|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||467||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
Gateway Casinos Income Fund (GCI-UN)
As Steve Wynn likes to say, the only way to make money in a casino is to own one, and Gateway Casinos Income Fund (GCI) offers an unusually good risk/reward profile for doing so. GCI is a Canadian unit trust that operates seven casinos in what are essentially oligopoly markets in British Columbia (BC) and
Why Is GCI Attractive?
Ø Classic Greenwaldian Competitive Advantage - Gov. License: There are currently only 18 gaming licenses in BC and a moratorium on new licenses has been in effect in since 2002 (the majority of GCI’s revenues are earned in BC), and new gaming license issuances in Alberta, the other Canadian provice that GCI operates in, are very hard to get. GCI’s also benefits from exceptional locations in the
Ø Growth W/in the Franchise For Free: With a CA$1.43 / share annual distribution and a 9.5% WACC, the current price of CA$15.00 implies essentially 0% growth for GCI. But:
o The fund has in fact grown distributable cash per share at a CAGR of 4.6% since the IPO in 2002.
o Recent acquisition of Cascades casino offers upside—it was accretive by about 3.7% per share but there is significant upside to the acquisition price EBITDA level .
o Burnaby expansion –Target opening of expanded property in the Spring of 2008, will double the casino’s current number of table games and increase its number of slot machines by 47%.
o BC demographics- BC has the highest rate of inter-provincial migration and its population is getting older (retirees like to gamble).
o BC is undergamed - BC per capital annual gaming spending is CA$427.50 with Canadian average at CA$516.80.
Ø Significant Inside Ownership & Good Management: Approximately 32% of GCI is owned by insiders, and management is sound and financially conservative.
Ø FCF yield: GCI is trading at a free cash flow yield of about 9.8% (including FDF reimbursements) or CA$1.46 per share.
Ø Cap Ex Reimbursement From The British Columbia Lottery Corporation (BCLC): Contributes to exceptional returns on equity.
Ø Paid To Wait: The 9.5% distribution yield (Note: 15% of distribution can be withheld for non-Canadian investors) lets you get paid while you wait for GCI to grow and investors to bid down the yield as they become more comfortable with the story. It’s also a good way to be short the U.S. dollar via a business w/ revenue and expenses in a stable Canadian economy benefiting from higher commodity prices.
Ø A Business I Would Like To Own In Its Entirety: Simple business and great margins, significant barriers to entry, growing market, good management team, strong cash flow production, and not capital intensive (due partially to FDF reimbursement, see below). I can’t predict the future, but I know that over the long haul things are more likely to go right than wrong for this business.
Why Is This Stock Overlooked?
Ø The Canadian business unit trust is essentially a retail investor product, especially for the smaller caps. These investors are totally focused on yield and not particularly interested in fundamental analysis or really drilling into these businesses to distinguish them from the 250+ trusts out there. Since GCI’s debt level will increase temporarily over the next two years, the perception is that this makes the stock and the yield more “risky.” A thorough analysis indicates otherwise.
Ø There is also concern about too much competition in BC, but again, a thorough analysis indicates that there is ample demand for GCI’s properties into the foreseeable future and that the business benefits from some significant barriers to competition.
Ø Macro issues – there was talk in late 2005 of changing the tax treatment of unit trusts, and most of them traded down. There will be no tax change over at least the next few years, but many stocks never recovered from this threat. Also since the unit trust is an income-oriented product, all of them are susceptible to market gyrations over interest rates, and GCI has suffered from this to some extent as well.
-Burnaby Casino in Greater
-Cascades Casino in
-Four Lake City Casinos in
-Palace Casino in
The company breaks out P&L for each property in its filings on Sedar, I won’t waste your time here repeating it.
Some additional detail on the key assets:
In April 2006, GCI purchased the Cascades Casino in
Gateway Casino Inc. (GC Inc.) & Inside Ownership
GC Inc. has managed casinos in BC since 1992. All the casinos that GCI operates were originally developed by GC Inc. At the time of the IPO, management opted to leave under-development properties at GC Inc. Once such properties matured and achieved stable cash flow generation, they could be acquired by GCI (GCI holds right-of-first-offer). The Chairman and the CEO of GCI are also directors of GC Inc. In addition, 3 other directors of GC Inc. are Trustees of GCI. As a condition to obtain the approval of BCLC for a secondary offering in Sep/2004, the GC Inc. shareholders have agreed that their collective ownership of GCI cannot go below 20%. Management and Trustees currently own 2.3% and 14.9% of GCI, respectively. GC Inc. is currently developing two properties that can be vended in: Queensborough Casino in
GCI essentially controls casino gambling in the BC interior, while Great Canadian Gaming (GCD), a public company that operates 7 casinos in BC, is the only casino operator on
The recently completed River Rock is the crown jewel of GCD’s properties. The resort portion of the hotel was fully opened during Q3 05 (casino floor opened in 2004). It is part of the next generation of BC casinos (larger, destination-style) and the main competitor of GCI’s Burnaby Casino. However, since the opening of the casino, both River Rock and
GCI currently derives about 83% of its revenues in BC (57% in the
The BCLC determines which games and products are available, the rules of play and operating standards and the payouts. GCI provides the facilities, furniture, labor, security, marketing and administration required to keep the casino running smoothly. In exchange, it receives a fixed percentage of the win (amount wagered less pay out to customers):
25% of slot win
40% of table games win
70% of win on craps up to CA$240,000 per quarter and 40% thereafter
75% of the “rake” (3-5% poker table charge for providing a dealer)
Cap Ex Reimbursement
