Casino Valuation Is Neither Traditional Metrics Nor Some Mysterious Metaphysics of Losing Bets

Valuation models for casino properties continue to amaze me. This week alone I read news stories about: the purported assessment of the Caesars acquisition; the failure of one large casino because of a slack in “high roller” traffic; and a debate over segregating tangible casino assets into a R.E.I.T. structure. One failed Las Vegas casino even blamed their catastrophes —in their property sales brochure— on “several unlucky months”.

           Amidst those mind-bogglers, in recent years I have been pitched: casinos at more than 20-times earnings; non-existent casinos hoping to build and “catch only “X%” of the market”; casinos for sale based exclusively on EBITDA; and “fire-sale” pricing pf casinos because “the market is dying without millennials gambling.”

           My take on the alleged “problem” of millennial gambling is well-known and much-discussed. But  this insanity of positing casino property valuations by either traditional metrics or some mysterious metaphysics of losing bets… has got to stop!

           Granted, the industry’s out-of-sync valuations, make traditional financing only rarely available for casino developers who don’t have substantial “skin-in-the-game”. In fact, other than corporate gobble-ups, many of the last decade’s mid-sized casino investments have been made by either high-risk hedge or private-equity funds, high-net worth individuals, or special-case investors[1].

Even within that limited realm, the methodology of many private equity funds still (and traditionally) relies heavily on EBITDA; because it strips out the effect of taxation (and thereby reduces the amount of equity capital needed to satisfy lenders).

At best, given the special metrics of casino operations, investor presentations that rely on EBITDA as the primary valuator are, at best, disingenuous. Warren Buffet’s famous skepticism of that methodology is even more germane to casino investments.

Buffet famously said, “references to EBITDA make us shudder; does management think the tooth fairy pays for capital expenditures?”

Further complicating the investment landscape, the standard business valuation metrics based on expectations of future profits and return on investment as assessment of purchase price of a business (typically 3x or 4x, maximum 6x earnings) … are very rare in the casino world; and for good reason (as we will see).

The standard alternative valuation of developing an appraisal of the tangible assets and FF&E, almost never has been applied as the single determining factor for pricing casinos; and especially not in Nevada.

Equally subordinate (and seemingly absent) have been most standard acquisition methods of accounting: valuations from income statement; cash flow and balance statements; book value, market value, enterprise value; and all the metrics that compare value to operations in a traditional business[2].

Even typical SDC[3] data reports coupled to include capital structure and enterprise value (which might show a precedent transaction table of 12x to 16x EBITDA for traditional businesses) alone are inoperable in the complex valuation of casino purchases.

This does not, in anyway, preclude the absolute necessity of professional valuation, application of GAAP (the Generally Accepted Accounting Principles of Financial Accounting Standards Board), and definitely the 157 Fair Value Measurement[4] guidelines (also of the Financial Accounting Standards Board).

However, it does require more emphasis than normally would be applied to comparable company analysis as well as precedent transactions analyses.

Because gaming is such an exceptionally high cash-flow business[5], the most important metrics for company valuation revolve around operational parameters, comparable analysis, and those traditional formulas weighed against the casino-seller’s perceptions and precedent transactions.

  For example, a traditional analysis may show gross operating costs that are substantially out of line with highly formulaic industry standards. While measure of operating costs is a standard metric in any good valuating analysis, the specific methodology for evaluating those costs is industry-centric and justifiably complex in the casino world.

The single metric of specialized casino operating efficiencies alone can have(and often has) impact on earnings multiples by 50% or more … even before other factors are even applied.

These “special” metrics are neither mystical nor particularly complex; in fact, they are highly formulaic; but again, they are also highly specialized for the casino gaming industry.

Typically the valuation models that I have found most accurate (and therefore useful) begin with two traditional methodologies and one industry-specific technique:

1.   Discounted cash flows;

2.   Comparison methods; and

3.   Win-per-unit models.

Still, each of these models, with the exception of the latter, must be adapted to the eccentricities of the gaming industry. The two traditional models become extremely useful in some of our verticals; specifically, slot machine placement inside casinos, greenfield casino development projects, and casino-based entertainment projects. The third, the “win-per-unit” method, is applicable to almost all gaming industry projects.

