Gamble on casino paying off Sun debt
Time Square will have to ‘increase revenue or profit margin’
● Sun International is managing to maintain a poker face in a high-stakes game that pits future cash flows against a heap of debt.
But the market might not be suckered in. Sun, which recently undertook a R1.6bn rights issue, might have its bluff called, with the gaming giant’s debt burden now almost twice the size of its R7.5bn market capitalisation.
The big gamble for the group, which first brought “homeland” casinos such as Sun City to SA in the 1980s, is a R4.3bn bet on the new Time Square casino at Menlyn Maine, Pretoria.
The Time Square deal, which required Sun to make settlement payments to rival gaming operators, accounts for about R5bn of Sun’s total R15bn debt burden.
This means that Time Square, which opened in April last year, needs to start paying off quickly.
But the crimping of discretionary spending suggests, as detractors have repeatedly argued, that Sun might have overplayed its hand with Time Square. At this point it is one of the biggest casino complexes in SA and enjoys a market share of just 13% in the competitive Gauteng casino market.
The key issue is that large rival casinos such as Montecasino, Gold Reef City (both owned by Tsogo Sun) and Emperors Palace are not seeing their offerings severely rattled by the opening of Time Square. At least not yet.
In May, Tsogo Sun CEO Jacques Booysen said the opening of Time Square had been far less disruptive than initially anticipated.
He said Tsogo had predicted an annual revenue loss of more than R200m. But the actual loss was between R80m and R90m.
Comments by Sun International CEO Anthony Leeming at the release of interim results this week will reinforce notions that the group has overcapitalised on Time Square.
In the interim period, Time Square generated revenue of R582m and earnings before interest, tax, depreciation and amortisation (ebitda) of R130m.
The casino’s margin of 22.6% is below that of other Gauteng casino complexes — including Sun’s own (and significantly smaller) Carnival City casino in Brakpan, which managed a margin of 25%.
It seems Sun is banking on Time Square’s revenue topping R1.2bn for the full financial year, which would imply an ebitda of about R300m if a margin of 25% is assumed.
And there’s the problem — Leeming noted that Time Square needed to generate ebitda of between R450m and R500m to service the interest bill on the borrowings accumulated in the development phase.
He believed that could be achieved in the next two years. But that probably assumes the prevailing economic malaise is not protracted.
Damon Buss, an equity analyst at Electus Fund Managers, said the 10.3% interest rate on Sun’s nearly R5bn debt on Time Square means an annual interest charge of R502m.
He said the Time Square depreciation and amortisation charge was R121m in the interim period to end-June, and could be assumed to be R242m for the full financial year.
“So to deliver profit before tax of zero, Time Square needs to produce an ebitda of R764m. To get to R764m in ebitda, Sun needs Time Square to either deliver revenue of R3.36bn at its current margin of 22.6%, or at current annualised revenue increase its margin to 65.6%.”
Buss said neither of these scenarios was likely.
With the weak macroeconomic environment in SA and the risk of a smoking ban
I’d be surprised if the banks are willing to raise the covenant levels again
Damon Buss
An equity analyst at Electus Fund Managers
hurting trade, Buss reckoned Sun should look to strengthening its balance sheet, either by selling some of its smaller casinos or through a second rights issue.
Sun’s share of the losses from Time Square was a hefty R182m in the interim period.
Leeming, though, was pragmatic about Time Square’s slower-than-expected start, stressing that the value of the property would come to the fore over time.
Despite being bedevilled by a low-win percentage, casino income in July and August was up 32% and 33% respectively. Market share, Leeming noted, had also picked up in recent months.
One positive result for Sun was that interim cash flows climbed 10% to close to R2bn. The debt-to-ebitda ratio of 3.2 times and interest cover of 3.1 times are both within the covenants of 3.5 times and 2.5 times respectively. But Buss still remained concerned over the overall debt burden — especially since the Western Cape Gambling & Racing Board could finally make a decision regarding the relocation of a provincial Cape casino licence to the Cape metropole.
He believed Sun would need to bid to limit the negative impact of a second casino licence in Cape Town because its key asset, GrandWest Casino in Goodwood, would be the entity that would lose market share to the new casinos.
“The banks have set Sun’s debt-ebitda covenant at 3.5 times, so there’s not much room — perhaps a R1bn capacity,” Buss said. “With the group’s recent poor capital-allocation track record, I’d be surprised if the banks are willing to raise the covenant levels again, and the new [Cape Town] casino would cost more than R1bn.”