Caesars Entertainment (CZR) will have a better position to compete against major casino rivals like Wynn Resorts (WYNN) , Las Vegas Sands (LVS) , and MGM Resorts (MGM) .
Shares of the Las Vegas-based chain were surging on the takeover premium expected from its merger with Eldorado Resorts (ERI) . The M&A happy upstart has now made the fourth largest casino chain in the United States, posing a significant challenge to the aforementioned leaders.
"As a combined company, Caesars and Eldorado will be America's preeminent gaming company," activist investor Carl Icahn said of the deal he helped reach fruition. "It is rare that you see a merger where because of the great synergies 'one plus one equals five.' I look forward to seeing our investment prosper."
The outlook on Wall Street has been largely positive on both companies heading into the transaction and a deal with leverage lessened by the involvement of Vici Properties (VICI) has allowed that sentiment to be sustained.
"ERI has proven its ability to execute and VICI has positioned itself to continue growing, both of which are consistent with our theses," Jefferies analyst David Katz said. "Although [the deal's] complexities could weigh on shares initially, we expect the long term positives for both companies could prove out."
Amidst ERI's significant decline on concerns on the deal, not least of which is the debt load acquired, Katz sees significant upside ahead for the ERI end of the deal in particular.
The company's aggressive acquisition strategy has been a hallmark of its expansionary policy that has allowed the stock to run nearly 500% from late 2015 into Monday's deal.
Operational Excellence
One of the key bullish items for the deal is the operational ability of Eldorado, which might be better able to navigate a tumultuous gaming environment.
Starting in late 2015, the company stepped up its acquisition spree and has shown a remarkable ability to protect shareholder returns amidst the action.
In November of 2015, the company bought Circus Circus Reno and finalized a full acquisition of minority owned casinos in Reno from MGM for $73 million.
Next, the company acquired the Isle of Capri Casinos for $1.7 billion to add to its national presence across the Midwest. Quickly after that deal, the company purchased operations of the Grand Victoria Casino in Illinois for $328 million, further asserting itself in the Midwest.
Perhaps most prominently, the company acquired the Carl Icahn-backed Tropicana Entertainment for $640 million, adding numerous casinos and real estate holdings to its burgeoning portfolio and continued to garner impressive returns for shareholders.
Despite the spending spree, the company has managed to maintain a relatively light debt load, only about one third of that held by Caesars as of the merger date.
With the use of Vici Properties to reduce the leverage in the deal and the recent offloading of three major assets to the aforementioned REIT in order to build cash for the deal. The company received nearly $400 million for its recent asset sales to Vici and will receive billions more for the sale of Harrah's properties associated with the new deal.
"We believe the deal is prudent from a balance sheet perspective, as it is deleveraging, while also eliminating a potential pressured sale, and a potentially weaker multiple, in the event of a required disposition related to a transaction," Deutsche Bank analyst Carlo Santarelli said of the recent deals that he surmised was indeed set up for the recently announced merger with Caesars.
Pushing for Pole Position?
To use a horse racing analogy, the company is making its run for the roses, but is unfortunately still out of the show in terms of size.
The main issue for the newly merged company is its lack of exposure to growing international markets, particularly those in China that should buoy the lead held by the Wynn, MGM, and Sands triumvirate.
"We expect there should be progress in the coming weeks, which would shift the market's perspective on Macau and on WYNN and LVS." Jefferies' Katz commented in a recent note. "We believe that WYNN has the greatest leverage - financial and operating - to an inflection in the Macau market, while LVS should be a strong beneficiary as would MGM based on its newly positioned Cotai property."
While he noted that impacts from the U.S. China trade war could be a warning signal to investors betting on the discretionary income necessary for increased casino traffic, the secular growth in the region is a significant catalyst to monitor.
J.P. Morgan analyst Joseph Greff also added to the strong outlook for Wynn as likely top of the heap among casino stocks at present after reviewing the recent opening of its new Boston Harbor casino.
