RUSH IN ROULETTE

Is it time to risk a shot at casino shares?

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In­vestors not afraid of bet­ting when the odds seem stacked against them might be tempted to have a flut­ter on the lo­cal gam­ing sec­tor. In par­tic­u­lar, they may want to look at the two large casino com­pa­nies that have lately en­dured some se­ri­ous shareprice pres­sure.

The share price of Tsogo Sun, SA’s largest casino group, has drifted down 28% since peak­ing at a R31 high in Au­gust last year. Sun In­ter­na­tional, which is car­ry­ing a heavy debt load af­ter re­vamp­ing its lo­cal casino port­fo­lio and in­creas­ing its ex­po­sure to the Latin Amer­i­can gam­ing sec­tor, has seen its share price crum­ble by more than 50% over three years.

Sun In­ter­na­tional is trad­ing at lev­els last seen in 2005, and IM es­ti­mates a nor­malised for­ward earn­ings mul­ti­ple of less than 10 times.

Though Tsogo’s share price has, rel­a­tively speak­ing, fared far bet­ter than Sun’s, the mar­ket rat­ing is still a mod­est trail- ing earn­ings mul­ti­ple of 10 times.

Dirk van Vlaan­deren, as­so­ci­ate port­fo­lio man­ager at Kag­iso As­set Man­age­ment, notes that casino com­pa­nies’ very high fixed costs mean that the on­set of low or even neg­a­tive casino rev­enue growth can have a huge neg­a­tive im­pact on prof­its. “So far rel­a­tively good cost con­trol from both casino groups has re­sulted in only small de­clines in op­er­at­ing profit. The chal­lenge for casi­nos will be to con­tinue to man­age costs while top-line growth re­mains weak.”

Van Vlaan­deren points out that both com­pa­nies do off­set a weaker SA out­look with Tsogo Sun gen­er­at­ing around 30% of Ebitda from ho­tels (SA, Africa and abroad) and Sun In­ter­na­tional gen­er­at­ing a sim­i­lar pro­por­tion of prof­its from its Latin Amer­i­can casino op­er­a­tions.

Aside from strug­gling for growth trac­tion as con­sumers’ dis­cre­tionary spend­ing drains away, there are a cou­ple of key sim­i­lar­i­ties be­tween Sun and

Tsogo. Both have re­cently suf­fered the de­par­ture of highly rated CEOs: Graeme Stephens at Sun and long-serv­ing Mar­cel von Au­lock at Tsogo. Stephens’ brief ten­ure caught the mar­ket’s at­ten­tion when he rat­tled Sun’s com­fort­able cor­po­rate cul­ture with se­ri­ous cost-cut­ting ini­tia­tives and op­er­a­tional over­hauls. He also geared up Sun to ex­tend its South Amer­i­can pres­ence and se­cured the re­lo­ca­tion of the Morula casino li­cence to the more vi­brant Men­lyn area of Pre­to­ria.

Von Au­lock’s (longer) ten­ure at Tsogo was per­haps slightly less event­ful. But he ran a tight ship and more re­cently over­saw the com­pany’s prop­erty pitch (in­clud­ing the ac­qui­si­tion of con­trol of the Hos­pi­tal­ity Prop­erty Group) and ini­ti­ated the ma­jor re­vamp of the highly prof­itable Sun­coast casino in Dur­ban.

There has been typ­i­cally colour­ful spec­u­la­tion around the de­par­ture of Stephens and Van Au­lock. But, as is the na­ture of such things, the truth will emerge in years to come.

Both de­part­ing CEOs were re­placed by com­pany “in­sid­ers”, and the mar­ket is not

Both Sun and Tsogo have di­ver­si­fied into al­ter­na­tive gam­ing via fast-grow­ing lim­ited pay­out ma­chine and elec­tronic bingo ter­mi­nal as well as sports bet­ting

an­tic­i­pat­ing that ei­ther com­pany will veer wildly away from ex­ist­ing op­er­a­tional strate­gies.

The other sim­i­lar­ity is that both Sun and Tsogo have di­ver­si­fied into al­ter­na­tive gam­ing via fast-grow­ing lim­ited pay­out ma­chines (LPMs) and elec­tronic bingo ter­mi­nals (EBTs) as well as sports bet­ting. Sun ac­quired LPM op­er­a­tions from Grand Pa­rade In­vest­ments (GPI), its em­pow­er­ment part­ner in the West­ern Cape, and the Sun­bet sports bet­ting op­er­a­tions from fi­nan­cial ser­vices group Pur­ple Cap­i­tal.

