Description

I am proposing an arbitrage trade between Century Casinos (short - CNTY) and Gold Reef City (long -GDF – listed on the South African Stock Exchange)

Century Casinos
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Century Casinos owns the following casinos:
- 100% of Womacks Casino in Cripple Creek, Colorado.
- 100% of the Caledon Casino located in the Western Cape Province of South Africa.
- Concessions to run casinos on 8 cruise ships
- 50% of the Casino Millennium located in the Prague Marriott


Womack
Womack’s competes against 19 casinos in Cripple Creek. It operates 647 slots, 6 limited stake tables and 21 hotel rooms. YTD revenue are down 3% due to the competitive environment. Further, in October 2004 a 4-lane highway was completed from the greater Denver area which will probably favor the casinos in Central City (4 casinos) and Blackhawk (22 casinos).

Salient Stats:
Revenue (YTD annualized) $18.6 mil
EBITDA (YTD annualized) $ 7.5 mil
EBITDA Margin 40%
AWPD (Average Win per Slot per Day) $100
Table win is negligible due to the $5 maximum stake

Caledon
The Caledon casino competes with 3 other casinos in the Western Cape Province of South Africa. The licenses in the Western Cape have a fair geographic spread with the nearest competitor 100km from Caledon. It operates 295 slots, 9 no-limit tables and 92 hotel rooms.

The Caledon Casino has done well for CNTY due to a strong economy which boosted YTD revenues by 22% and a strengthening South African Rand (ZAR). (The ZAR was 6.95 to the dollar in Sept 2003, 6.47 in Sept 2004 and is currently 5.95 to the dollar)

Salient Stats:
Revenue (YTD annualized) $14.1 mil
EBITDA (YTD annualized) $ 4.8 mil
EBITDA Margin 34%
AWPD (Average Win per Slot per Day) $107

Concessions on 8 cruise ships
CNTY have concessions to operate casinos on 4 Silversea ships, 3 Oceana ships and on the World of ResidenSea. (208 slots and 30 tables) Revenue from ships can fluctuate wildly depending on the number and quality of players and passengers.

Salient Stats:
Revenue (YTD annualized) $ 2.6 mil
EBITDA (YTD annualized) $ 0.8 mil
EBITDA Margin 30%


Casino Millennium
The Casino Millennium operates 38 slots and 15 tables from the 5 star Prague Marriott Hotel. This operation is equity accounted and should contribute $130 000 to CNTY’s 2004 results.

Summary
- Market Cap = $108mil
- EV = $128 mil
- EBITDA 2004 = $10.3 mil after subtracting $2.8mil Head Office costs from the EBITDA generated by the casinos.
- EBITDA/EV = 8%
- The Western Cape (Caledon) generates 40% of CNTY’s revenue.

But, Gold Reef City (GDF) which owns 2 casinos in the Western Cape trades on an EBITDA/EV of 14%. Is it fair that CNTY trades at a 78% premium to GDF despite the fact that both operators generate revenues from the same country/province? The rest of this analysis will examine this question?


Gold Reef City
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Gold Reef City owns the following casinos:
-85% of Gold Reef City Casino in Johannesburg, South Africa. (1600 slots and 50 tables)
-85% of the Golden Horse in the KwaZulu Natal Province of South Africa. (450 slots and 22 tables)
-54% of Casino Mykonos in the Western Cape Province of South Africa. (250 slots and 12 tables)
-40% of Garden Route Casino in the Western Cape Province of South Africa. (250 slots and 12 tables)
-10% of a Casino in the Freestate Province of South Africa.

Estimated 2004 Revenues, EBITDA and EBITDA margins are listed below. (The numbers have been converted from dollars into Rands using an average exchange rate of $6.4) Revenue EBITDA Margin
Gold Reef City Casino $130.0mil $50.0mil 38%
Golden Horse $ 21.0mil $ 7.2mil 34%
Mykonos $ 10.6mil $ 3.9mil 37%
Garden Route $ 15.6mil $ 6.9mil 44%
Service Agreements $ 2.3mil
TOTAL $177.2mil $70.3mil** 39%

** Total Rand EBITDA = 450mil

EV in ZAR is calculated as follows:
Market = R3 050mil
Associates = (R 28mil)
Cash (R 13mil)
Debt R 112mil
Minority R 83mil
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EV R3 204mil
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Translating at the current exchange rate of 5.95 equals $534mil. Therefore EBITDA/EV= 70.3/534 = 13%. The better measure is however in Rands = R$450mil/3 204mil = 14%.