"We get that Macau is the big (biggest) driver of the equity as well as sentiment/valuation multiple," he acknowledged, noting that this is subject to trade uncertainty.
However, he viewed the growth pillars of the new Boston property, added resorts on the Las Vegas Strip, and a steady path to deleveraging the balance sheet as key competitive advantages that are possibly obscured by the enticing Far Eastern opportunity, accelerating EBITDA in 2020 from key growth pillars.
We see WYNN generating $8.95 of FCF per share in 2019, $11.89 in 2020, and $12.88 in 2021, implying 7%, 10%, and 10.5% FCF yields, respectively," he concluded, setting an ambitious growth road map ahead.
The targets set put the Eldorado deal into context, wherein while it makes it a contender, it will still need to play catch up to inch toward becoming the pit boss.
Online Angle
Besides China, the elephant in the room is the online gaming industry that has rapidly rivaled the traditional casino industry in terms of market demand.
According to Statista, the online gaming market is set to more than double to a total market size of nearly $100 billion by 2024, helped along by the Supreme Court which has opened the door for states to allow for in-state online gambling activities.
With the ability for consumers to place bets more rapidly and freely from the comfort of their own homes, this puts a notable potential strain on foot traffic heading towards lavish betting houses that each of the companies continue to construct.
Luckily for Eldorado, it has paved a road into the industry alongside Stars Group, the owner of brands like PokerStars and Full Tilt Poker, to cement its status in the emerging online gambling economy. The two companies signed a 20 year agreement in 2018 to expand the reach of the online gambling company to numerous jurisdictions occupied by Eldorado.
"We are excited to announce this agreement with Eldorado, one of the fastest growing regional gaming companies in the United States," Rafi Ashkenazi, chief executive officer of the Stars Group, said at the time of the agreement. "This agreement establishes the foundation for our U.S. strategy as we tactically pursue access to other key states and opportunities with potential media partners."
Following the deal with Caesars, the impact of Eldorado may extend beyond simply a regional play, given Caesar's operates more than twice the number of properties initially owned by Eldorado.
The partnership also helps the company compete as major media conglomerates and sports leagues themselves come into play for the jackpot of online gambling. To the contrary, it offers the company an avenue to draft behind media giants intrigued by the industry like Disney (DIS) and Fox (FOXA) .
In May, Stars Group announced a partnership with Fox to form FOX Bet, "the first-of-its kind national media and sports wagering partnership in the United States."
As part of the agreement, Fox agreed to invest $236 million in The Stars Group in exchange for about 5% equity in the company and the opportunity to take a controlling stake over the next decade. The terms provide Stars Group with exclusive use of Fox trademarks.
"Digital sports wagering represents a growing market opportunity that allows us to diversify our revenue streams, connect directly with consumers and expand the reach of the FOX Sports brand," Fox Sports CEO Eric Shanks said in a statement last month.
The effort will seek to compete with companies such as FanDuel and DraftKings that have pursued partnerships with governing bodies of sports rather than existing gambling giants.
For Eldorado, this offers an entry point to compete with established online enterprises that may have snuck by some of their peers and an opportunity to work alongside a major sport-focused media enterprise rather than compete directly.
In this case, Eldorado may be accelerating in an area that other casino companies have missed by simply coming a bit late to the online marketplace.
Bottom Line
The gambling industry is growing in a complex manner, highlighted by uncertain opportunities online and abroad that could be curbed significantly by governmental policy.
Similarly, Eldorado is in a complex position wherein it must assume significant debts from a formerly bankrupt casino player and is still chasing a Chinese opportunity that CEO Tom Reeg may yet take years to expand into.
Overall, the new Caesars is in a solid position, but it is hard to justify anyone betting the farm on the stock.
"The combined companies will pose a challenge to Las Vegas Sands and Wynn, but there's plenty of space in the industry for all three," Real Money contributor Timothy Collins suggested. "I believe a small wager on CZR shares here is worthy of consideration, something in the neighborhood of 1%-3% of a trading portfolio, likely to the higher side."
For a look at what the charts are telling us in the cards, click here.
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