|Shares Out. (in M):||32||P/E||0||0|
|Market Cap (in $M):||32||P/FCF||0||0|
|Net Debt (in $M):||29||EBIT||0||0|
Dover Downs Entertainment (DDE):
We are providing a short write-up on DDE due to this being a timely opportunity for personal accounts and smaller funds to participate in a unique situation that we believe has meaningful near term upside. Given this is small and not appropriate for many funds, we will not count this towards our annual idea requirement.
· Company trades at <5x FCF and 27% of tangible book value
· Chairman who controls the company has been buying shares
· Potential government tax relief in the next 6 months
· Big seller that has weighed on the stock may be nearly cleaned up
· If the Chairman isn’t continuing to buy, we likely have a new institutional holder taking a position
Quick Business Summary: DDE owns and operates Dover Downs Hotel and Casino in Dover, DE. The casino is 165,000 square feet of the popular table games such as blackjack, roulette, craps, etc and a large floor of slots. The hotel is a 500-room AAA Four Diamond hotel with a full service spa/salon, conference rooms, banquet rooms, ballrooms, and concert hall. In addition, it also operates Dover Downs Raceway, which is a harness racing track with pari-mutuel betting on live and simulcast horse races.
Back in its heyday, Dover Downs was a highly sought out destination for gamblers living throughout Delaware, Maryland and Pennsylvania. Over the last few years, the Northeast has become littered with casinos, and new casino builds in the Baltimore and Philadelphia areas in particular have lured away customers from Dover leading to revenue declines since 2011. Recent casino failures in Atlantic City highlight how tough this industry is, and the Yelp reviews are very mixed. Despite these troubles with the business, we believe this is an attractive security as discussed below.
Cheap Valuation: The company doesn’t produce a GAAP profit due to the material D&A associated with historical PP&E spend. It does however, continue to throw off meaningful cash flow. Looking at the cash flow statement, if you back out all of the net working capital changes, which fluctuate each year, the company produced $8.8M of cash flow from operations in 2014, and $10M in 2013. Cash flows have been in decline since ’07, so one could argue this may be a value trap. We believe the current price of the equity more than factors in this decline though, and as discussed below we think it could stabilize if the government provides relief.
Capex in 2014 came in at $900K, which was light compared to the last three years of $1.5-$2.5M. We will use $2M as a more normalized number (management also noted in the Q4 call this is more appropriate as they have been underspending to pay down debt). Longer term this may need to go up to renovate the property (the property last underwent serious renovation back in the 2006/07 timeframe and is becoming outdated). Using the normalized capex, the company produced $6.8M of FCF in 2014 and $8M in 2013 on a market cap of $30M.
As discussed above, revenues are coming down as a result of increased competition, and will likely continue to put pressure on FCF. However, we think there is a reasonable likelihood of the legislature pushing through some relief (discussed more below) which will decrease expenses and stabilize FCF. We recognize this is a shrinking business, not a growing one, but it has become too cheap, even for a declining business. Additionally, we take some solace in knowing the depreciated net tangible asset value is $112M, implying the company is trading at a P/B of 0.27x (with gross PP&E asset value of $276M, which includes some land that we believe was likely purchased in the late 60s, implying replacement cost far above and beyond TBV). The only reason replacement cost matters is when thinking of DDE as an acquisition candidate. A competitor could buy them and renovate it for substantially less than it would take to build a new casino. To summarize, it’s not often these days we find a company trading at 27% of book that is generating positive FCF, especially FCF that represents 20%+ of the market cap.
The priority of the management team is to use cash flow to pay down debt. Currently the company has $39M of revolver debt that it has been paying down aggressively. The revolver limit decreases from $50M as of 12/31/14 to $47.5M as of 6/30/15, still providing ample liquidity for the company when also considering the $10M cash it has on hand. The company paid off over $8M in debt in 2014 and has paid off ~$70M since 2009. We expect future cash flow to continue to be used to reduce debt, which should remove investment risk for equity owners.