If requested I can go into these operations in much more detail. For now I think the following points are important:
-The South African Casino market is highly regulated. All the planned licenses have been issued and the even geographic spread has effectively resulted in each casino operating a regional monopoly.
-South African gaming stats are published monthly for every province and they are currently reflecting 20% yoy growth. These trends reflect the strong consumer growth within the economy.
-The Gold Reef City competes with 3 other casinos for the Johannesburg market. 80% of South African economic activity occurs within a 100km radius of Johannesburg. Again, the casinos are evenly spread effectively eliminating head-on competition.
-CNTY and GDF have similar tax rates.
-GDF’s strong gearing will allow it to repay all it’s debt in q1 2005 and the expectation is that they could lower the dividend cover to yield 6% on the current price.
-GDF can be bought through large brokers who have offices in south Africa (e.g. City Group, Merrill’s, JPMorgan, UBS, Deutche Bank etc)


Do Future Growth Opportunities explain the difference in Value?
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CNTY are hoping to open the following casinos:
-Edmonton, Alberta: CNTY are the only operator to reach step 7 of an 8 step process for a planned casino of 600 slots and 42 tables. CNTY will own 55% of the casino but due to Canadian law will share 75% of the revenue with Canadian charities. The casino is expected to open mid-2006 and generate $2.3mil PAT for CNTY. Expected capex= $22mil
-Central City, Colorado: Own 65% interest in a 650 slot facility in Central City. Proposed capex = $40mil and it is expected to open mid-2006. There are no limits to the number of casinos and all that is required is a successful background check. It appears that CNTY want to take advantage of the new highway, but, one must be concerned about the cannibalization of Womacks plus even greater competition.
-A recent application for a casino in Iowa.
-CNTY were going open a 5th casino in Johannesburg, South Africa. The opening of the casino has been caught in a legal tangle which is finally coming to an end. The SA Supreme Court heard the final case on 25th February 2005 and judgment is expected with weeks. HOWEVER, CNTY sold the option for this casino to GDF. The casino is planned for 900 slots and 30 tables and will prove to be highly accretive to GDF if the court case goes their way. (I believe the case will be ruled in GDF’s favor as the Supreme Court is expected to support the ruling of a highly regarded High Court judge.)

As both companies have projects in the pipeline with various degrees it is not possible to factor in the optionality of new projects at this stage.


Insider Selling
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A recent Reuter’s article referred to strong insider selling by CNTY insiders.
http://yahoo.reuters.com/financeQuoteCompanyNewsArticle.jhtml?duid=mtfh19381_2005-03-03_19-20-34_n03303102_newsml

Important extracts are:
“Century Casinos' former beneficial owner Lloyd Miller sold 186,254 shares so far this year, reducing his holdings below 10 percent, according to data provided by InsiderScoop.com. The last time Miller bought shares was in 2003.”
“Three Century Casinos insiders and two top Monarch Casino executives have sold their stock in 2005”

Conclusion
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There appears to be an attractive arbitrage trade between CNTY and GDF which exploits the difference in valuations between two companies which depend on South Africa for a large portion of their revenues/profits.

A corollaries to the trade include:
-long exposure to the monopolistic South African environment while shorting the competitive Denver region.
- Long unlimited tables, short limited tables.
- Long a possible 6% div yield short 0% dividend.

Catalyst

- Outcome of Supreme Court case for 5th Johannesburg licence within next few weeks.
- Insider sales
- Both companies report within a week. CNTY could run on the results as the stronger rand will boost dollar profits for the seasonally strong Caldon quarter. Short should be placed into this strength. (My anaylis has used estimated numbers for 2004 which I will update as earnings are announced.)