Under the terms of the COSAs, the BCLC deposits a facility development fee (FDF), equal to 3% of the total revenue generated from the table games and slot machines at each BC casino into a trust account managed by the casino operator. These funds are used to reimburse GCI for eligible capital expenditures. When GCI incurs an eligible expenditure, it can draw the amount of the expenditure from the FDF. Any funds not reimbursed accumulate in the facility development fund for future eligible expenditures. In general, all capital expenditures to develop or improve a casino are eligible for reimbursement (e.g. building, leasehold improvements, cash and coin equipment, and leases for premises net of interest). For example, GCI will be reimbursed via the FDF for its major expansion of the
No New Licenses
In January 2002, the BC government announced a moratorium on new casino licenses and restricted relocation of existing licenses only to those casinos that had already taken significant steps and made investments based upon direction from government. Thus, the only way to get access to the gaming market in BC is to buy existing operations subject to a rigorous license approval process by the BCLC. It is possible that this moratorium could be lifted in the future, but the need to obtain community support for new locations makes expanding existing licensee properties a more desirable route for increasing the BCLC’s revenue. Further, since the BCLC provides the slot machines and other gaming equipment used in any licensed casino, it must consider ROI for each license it grants. It is economically preferable for the BCLC to invest in proven existing locations with high traffic levels and proven operators by licensing expansion (ex., adding 200 slot machines, expanding gaming floor) instead of taking the risk of outfitting new, possibly less desirable locations/facilities that may suffer from low attendance. This is demonstrated by the trend towards expanding existing casinos into miniature destination-style casinos (ex.,
There are several ways to think about valuation for GCI, all of converge on a value of CA$20.00+.
First, given that business unit trusts were designed to be stable cash-flow businesses that distribute all of the cash they generate to income-oriented investors, it is useful to think about the stock in terms of the Gordon Growth Model. GCI’s current annualized distribution per share is CA$1.43 (excluding annual top-off payments which have in fact been made each year since 2002). GCI has grown the distribution at a CAGR of about 4.6% since the IPO, and given the expansion of the Burnaby facility, the potential accretion from Cascades, limited competition in an “undergamed” BC, and a Canadian economy growing at 2.5% a year (average annual GDP growth rates are 2.83% and 2.97% over the 1986–2005 and 1976–2005 periods respectively), it seems reasonable to assume a perpetual distribution growth rate of say 2.0%. Assuming a cost of capital of 9.5%, this produces a value of about CA$20.00 per share.
Second, GCI at its current price compares favorably to public comps. GCI is currently trading at about 9.7x 2007 proforma EBITDA (includes Cascades acquisition but does not include increased revenue and debt from
Third, given the steadiness of the GCI business and the relatively predictable nature of its distributable cash, a 5-year DCF is also a useful approach to valuation here. Assuming a discount rate range of 8.5 - 9.5%, Revenue CAGR of 11%, EBITDA margins that erode slightly into the 38% range, and a terminal value calculated using a 2% perpetual growth rate (terminal value accounts for approximately 75% of the NPV), GCI shares are worth CA$20.00 - CA$23.00.
Finally, perhaps the most practical consideration in terms of GCI’s share price appreciation potential is the distribution yield, as this is how most Canadian investors think about these stocks. Since the IPO, GCI average yield has been about 8.6% (7.7%, since Jan-04) and it currently trades at about a 10% distribution yield. Assuming some of the concerns about GCI that have been holding the stock at this yield (see Bear Case) fade over time as the company continues to deliver solid distribution growth but that rising interest rates still prop up the yield somewhat, it is reasonable to assume GCI settles into say an 8.5% trading value over the next two years. Assuming that the distribution grows only at its historical rate of about 4.6% (this rate was purely organic other than an increase in the number of slot machines at Burnaby from 300 to 679 in 1Q05), GCI would trade at about CA$18.46 in two years. This would equate to a total return (distributions plus unit appreciation) of about 44% at the current stock price of CA$15.00 (20% per year). Also, GCI is currently distributing only about 92% of its distributable cash—management expects to increase this rate over the next few years as it completes the
Some potential negatives on GCI are as follows:
Competition/Demand – Three new casinos opened in BC in 2005: River Rock, Cascades, and Edgewater. Some have been skeptical of the area’s ability to absorb this much gaming, and this has weighed on the stock. But the fact is that revenue has continued to grow steadily at GCI’s BC properties despite these additions and a thorough review of the market shows that there is ample demand for gambling among BC’s growing population. The BCLC could end the moratorium at some point in the future and increase its share of it revenue splits with operators after their agreements expire. This is certainly a risk, but BCLC has a strong economic incentive to ensure the success of existing operators by not making dramatic changes in the supply of gaming venues going forward, and changing the splits would surely damage the BCLC’s reputation and diminish interest among operators in working with the BCLC in the future. A change in the splits would also be unprecedented—no Canadian province has ever done it.
Cascades Vend-In – The recent purchase of the Cascades casino from GCI Inc. passed the shareholder vote by a very narrow margin. The opposition viewed the purchase price multiple as too high, and there was a suggestion of insider dealing, given the relationship between GCI and GCI Inc. (see above). Some investors may have bailed out of the stock after this, putting pressure on the stock price. But the acquisition was accretive at an EBITDA level that is probably significantly below where it will be in the next two years, and it was a competitive auction process.