Overview

Short Borgata bonds - the casino owned by Boyd in Atlantic City

Currently the bonds trade in the low 90s,  for about a 12 % yield

Pricing on 4/5/2012

                     Bid Ask         Bid Ask     Bid Ask  Amt

Security              Px Px          YTW YTW    ZSPR ZSPR Out    Mdy  S&P

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BORGAT 9 1/2 15   91.500-92.500   12.546/12.170 1170/1132 3.6MM  B2   BB-

BORGAT 9 7/8 18   90.000-91.500   12.170/11.805 1069/1032 393.5M B2   BB-

The catalyst is

-         Revel (a competitor) has just come online (fully opening in 2 months) which will be direct competition to Borgata (which has operated with relatively little competition since it opened in 2003)

• Both Revel and Borgata both cater to the higher end market, this is going from a monopoly to duopoly  

-         Atlantic City has and will continue to be under pressure & shrink with all the new casinos that have been coming online and taking market share in the area

-         Bonds still trade in the low 90s at about 5.25x LTM leverage. 

• I think EBITDA is going from ~$158mm to $95mm or so,  i.e. going to about 9.1x total leverage after Revel fully sets in.  It could of course potentially become worse, in which case I don’t think it should be trading in the 90s.
  • Also, they’ll breach their revolver minimum EBITDA covenant, and not be able to draw on that anymore
• I think these bonds will probably go to 70 at least and trade more at recovery value (using about 6.5x EBITDA)  as it’ll have a tough time supporting its capital structure and will be FCF negative – given maintenance capex + cash interest of about $110mm total.  That’s not including expansion capex,  which is necessary every few years. 
  • They’re just about to finish a rehaul of their rooms though, which cost them about $50mm over the last year and will be finished by mid 2012.
  • And liquidity will be tight as their revolver was recently downsized and their cash is fairly low at $46mm
• Meanwhile even if everything goes extremely well for Borgata and they somehow remain unscathed,  the downside in the short is about 13 pts in price terms given the call price of the bonds is around 104 ish

-         I prefer shorting the 9.875 given the longer duration

These have been one of the few bonds that are actually down YTD, and have been moving down slowly as Revel’s opening approaches

Here are some other negative issues facing Borgata

-         Borgata has already been cutting costs substantially over the last few years

• Company management has said that they can’t cut costs much more and are wary to do so given that Borgata is supposed to be a higher end product with good service.
• Anecdotally,  staff levels at Borgata are already pretty light as it is

-         Borgata has already been losing employees over the last few months, which will make it even more difficult to reduce costs

-         Borgata has already been increasing comps and incentives to lure more gamblers and compete against Revel,  which will further hurt margins

• E.g. Revel’s poker comps are far better than Borgata’s and other Atlantic City poker rooms

-         Revel increases Atlantic City gaming capacity by about 10%.  My projections assume a revenue drop of that amount, though it could be more given that Revel is going directly after Borgata

• Back when Borgata opened, it similarly dropped revenue from competitors by 8-10%, but that was when the Atlantic City market was still growing

-         Revel has made much progress in the convention business – already signing up tens of thousands of rooms,  which Boyd has said will hurt their mid-week business

• Revel has already booked 20,000 room nights, and is looking to book 80,000 by September of this year (they have 1,400 rooms)

-         Early reviews and walk through of Revel are highly positive. And early visitation is surprisingly strong

Competition

Main catalyst for the short is Revel Entertainment opening in Atlantic City. 

Borgata has been operating in Atlantic City and has had somewhat of a monopoly catering to the high end gaming segment in the region. 

However, that will now change with Revel entering the market and partially opening on April 2, 2012 and fully opening on May 25^th, 2012.  Revel cost $2.4bn to build (vs. the $1.9bn for Borgata – including improvements - which opened in 2003)

The bet is whether or not Atlantic City support another mega, higher end, Vegas style casino without hurting impacting Borgata.  I predict that Borgata’s margins will fall and customers will be diverted to Revel.   Revel management has said that they want to target Borgata’s customers.  Clearly, from a competitive point of view, Revel would be silly to position themselves as another Trump or Bally’s or Harrah’s in the area.  Indeed, the amenities and upscale restaurants point to a Borgata like experience – arguably it’ll be a better experience as Revel is attempting to position itself as a resort with gaming complete with beachfront and sunlit views (rather than a smokey, dark casino room)   

Revel is non-smoking though, which is an interesting wrinkle.  The hard-core gamblers may be put off by this choice – and many hard-core gamblers aren’t the ones who will switch over quickly given the difficulty of weaning high rollers off other loyalty programs.  I view this as a positive as it differentiates Revel.   Revel may turn into the destination for the more leisure patron over time (given its nicer amenities and offering a beach front).  Revel has also done a much better job of building its convention market which will help it do well in the middle of the week.  I lean towards the view that Revel won’t grow the market by much given the declining nature of AC & Borgata, and the continued regional competition.