The best usage of a discounted cash flow model takes the value of any gaming asset as the net present value (NPV) of the sum of expected future cash flows. This is represented by a relatively standard accounting valuation formula used by financial analysts in multiple industries:

NPV = Σnt=1 CF1 / (1+r)t

In our usage of the formula:

?       r is the risk-adjusted required rate of return for the investor;

?       CF1 is the projected cash flow

?       in the time period (t); and

?       n is the number of the future period over which the cash stream is to be received.

To illustrate this most simply, let’s assume that the investor’s expected rate of return is 9% and the expected cash flow from our share of revenue of a small foreign slot machine company’s placement of games in several casinos is $3-million, $2-million, and $1-million for the next three years respectively.

Let’s also assume that the lease agreement for the games is for a three-year term and therefore that investment has no value after the third year[6].

The Net Present Value of the contract would then be $5.205-million, as shown here:

3/ (1.0 + 0.09) + 2/ (1.0 + 0.09)2 + 1/ (1.0 + 0.09)3 = 2.75 + 1.683 + .07722 = $5.205-million

Applying this discounted cash flow model to the unusual and complex business model of slot machine distribution, we are able to project a decision-trigger for valuation of that type of investment for our company and our investors.

The only piece remaining is a thorough understanding of the distribution model[7] (which is too lengthy for this article).

Meanwhile, using the comparison models, we often evaluate a wide range of proximity and comparable property metrics including:

?     Revenue figures reported to various gaming regulatory boards in jurisdictions where such reporting is public record;

?     In jurisdictions where revenue numbers are proprietary (and hence not available), we frequently perform regression-analyses from gaming taxes paid (thus determining actual revenue of specific comparable properties or at very least districts within the jurisdiction);

?     In the few jurisdictions where the information is available, we review known price multiples of cash flows, estimates of earnings, owners’ equity, and revenue growth relative to those of similar properties in proximity;

?     For comparison targets that are publicly-traded and use different accounting standards, one of the best comparative value methodologies is to examine the ratio of property enterprise value (EV) to EBITDA. Enterprise value[8], equals total common shares outstanding times share price[9] plus debt minus cash. Using that model, we are careful to keep the Buffet-esque skepticism at the forefront of our analyses but can create a “relative” valuation.

This comparison model is adequate in the casino world for only one purpose: determining the validity of market-pricing of a particular property; but it is completely inadequate for determining the true asset valuation.

Without a highly-specialized benchmarking metric, most casino valuation methods have proven to be little more than fiction; and, ultimately, investor disappointment. That disappointment has been especially painful for investors in some of the more-publicly exposed business failures.

Our Gambling Industry-Specific Metric

For a more accurate (and operatively useful) valuation of a casino property (hotel, resort, etc.), I always rely heavily on a gaming industry standard metric to develop our own analysis; the win-per-unit model. This gambling metric, primarily for slot machines, is: the net amount of money wagered minus payouts to “winning” players.

For each slot machine (and for each seat at a table) we measure this as “win” for the casino[10]. Referring to slot machines as a “unit”, we denote this metric as either wpu (for “win per unit”) or wpupd (“win per unit per day”).

In our own copyrighted and patent-pending methodology, we created a specialized application of that metric and combined it with a modification of the 1970’s Texas Instrument Corporation’s ZBB (zero based budgeting[11]) paradigm.

In our model, there are two steps: (a) we determine the ratio of cost-to-revenue of each line item; and (b) we build a budget “backwards” basing each line item on the volume of business; the amount of revenue.

That process tells us what the OPEX should be (if the property is properly managed) and therefore, ultimately, what actual earnings should be. It also is a great benchmarking tool to determine if a property is performing at is optimal potential.

Ultimately, from this methodology, we can line-item each operating expense and build budgets; even setting a line-item-like minimum to account for return on investment.

This technique gives us the best tool for quickly and accurately determining a value proposition for potential investment in a casino resort. It is accurate; it is based on actual numbers (rather than fanciful projections); and it demands, from the onset, that proper operational management be in place.

We begin that analysis with the proposition that at least 80% of total property revenue comes from gaming.