Tsogo is fi­nal­is­ing the ac­qui­si­tion of al­ter­na­tive gam­ing as­sets (LPMs, EBTs and sports bet­ting) from Niveus In­vest­ments. This is a re­lated party trans­ac­tion as Niveus and Tsogo are con­trolled by em­pow­er­ment gi­ant Hosken Con­sol­i­dated In­vest­ments (HCI).

Re­cent re­sults sug­gest the LPM and EBT mar­kets are still en­joy­ing sprightly growth com­pared with trad­ing in the bricks and mor­tar casi­nos.

While LPMs and EBTs don’t have the rev­enue-gen­er­at­ing power of larger ur­ban casi­nos, these gam­ing niches gen­er­ate at­trac­tive prof­its with­out in­cur­ring huge de­vel­op­ment costs or be­ing bur­dened with de­mand­ing cap­i­tal ex­pen­di­ture for up­grades and main­te­nance.

To il­lus­trate the profit prow­ess of al­ter­na­tive gam­ing as­sets, Sun’s year to end-De­cem­ber 2016 re­sults showed that the 70%-owned Grand­slots LPM op­er­a­tions and Sun­bet gen­er­ated op­er­at­ing prof­its of R90m — rep­re­sent­ing more than 10% of to­tal op­er­at­ing prof­its of R845m.

Put an­other way, the al­ter­na­tive gam­ing op­er­a­tions came close to gen­er­at­ing as much op­er­at­ing profit as main­stay casino Car­ni­val City in Gaut­eng, and al­most as much as the col­lec­tive profit con­tri­bu­tions of four smaller casi­nos (Meropa, Flamingo, Wind­mill and Golden Val­ley).

In the year to end-March, Niveus re­ported an in­crease in earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion (Ebitda) by its 2,350-strong EBTs (and share of the small Ku­ru­man casino) to R104m from R62m pre­vi­ously, while the Vukani LPM op­er­a­tions (com­pris­ing more than 5,600 ma­chines) in­creased Ebitda to R343m from R300m.

The in­vest­ment by Sun and Tsogo in LPMs and EBTs may seem, at first glance, a de­vel­op­ment that could un­der­mine its core casino op­er­a­tions. In­deed, LPMs and EBTs (which are in­creas­ingly viewed as mini-casi­nos) have wooed pun­ters away from ur­ban casi­nos com­plexes. This seems to have more of an im­pact on small casino op­er­a­tions — with Sun’s Morula, in par­tic­u­lar, hav­ing its vi­a­bil­ity threat­ened.

Van Vlaan­deren reck­ons the long­stand­ing struc­tural change

in the gam­ing sec­tor is the growth di­ver­gence of these al­ter­na­tive gam­ing for­mats. “Growth rates are sig­nif­i­cantly higher. These for­mats con­tinue to roll out off an im­ma­ture foot­print ver­sus the ma­ture and slower-growth tra­di­tional ur­ban casi­nos.”

He thinks it is pos­si­ble there will be more cor­po­rate ac­tion within these higher-growth for­mats — es­pe­cially given the growth run­way that still ex­ists.

The big­ger play­ers in the al­ter­na­tive gam­ing space would in­clude listed coun­ters like RECM & Cal­i­bre, which con­trols large EBT and LPM spe­cial­ist GoldRush, and Phumelela, which is best known for its size­able fixed odds and sports bets of­fer­ings.

With LPMs and EBTs set to con­tinue along a profit growth path, it is not im­pos­si­ble that Sun might con­sider re­struc­tur­ing its casino port­fo­lio with a view to sell­ing or spin­ning off the more mar­ginal op­er­a­tions.

Though LPMs and EBTs trade at mar­gins that are lower than smaller casino prop­er­ties, the re­turn on in­vest­ment po­ten­tial is far more at­trac­tive. The abil­ity to roll out new LPM and EBT sites (and per­haps em­bark on cor­po­rate ac­tion to for­tify mar­ket po­si­tions) also looks, at this junc­ture, a more com­pelling op­tion than the con­sol­i­dated casino in­dus­try.

Reshuf­fling op­er­a­tions could cre­ate a more solid hand for Sun, and ease some un­com­fort­ably tight gear­ing. A re­fined Sun hand could com­prise larg- er casino prop­er­ties in SA (GrandWest, Car­ni­val City, Sibaya and the Board­walk) and the solid rather than spec­tac­u­lar Dream casino op­er­a­tions in Latin Amer­ica — en­hanced by an LPM, EBT and sports bet of­fer­ing.

The smart money might bet that Sun — car­ry­ing to­tal debt of around R14bn — might move sooner rather than later in play­ing a stronger hand with less cards. The com­pany, which has spent well over R3bn on its big new Time Square casino in Men­lyn, has al­ready said bal­ance-sheet strength­en­ing is a pri­or­ity.

