buying back stock or piling up cash. So, the free cash flow yield is no higher than the dividend yield. A dividend yield of 8% sounds amazing. But, a stock trading at 12.5 times free cash flow (for an 8% free cash flow yield) isn’t unheard of. It’s still cheap. But, you need to do some research to make sure there aren’t good reasons for it being that cheap. Two, the dividend coverage ratio is obviously 1 to 1 on a stock that has a dividend payout ratio of roughly 100%. A stock paying out just one-third of its earnings as dividends can see its earnings drop by 65% and still cover the dividend from that year’s earnings. Any decrease in the earnings of a stock with a 100% payout ratio would threaten the dividend. Three, it’s usually hard for a company to grow it sales, earnings, free cash flow, etc. over time if it retains literally no earnings in any period. For some companies, it’s not impossible. But, for a stock like Gamehost – which does have a fair amount of tangible assets – it’s impossible to organically grow those things aside from just capacity utilization increases. Luckily, Gamehost’s properties are currently operating far below capacity. When I describe what these properties are and – most importantly – WHERE they are, you’ll see why.
Gamehost’s EBITDA and other measures of earning power peaked about 5 years ago. The company operates both hotels and casinos in Alberta. It also provides food and beverage services in those hotels and casinos. The company claims to have 3 segments – casinos, hotels, and food and beverage. It also owns a strip mall. However, the only real source of profit we’ll be talking about here is the first segment: casinos. The other segments don’t lose money. They make a slight profit. And they do deliver some returns on an EBITDA basis. However, the primary economic purpose of the hotels is to provide a captive source of traffic for the casinos. The food and beverage business is more of a necessary evil than a profit source. For the most part, Gamehost does not even provide the food service itself. Gamehost outsources the preparation of food and keeps the liquor business. The liquor business at hotels and casinos is a higher margin business than actual food anyway. Actual gaming revenue is a very high margin source of profit. If you look at what segments use what assets and what segments produce what EBITDA at Gamehost – I think it’s easier just to discard everything other than gaming and treat them as somewhat better than break-even businesses that support the core profits from gaming.
Gamehost operates 3 casinos. All are in the Canadian province of Alberta. One is the Boomtown Casino in Fort McMurray. Another is the Great Northern Casino in Grand Prairie. The third is the Deerfoot Casino in Calgary. Gamehost only owns 91% of the Deerfoot casino. It owns 100% of the Boomtown and Great Northern casinos. The size and competitive positions of these casinos is a little different too. Calgary is a big city. The Deerfoot casino is not a destination casino like you might see in Las Vegas, Macau, etc. We’re not even talking what you’d see in Atlantic City. However, the descriptions of that casino’s property, the reviews I read, etc. suggest that if any of these casinos are in a more competitive market, if any of them are better upkept, etc. it’d be the Deerfoot in Calgary. The other two casinos are local to the point of being monopolies. Calgary is a city of 1.3 million people. With the exception of the Great Depression, the city has seen pretty much constant growth for the last 120 years. It’s a stable, growing major city. It has a diversified economy. Meanwhile, Fort McMurray has a population of just 65,000 people. The city’s population growth has historically been very, very uneven. It goes through a boom and bust cycle of bringing in outsiders and then losing population to the outside world. Almost no one lived there 70 years ago. The population surged throughout much of the last half century or so. However, it showed at least two major population declines. These look to me as if they coincide with the two major oil price collapses of the last few decades. The city’s economy is not diversified like Calgary, It’s dependent on oil sands, pipelines, etc. It is more cyclical. It also has far fewer gambling venues. In fact, Gamehost’s SEDAR (like EDGAR, but for Canadian companies instead of U.S. companies) filing specifically says both that “Boomtown Casino in Fort McMurray operates without any gaming-related competition in the trading area” and that “gaming demand is well served by the company’s current capacity.” Reading between the lines, Gamehost is telling us: 1) Boomtown casino is a monopoly and 2) The Boomtown casino has excess capacity. This makes sense if I divide certain population figures of the number of people who could realistically visit the Boomtown casino and compare them to the number of casinos in Fort McMurray (one), the number of slots, table games, square footage of the venue, etc. This is a local casino that can handle all the demand in town.