Chairman is Buying: Henry Tippie is the chairman of Dover Downs Entertainment and Dover Downs Motorsports (DDE was spun off of DVD in 2002) and controls both companies through his 65.6% ownership of DDE Class A stock and 62.1% ownership of the DVD Class A stock, both of which get 10 votes for every 1 vote of the common. He filed a Form 4 on 2/4/15 noting he bought 129,219 shares of DDE common over the preceding 3 trading days. Additionally, on 2/5, there were 674K shares traded vs. a 3 month ADV of 70K. Someone is taking a position.
We will not know for a few more days (until he would be required to file a Form 4) if Tippie was the one buying big on 2/5, but we do believe it was likely the same seller (discussed below). Regardless of whether it was him on 2/5, the stock has become cheap enough that Tippie is deciding to begin buying in the open market almost immediately after the earnings blackout period, which likely expired shortly after the earnings release on 1/29. We can speculate that he potentially wants to roll DDE back into DVD or take DDE private. But it appears that he already has the voting control to make that happen. As such, we conclude he must think the stock is cheap and wants to increase his economic interest, which gives us some comfort on the future outlook for the company.
Tax Relief Likely: The state of Delaware relies on DDE for its gaming revenues as a material portion of its budget. Gaming revenues in the state are down as a result of competition, and the government officials are feeling the pinch. However, as described in this article (http://www.delawareonline.com/story/news/local/2014/11/22/dover-downs-delaware-casinos-struggle/19395797/?from=global&sessionKey=&autologin), it would be a much worse scenario for the local economy/gov’t to not develop a way for the casinos to stay in business and reinvest in their properties. Government officials have come to the drawing board on an annual basis over the last few years to provide some relief, but legislators and casinos are both now calling for a longer term solution. We are guessing that part of the relief leads to subsidies to support capital improvements, which would allow DDE to invest in its property and stabilize deteriorating revenues. In the end, we believe there is very little risk the government would put them out of business because it relies on its revenues.
Big Seller Likely Close to Cleaned Up: Gates Capital Management is the 2nd largest institutional holder of the stock as reported in a year end 13-G. According to its filings, Gates owned roughly 2.8M shares in 2011 and has gradually been selling its position over the last 3.5 years. For a stock that typically has traded 30-60K shares per day, this has provided tremendous selling pressure on the shares, particularly over the last year as the company exited nearly 1M shares in 2014. As of 12/31/14, Gates reported 940K shares remaining on its books. Just for reference, Gates runs over $3B, so a $1M position is not even a rounding error. Given that Gates has been exiting its position and it is such an immaterial position for the company, we have reason to believe Gates will continue to fully exit.
Looking at the top holders list, Down River Capital Management, a micro cap special situation fund in Spokane, WA, is the current largest institutional holder. While Down River is not big enough to be regulated by the SEC, it triggered the 13G filing requirement in Q4, likely meaning Down River is adding shares not selling them. The remaining top holders include Vanguard, DFA, Blackrock, Renaissance, etc. which we doubt are exiting material blocks of stock at one time (as these are either index / mutual fund / or quant strategies that seem to own almost every stock in the market).
Over the past 5 trading days, over 1M shares of DDE have traded. Based on the filings, we don’t see anyone else trying to blow out of their stock the way Gates is, and therefore we believe it is likely Gates is on the selling side of many of these trades. If this thesis is true, Gates likely has 200-400K more shares to be cleaned up. With the selling pressure of Gates removed, and a new large holder in Down River, we believe the stock could rise materially over the next 3-6 months.
Conclusion: DDE is a very cheap stock on an asset and cash flow basis that has seen recent insider buying by the Chairman and controlling shareholder. The removal of the overhang coming from cleaning up a large institutional seller should allow the stock to trade back up to a reasonable value based on its fundamentals.
Disclosure: The author and his clients are long DDE and may trade in and out of their positions at any point in time.