RUSH IN ROULETTE
Is it time to risk a shot at casino shares?
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.
Tsogo Sun’s Montecasino in Fourways, Johannesburg. Picture: TSOGO SUN