The Great Northern is in Grande Prairie. Gamehost says this about competition there: “The Great Northern Casino is Grand Prairie is the only full-service casino in the city.” This means there is some other kind of gaming choice in the city. I don’t know what it is. The population of Grand Prairie is about the same (63,000) as the population of Fort McMurray. I don’t know enough about Grand Prairie to know if it is as dependent on oil as Fort McMurray. However, I can see that the major industries in both cities are much the same (oil, forestry, tourism, etc.). They are also both likely to be the kind of places where a casino would serve the local population well and operate as a monopoly.
Reviews of the Great Northern casino in Grand Prairie and the Boomtown casino in Fort McMurray are consistent with what I expected after reading about those cities, looking at the financial statements of Gamehost, etc. These seem to be local monopolies that do not spend on cap-ex. Reviews are very middle of the road. And complaints are about a lack of capital spending to keep the casinos looking up to date, poor food service (which is outsourced and not a profit center) as compared to liquor sales (which aren’t outsourced and do contribute to profits), etc. I’ve read reviews of small casinos that operate as local monopolies in various smaller and more remote U.S. cities – and the reviews I see of Gamehost’s casinos look very, very similar to reviews of those kind of establishments. I suspect that – since oil prices declined years ago – these casinos do operate at well below capacity, they don’t spend as much on cap-ex as larger casinos in more competitive markets would, and they put a very low priority on food. Reviews also indicate that guests of the hotels do frequent the casinos. This would be consistent with synergies between owning the hotels and casinos being mainly about providing a consistent traffic source to the casinos rather than capturing additional revenue from people who’d be staying in the area to visit the casinos anyway. In other words, this is probably a reverse “Disney World” situation here. Disney added more hotel capacity within its parks after decades where it would attract people to the area from all around the world and then lose out on most of the hotel revenue to companies that built hotels just outside the park. Here, it seems much more likely that people would be staying in Fort McMurray and Grand Prairie regardless of whether or not the casinos were there. But, putting hotels and casinos next to each other (or literally together in one place) increases the revenue the company can capture versus what an operator of just a hotel would make. Again, I don’t think these casinos are destinations people seek out. I think they are local gambling monopolies.
This brings us to regulation. I’m obviously not knowledgeable about this situation. I’m an American. I don’t know Canadian politics generally or Alberta politics specifically. I can only go on what Gamehost itself says. There are a couple hopeful bits of information the company gives here. There’s also two risks. The two risks are much the same risks faced by U.S. casinos. One, there are sometimes more favorable terms given to First Nations (descendants of people who lived in Canada prior to the arrival of Europeans). Two, governments can unilaterally set the revenue share for gambling. In theory, this means governments can simply raise more revenue by lowering the amount existing casinos get to keep and increasing the amount that goes to the government. Since existing casinos are very profitable on a cash return on incremental tangible investment basis – this kind of move would be unlikely to reduce total gambling much. Yes, it would reduce the likelihood of for-profit companies wanting to build totally new locations. But, once the location exists – it’d be in the government’s interest to shift more and more of the profits from gambling away from casino operators and towards governments. This is a risk. But, it’s a similar risk to the U.S. Canada is not generally a country that worries me in terms of legislative risk of governments shifting profits like this. It can happen. But, the reverse can happen too. It’s like the risk – more generally – of a country greatly increasing corporate tax rates. It’s just something we investors have to live with.
I’m not sure either of these risks are big right now. If one is big – it’d probably be the risk that a government trying to balance its budget in hard economic times might try to raise more money through shifting agreements on gambling to favor the government more. The First Nations risk does not seem big here, because this hasn’t been a growing market for a long time.
Gamehost says that Alberta has not granted any additional gambling licenses since 2008. It also says that Alberta has not revoked the license of an existing operator. Once granted, the license has stayed in place. If both of these things were to stay true in the future – Alberta never again issues another license for a casino and it never revokes the license of an existing casino operator – this would be a very, very good form of regulatory protection. It’d be similar to the history of local TV station licenses in the U.S. While those are theoretically risky because they have to be renewed, there are some requirements on the station owner, the government could theoretically grant a lot more licenses etc. – in reality, they act as a high barrier to entry that helps create monopolies, duopolies, and oligopolies and keeps returns for anyone granted a license higher than they would be in an unregulated market. So, I don’t want to ignore regulatory risk here. But, the truth is that a regulated local casino monopoly is probably one of the safer kinds of business out there in terms of avoiding competition.