The in­terim div­i­dend was

skipped for the six months to end-De­cem­ber, and only es­sen­tial cap­i­tal ex­pen­di­ture will be au­tho­rised.

Sun has al­ready raised cap­i­tal by sell­ing off, to Tsogo Sun, part of its con­trol­ling stake in Cape Town’s GrandWest — the big­gest and prob­a­bly most prof­itable casino in SA — and the smaller Golden Val­ley casino in Worces­ter. But bundling the smaller casi­nos — which have per­formed bet­ter than the big­ger prop­er­ties of late and are solid cash gen­er­a­tors — into a sep­a­rate ve­hi­cle and sell­ing these off could raise from R1.7bn to as much as R2.5bn.

Much de­pends on how much cash the new Time Square spins. This casino opened only in April, which means the full-year re­sults to end-June (set for re­lease in Oc­to­ber) will in­clude only three months of trad­ing. Whether that abridged trad­ing pe­riod will be enough to form an opin­ion on the po­ten­tial of Time Square is de­bat­able. A more pru­dent as­sess­ment might be pos­si­ble only af­ter the re­lease of the in­terim re­sults to end-De­cem­ber this year.

Sun has guided for an ex­tra R750m of Ebitda from the new Men­lyn com­plex — but that is only once the casino, arena and ho­tel are all open in March next year.

The key fac­tor is that Time Square will rank as SA’s sec­ond-largest casino, and that means re­duc­ing Sun’s de­pen­dence on GrandWest. This is im­por­tant since GrandWest’s pe­riod of ex­clu­siv­ity in the Cape Town metropole ended in 2013, and there are still in­di­ca­tions that the West­ern Cape gov­ern­ment will al­low an ex­ist­ing pro­vin­cial li­cence (ei­ther Cale­don, Mykonos, Golden Val­ley or Gar­den Route) to be trans­ferred to the city.

Tsogo, which boasts a mar­ket cap al­most four times larger than Sun, looks un­likely to scale down in any form.

The com­pany has ex­tended its ho­tel and prop­erty seg­ments both lo­cally and abroad, and re­cently ac­quired the sig­nif­i­cant mi­nor­ity stake it did not own in the small-but-feisty Mykonos casino.

The fact that Tsogo — which al­ready con­trols the Cale­don, Gar­den Route and Mykonos casi­nos in the West­ern Cape — ac­quired sig­nif­i­cant mi­nor­ity stakes in the GrandWest and Golden Val­ley casi­nos un­der­lines a de­ter­mined po­si­tion­ing around the pos­si­ble re­lo­ca­tion of an ex­ist­ing casino li­cence to Cape Town.

Sun, with its debt bur­den, might be hes­i­tant about pour­ing bil­lions into a new Cape Town casino. Tsogo, on the other hand, has, or could find, the

The smart money might bet that Sun might move sooner rather than later in play­ing a stronger hand with less cards

de­vel­op­ment fund­ing ca­pac­ity — es­pe­cially if the open­ing of the well-lo­cated Time Square casino de­tracts from Tsogo’s strong Gaut­eng pres­ence via Mon­te­casino, Gold Reef City and Sil­ver­star.

Over­all, Tsogo’s larger casi- nos seem to be far­ing a lit­tle bet­ter than Sun’s larger prop­er­ties. In the year to end-March the mar­gins at Tsogo’s big­gest five casi­nos were fairly steady — with Mon­te­casino, Gold Reef City and Sil­ver­star frac­tion­ally down but Sun­coast and Golden Horse marginally up.

At this del­i­cate junc­ture, Tsogo — with sub­stan­tial value un­der­pin from its ho­tel prop­erty as­sets — would ap­pear to carry less risk for pun­ters keen on build­ing gam­ing ex­po­sure ahead of an eco­nomic up­turn. The mean­ing­ful ex­po­sure to the fast-grow­ing EBT sec­tor is ad­mit­tedly an X-fac­tor in the years ahead.

Sun’s prospects hinge heav­ily on Time Square pro­duc­ing not only a bot­tom-line kick but re­as­sur­ing op­er­a­tional cash flows too. Ef­forts to re­in­force mar­gins at the big­gest casino prop­er­ties will be an­other im­por­tant ini­tia­tive, though no easy task in leaner trad­ing times.

The over­rid­ing ques­tion is whether Sun, which has no out­right con­trol­ling share­holder, is trad­ing close to lev­els where per­haps a pri­vate eq­uity buyer or op­por­tunis­tic preda­tor might start stalk­ing.

Ei­ther way, both com­pa­nies are gam­ing chips worth play­ing at cur­rent lev­els.

Pic­tures: iS­TOCK

Pic­ture: iS­TOCK

Tsogo Sun’s Mon­te­casino in Four­ways, Jo­han­nes­burg. Pic­ture: TSOGO SUN

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