If Revel does well, that would more likely be because they take some of Borgata’s customers.   If Revel doesn’t do well, they’ll probably try to discount in order to drive traffic, which will hurt everyone.  

Timing:  Revel is opening up soon, however it may take time for Revel’s foot traffic to pick up (as is usual), aside from the initial excitement.  So the full impact may take a while for it to be felt.

Also, Revel is closer to the rest of the casinos, which may be a positive or a negative.  Perhaps people like the fact that Borgata is further away from the ‘strip’. 

Atlantic City casino revenue was $3.3bn in 2011 (down 6.9% YoY) down from a peak of $5.2bn in 2006.   This was mostly due to ongoing gaming expansion in surrounding areas (mostly Pennsylvania and New York).  Gaming expansion continues as state budgets are stretched and weak.  Farther off in the future, you could see more gaming expansion in Maryland & New York.  We’ll see how much Revel can grow the market (if at all),  but I remain pessimistic.  Borgata has outperformed,  but has lost 8.6% of their revenues (which peaked in 2007/2008). 

Online gaming may also be another competitive entrant that could eat into brick & mortar. 

Revel has already booked 20,000 room nights, and is looking to book 80,000 by September of this year (they have 1,400 rooms)

Borgata Financials

To Borgata’s credit, they have been outperforming through the secularly declining Atlantic City travails of the last 5 years, and they’ve been taking share.  But their competition has been undifferentiated and weak. 

Maintenance capex is around $20-30mm,  interest expense around $80mm

Of course not including the expansion capex that they do every one in a while.

Borgata is the best way to short the increasingly oversupplied Atlantic city gaming market.

Revel’s marketing strategy is to go after Borgata supposedly – management has said as much.  They’ve spent more money on revel than Borgata has.  Borgata hasn’t had to deal with any real competition since the high end market was pretty much there’s.  Now the competition will probably increase.  So clearly revenue will be down, promotional spending will be up, and margins will probably fall. 

Tough to say how much in expenses that they can cut.  But given that they’ve been cutting expenses for years, would be surprising if they can cut out a lot more.  Plus they are catering to higher end clientele so it’s tough to cut service levels to the bone. 

Q4 2011 financials were pretty good and finally showed some YoY growth; but it’s too little too late

Borgata has definitely been outperforming the space and taking share over the last few years.   Having been to AC a few times,  I do think Borgata is much better than the other casinos.  But Going from a monopoly to duopoly is game changing. 

4Q Borgata gross gaming revenue grew 6.8% YoY - the first quarter of year over year growth since 3Q 2008.

-         Borgata EBITDA grew 11.0% YoY and achieved 21.5% EBITDA margin at the property in the period.  The highest 4Q margin since the 4Q 2007.

Cap Structure

They recently reduced the revolver to $75mm in capacity from $150mm (I think this may be an issue in 1-1.5 years as they may run out of liquidity).  Clearly, the revolving lenders were similarly afraid.

Covenants:

The revolver has an LTM EBITDA covenant of $125mm

Can’t buy senior secured notes if they have $65mm+ on the revolver

Revolver drawn: $40.2mm (ahead in priority to the senior secured notes)

9.5% $398mm

9.875% $393.5mm  (new issue proceeds refinanced debt and provided a dividend to owners).  These bonds are only secured by Borgata,  nothing else. As a single site bond, it should trade a bit wider naturally.  Also, as a dividend recap bond, that should be a red flag right there

So 5.26x total leverage

The bonds are rated BB- / B2.  The proceeds were used to refinance previous debt and a $240mm 1 time dividend.  

Borgata repurchased $8.5mm of the senior secured bonds in Q3 2011 during the sell off. 

Call price

104.75 in 2013 for the 9.5% bond and

104.9 in 2014 for the 9.875% bond <  So these bonds likely won’t be ripping to 110 if everything is great and they weather the competition well.

Boyd is also rather levered as well (around 7.5x total leverage).  So they’re not in much of a position to be saving Borgata if necessary.  

One could potentially short BYD as well – about 16% of EBITDA comes from Borgata.  So could be a 5% drop in BYD EBITDA as well.  There’s about $1bn of bonds that are shortable.  $2.5bn total debt and $675mm market cap. 

Also there is CDS 5yr CDS which has come down quite a bit.  But I haven’t had as much a view on BYD though.  I think BYD will continue to be pressured like all regional gaming companies.   As an aside, BYD stock has pretty much been flat YTD.

Projections

Basically, Revel is increasing the gaming supply by about 10%, which will hurt everyone.  They’ll open with 2,450 slots and 160 table games.

I don’t think Revel will grow the overall gaming market (which has been shrinking for years).  Borgata management even said it doesn’t expect the AC gaming market to grow and is expecting to be hurt a bit. 