Despite Las Vegas Sands (the Venetian) owner Sheldon Adelson’s infamous pronouncement in The Economist magazine that that 70% of his revenue comes from non-gaming sources, nationwide indications are that our proposition is the norm and not his. Moreover, if one examines his annual reports, it is revealed that our metric is more accurate than his if we include his worldwide revenue (especially Macau) in the overview; his pronouncement is for his Las Vegas property only, and even then, is questionable.

The magazine further reported: “Mr. Adelson, the head of Las Vegas Sands and for some years the world’s third-richest person, insists that he is not in the gambling business, nor even in the gaming business (a distinction he and Michael Leven, Las Vegas Sands’ president, consider important; the difference between gaming and gambling, according to Mr. Leven, “is the difference between having a cocktail and going out drinking”).

Despite that lofty distancing from the not-so-pretty history of the gambling business, a review of their annual reports reveals that actually 79% of their revenue comes from gambling. More specifically, Investopedia reports: “For every dollar Las Vegas Sands takes in from room fees — and remember, the company has 7,000 rooms at one joint property alone — it takes in $8.24 in gambling revenue. Dining, shopping, and convention revenue combined barely match the money garnered by renting out rooms. ”

Understand what that means! Their casinos make more than eight-times what their “non-gaming” businesses make.

 So, again, we begin with the proposition that at least 80% of total property revenue (not just gaming revenue) comes from gaming. We add to that proposition that OPEX for the entire property (again, not just gaming) is something less than 80% of total revenue[12].

If both propositions are valid, then 100% of OPEX (Operating Expenses) for a casino-resort property’s business units can be expressed as a percentage of gaming revenue; even for the non-gaming departments.

This simple basis, when combined with our company’s proprietary operational marketing methodology provides an operational blueprint that structures all operating costs (non-CAPEX) from win per unit.

So, again, casino property valuations by either traditional metrics or some mysterious metaphysics of losing bets falls far short of operational valuation metrics. THAT is what we do when we vet a property.

—from my book “Overachieving Returns in Casino Gaming Investment: A How-To Guide for Small to Mid-size Investors” available from Amazon: (https://www.amazon.com/gp/product/1732621357/)

 

NEXT TIME: How does a casino measure success? How profitable should a casino be? What ROI should casino owners expect? How much debt can a casino realistically service?

 

 

FOOTNOTES:

[1] Among them: Blackstone, TPG, Apollo, Appaloosa, Oaktree, PAR, Elliott, Centerbridge, Starwood Capital, etc.; or Icahn, Wynn, Adelson, Tilman Fertitta, EB-5 groups; or Phil Ruffin, Michael Gaughan, Ed Roski, George Maloof, Tony Marnell, Terry Caudill, etc.

[2] Anecdotally, when I looked at one casino in downtown Las Vegas a few years ago the then-owner offered the property for $22-million against declining earnings of $1.2-million annually; 18? times EBITDA. Mind-bogglingly, he found several investors at that valuation and sold the damned place.

[3] Securities Data Company

[4] Financial Accounting Standards Board (FASB) of the United States: Statement of Financial Accounting Standards 157

[5] At the one Native American casino in Southern California, our monthly cash-flow routinely was in excess of $100-million with a net of $8.5-million after player payouts (before operating expenses, etc.). That seemingly unusual large amount of cash is actually quite normal for a mid-size casino but is illustrative of one of the many factors that impact the valuation metrics of an operating casino.

[6] This slot machine revenue model is often used as a casino financing tool; especially in Indian Country.

[7] ibid

[8] Subject to adjustment for preferred shares and other off-balance-sheet items.

[9] “equity capitalization”

[10] Average national win per slot machine unit and a detailed discussion of that metric also is a separate discussion.

[11] Texas Instrument’s long arcane accounting process also used in government by the Carter Administration. In 2015 a Brazilian private-equity firm, coincidentally named “3G” Capital Partners and their partner Berkshire Hathaway, adopted the methodology for the food industry as they bought Burger King, Kraft Foods, Tim Hortons, and other companies.

[12] Even if we posit that that gaming in general (rather than specifically slot machine) is responsible for that 80%, we know that slots are responsible for 80%+ of gambling revenue at a US casino, so at “worst” 64% of total revenue (80% of 80%) comes from slot machines and total property OPEX is less than that number as well. Our methodology holds, regardless of the starting model.

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