I can’t evaluate the competitive situation of the Calgary casino (Deerfoot) as well as the casinos in Fort McMurray and Grand Prairie. The company claims that the casinos in Calgary are far enough away from each other so that there is limited true competition between them. However, the distances given between the casinos seems close enough to me to suggest the Calgary casino market could be a lot more competitive than the markets in Fort McMurray and Grand Prairie.
All the write-ups of this stock focus on the cyclicality of the economy of Alberta generally and oil sands specifically. I can’t bet one way or the other on that. Obviously, I’d rather – other things equal – buy a stock with an 8% free cash flow yield in a bad economic year than one with an 8% free cash flow yield in a good economic year.
Return on tangible capital here is quite good. It looks to me like recent free cash flow can get as high as 25% of the tangible capital invested in the business. This probably overstates returns on these casinos over their entire lifetimes. However, a shareholder buying into the stock today is not responsible for building the casinos in the first place. If you buy a toll bridge a decade after it’s built, the original cost of the toll bridge doesn’t matter. It’s just the very low future cap-ex and the rate at which you can raise tolls that matters. The situation is the same here. And, in fact, if there is any increase in the traffic to these casinos due to an improving economy – this would be a very high return form of growth. Management does mention asking for approval to make some changes to these casinos to update them, expand them (it doesn’t sound like much of an expansion), etc. So, cap-ex could certainly be higher in the future than in the past. But, even growth driven by cap-ex would probably be pretty high return. The risky and expensive part is planning, getting approval, opening, and marketing the casino to the local population initially. Once a casino is long-established, my main concern would just be what’s the chance another casino is opened nearby. Here, the chance of that happening seems lower than at most casinos.
Debt here isn’t very high. But, it’s not nothing. Compared to “peers” – and I’m not sure there really are many peers with as few, as local, as old, as remote, etc. casinos as this company operates – the stock looks cheap. It might be attractive to a private buyer. It definitely seems much, much safer than most casino stocks I’ve looked at. Risk of new competition seems lower. Risk the area is presently in a boom seems to be completely nil. And risk of debt is extremely minimal compared to the debt loads carried by most casino operators. The stock’s price seems very reasonable versus other casino operators. If I had to buy a casino operator, I’d definitely consider Gamehost.
But, without betting on a recovery in the Alberta economy – I’m not sure it’s cheap enough to guarantee market beating returns. You might not really do much better than just collecting the 8% or so dividend yield. Multiple expansion from say 12 times to 15 times earnings (free cash flow, etc.) might provide another 2% a year in returns over as long as 10 years. If growth due to a recovery in the local economy could provide let’s say 2-5% type annual returns over as long as 10 years, this would make a good long-term investment. The company could also increase its debt load if it did ever want to acquire anything.
Management’s incentives are generally good. Two people – Darcy and David Will (I assume they are son and father) – own a lot of stock. There are related party transactions. For example, “the Wills” are entitled to sort of management fee type deals that give them additional revenue / profit share off the top at some casinos. Even these incentives mostly align with what would benefit shareholders too. It’s just an additional way of extracting more value for management. But, I didn’t see examples of stuff where management would make a lot of money without at least indirectly causing minority shareholders also to do well. I don’t really have an opinion one way or the other about most of what I read about management’s ownership stake, incentives, side deals, etc. I’d definitely consider this a controlled company. It’s pretty much founder led. I’ve seen casino stocks run by professional managers who owned a lot less stock and extracted at least as much value as this. So, nothing in the little bit I’ve read so far seems egregious. But, my initial attitude on management is just neutral – not necessarily positive.
I’d be a lot more interested in Gamehost stock if it was about 30% cheaper (for a free cash flow yield of closer to 12% than 8%), or if I was very sure of an eventual recovery in the economies of cities that depend on the oil industry.
Right now, I don’t think I like Gamehost as much as I like Vitreous Glass. But, I do think I like it more than a lot of casino stocks I’ve seen.
Geoff’s Initial Interest: 60%