So even if it only takes 10% of everyone’s market share,  Borgata’s win/slot/day goes down to 305 (down from 340),  which is still higher than everyone else in the Market (Caesars has 2 casinos at about 282 win/slot/day and everyone else is lower)

Then they’ll probably have to be a little more promotional, and can’t cut costs much given that they’ve been cutting costs for the last 4-5 years

I think after Revel competition fully sets in, EBITDA is probably going to $97mm in my base case. i.e. I have net revenues down 13% and EBITDA down about 38% (after Revel’s impact is fully felt)

Then you’re getting to 9.1x total leverage.

They have about $80mm of interest expense

$20-30mm of maintenance capex.  

And about $7mm of CDRA obligations (1.25% of gross gaming revenue)

Total around $112mm

So you’ll be FCF negative (more negative with extra expansion capex that they’ll need to do in the future) in that scenario. 

In addition, they will need to do more expansion capex at some point to keep the product fresh and exciting.   Meanwhile, they’ll also lose access to their revolver which has a $125mm minimum EBITDA covenant.  

I could also see them running out of liquidity as well in 1-2 years.

In this case, I think the bonds should trade to 70,  i.e. create the company at about 6.6x EBITDA (which is roughly where comps like Isle of Capri, Ameristar, and Pinnacle trade).  I also think gaming companies trade a bit too rich given the headwinds they face, increased competition, their cyclicality, capex needs (mostly to keep up with others), and other issues.  But anyway

As an aside, 80 is where they bonds bottomed during the Q3/Q4 2011 market selloff

The above is more my base case.  Could margins come down a lot more, traffic drop heavily, and promotional allowances increase more significantly?   Sure.  

Slightly Worse Case

To illustrate the sensitivity, maybe EBITDA goes lower to $85mm if things are really bad and burning cash.  In this case you’re closer to 10x total leverage through these bonds,  in which case I think these bonds to go 60 in order to create the company around 6.5x EBITDA. 

Sell side expectations:

I’ve seen a few models that have EBITDA dropping to $120mm-$125mm, with some as low as $106mm.   Again, I think it could be worse.  It’s tough to assume it won’t be down at the very least.   Seems like that may be where buyside expectations are as well.  But at those levels, you’re not a much FCF after including some expansion capex.  I’d assume that if they put up a few quarters of dismal numbers, you may get some more sellers despite it being “priced in”

It’s hard to get long something when your first and best argument is “it’s not going to be as bad as people think”

Relative Value

HY Gaming bonds in general yield about 8.4%,  these Borgata bonds are clearly a bit wide to the index at ~12%.

Which is similar to MTR gaming’s bond yield of 12%, which is also going up against a lot of competition from Ohio (after a big run up from people excited about its Scioto Downs expansion and some decent numbers).  But MTR gaming has some projects and prospects to offset the competition.  And MTR’s competition is farther down the road.  Borgata’s prospects are more dim.

Or maybe Tribal bonds are a good example, which has clearly had many more issues (including increased competition) and are down in the 60s.

Or you could buy QUAPAW bonds at 10% yields – which is also a single site casino but should be a lot more stable.   QUAPAW is a much more solid name.   Perhaps that’s a good pair trade for 2% different in yield

I think there are plenty of good pair trades against Borgata in gaming land.

Channel Checks

I’ve been asking gamblers about Revel.  Of course all have heard of it and most will check it out – except some who want an established poker room (but that’s not a big driver in the model).  Hardcore gamblers aren’t sure if it’ll be better or not of course.  Depends on the whole set up, experience, and how it compares to Borgata.  But certainly will take away customers at least in the beginning.

Most expect Revel will try to undercut Borgata. 

Employees are leaving & going to work at Revel.  May impact margins, raise costs, or reduce the experience.

Risks to the short

-         Boyd helps out  

• MGM used to be an owner as well but was forced to divest their stake.  They spent 1.5 years recently trying to sell it but there were no buyers (not surprisingly)
• As I said above, I don’t think BYD has the balance sheet flexibility to help.  One of Boyd’s top goals is to reduce leverage

-         Maybe Revel doesn’t take much share,  a possibility, but highly unlikely

-         Shorting the bonds is a tad expensive – but one of the only ways to short Atlantic City and catalyst is very near term

• Can put on a pair trade to help fund it (almost any other gaming bond will do)

Catalysts

-         Revel opening soon

• People excited about how nice it is

-         Other casinos / substitutes opening

-         Price / promotional wars

-         Liquidity running low, FCF negative

-         Breaching their $125mm EBTIDA covenant

-         High oil prices

-         Further impact from Aqueduct as that continues to ramp up

• If New York allows table games, Genting at Aqueduct wants to build a huge convention center and expand it.   That could be a huge issue.   But probably far away. 

-         Revel opening soon

• People excited about how nice it is

-         Other casinos / substitutes opening

-         Price / promotional wars

-         Liquidity running low, FCF negative

-         Breaching their $125mm EBTIDA covenant

-         High oil prices

-         Further impact from Aqueduct as that continues to ramp up

• If New York allows table games, Genting at Aqueduct wants to build a huge convention center and expand it.   That could be a huge issue.   But probably far away.