Description

Quick Overview

Eldorado Resorts (ERI) began as the Eldorado Hotel, in Reno, Nevada in 1973.  Twenty-two years later, the family-run casino partnered with MGM Resorts to open the Silver Legacy Resort Casino.  By 2015, Eldorado had grown to 7 properties through small “one-off” acquisitions and partnership buyouts.  However, starting in 2016, ERI surprised the market with five acquisitions in quick succession totaling $4.4 billion, increasing to 26 properties and expanding its footprint primarily into the Midwest and Southeast segments of the US.  With each successive deal, Eldorado was able to leverage its operation skills and cost-cutting expertise, to quickly integrate the new casinos into the Eldorado family.  In late June of 2019, ERI announced its largest and most ambitious acquisition, Caesars Entertainment (CZR), for $17.3 billion.  When completed, the combined entity will carry the Caesar Entertainment brand, be managed by Eldorado’s executives, and will have a footprint consisting of 60 properties in 16 US states, 13 international properties, and several iconic casino properties along the Las Vegas strip. 

In 1931, Nevada was the only state to legalize casino gambling, a distinction it held for forty-five years.  Over that time, Las Vegas became the United States' mecca for gambling and the casinos that operated there were given a license to print money.  Today, casino gambling is legal in twenty-three states with sports betting available in twenty (thirteen are live & seven in process of launching) and online gambling making its debut in five.  In total, there are approximately 450 commercial casinos in the US generating around $75 billion, with the Las Vegas Strip accounting for less than 10% of those casinos and over 22% of total revenue.  Over the years, the negative perceptions surrounding casinos, gambling, and betting have changed dramatically, with 75% of Americans identifying gaming as providing both entertainment and viable source of state tax revenue.

Investing Thesis

With its proven track record for streamlining operations and improving margins, Eldorado is taking on its largest acquisition challenge, the $17.3 billion integration of Caesars Entertainment.  The targeted synergies are conservative and will probably be achieved earlier than ERI’s management has guided.  In addition, with the growth in sports betting, mobile gaming, and its ability to leverage Caesars brand and loyalty program, Eldorado’s management will have new ways to continue to streamline operations and monetize its assets.

Synergies

The main question an Eldorado investor needs to consider is what competitive advantage a regional casino operator would gain from acquiring the third-largest US casino brand that recently emerged from bankruptcy protection with a large foothold in Las Vegas.  First off, ERI has built an impressive track record over the past 4 years in both integrating and operating casinos it acquired, setting clear targets for both and surpassing them.  Over the past three years, Eldorado has achieved economies of scale both through its enterprise technology (front and back-end platforms) and its ability to get more competitive pricing from its vendors.  When combined with streamlining corporate expenses and operations on the property level, ERI was able to exceed its projected cost savings.  The same is expected to hold true for the merger of Caesars Entertainment, as management has guided an annual savings of $500 million, which many believe is a conservative hurdle creating an opportunity to both meet and surpass that goal.  Most of the synergy savings will come from reduction or elimination of expenses from corporate spending, 3^rd party professionals, streamlining staffing needs, and leveraging ERI’s legacy properties once they are added to the Caesars Rewards program.  During its time in bankruptcy, Caesars Entertainment was limited in the amount of capital expenditures it could make to maintain and upgrade its properties.  CZR’s recent spending was both accelerated and elevated to make up for the lost time.  The return on this investment is expected to start paying off in late 2020 and early 2021.  ERI’s $500 million synergy target includes lower spending targets and additional cost-cutting Caesars Entertainment had already slated for 2020 & 2021, and the reason many believe that Eldorado’s management will be able to wring out additional savings from SG&A, corporate overlap, and overhead expenses.

Debt Reduction

In addition, $4.5 billion of debt is expected to be retired within 2 years of completing the acquisition.  The money to pay for debt reduction is expected to come primarily from post-acquisition property sale-leasebacks along with increased free cash flows.  At the time of the CZR merger announcement, ERI disclosed that it proactively entered into a sale-leaseback agreement for three of its casino assets to avoid anti-trust concerns: Harrah’s New Orleans, Harrah’s Laughlin, and Harrah’s Atlantic City.  These property sales along with the uniform extension of Caesars’ current lease agreements with VICI Properties amounted to approximately $3.2 billion.  As part of the deal, VICI will have the right of first refusal for sale-leaseback on two of the Las Vegas properties currently owned by Caesar Entertainment, if and when they decide to sell, which includes:  Planet Hollywood, Paris Las Vegas, Flamingo Las Vegas, and Bally’s Las Vegas.  In October of 2019, Blackstone Group purchased the Bellagio on the Las Vegas Strip for $4.25 billion in a sale-leaseback agreement with MGM Resorts International.  That deal equates to over 17x the annual rent vs. the roughly 12.5x multiple that ERI received for its $3.2 billion deal with VICI.  With only 4 REITs (Real Estate Investment Trusts) competing in the gaming space, and a limited number of premier Las Vegas properties, one can expect that a sale-leaseback of up to two of Caesars’ Las Vegas properties will produce significant premiums for the combined Caesar's entity.

Sports Betting

Since the Supreme Court gave the states the right to legalize sports betting in May of 2018, it has been the fastest-growing segment of the gaming industry, especially outside of Nevada.  Caesars currently operates 29 sportsbooks across the country, including 17 outside of Nevada.  With the inclusion of ERI’s properties and more states welcoming sports betting, that number of sportsbooks and the revenue they generate will quickly increase.  Currently, legal US sports betting accounts for a mere fraction of the total sports betting already taking place and less than 8% of gaming revenues.  As more states legalize and expand sports betting, many expect it to help offset the casino's dependency on live gaming.  Having been a pillar of Las Vegas casinos for many years, sports betting draws a loyal crowd and CZR is known for running one of the largest sportsbooks on the strip.  With its favorable odds, betting lines, wagering options, and expanding national footprint, the new Caesars entity is in a strong position to leverage both the size and scope of its branded sportsbook to gain market share.  Caesars’ CEO, Tony Rodia, has mentioned that properties experience a “roughly 10% increase in casino traffic once sports wagering is added, which drives incremental gaming, hotel, and food and beverage revenue.”  The increase in casino traffic is also helping increase membership in Caesars' loyalty program.

Loyalty Program

The Caesar Entertainment acquisition not only gives Eldorado an immediate foothold in Las Vegas but also access to over 55 million active Caesar Rewards Members.  For over 20 years, Caesars has been monetizing its brand into loyalty amongst its customer base and through its rewards program, driving traffic to their properties with discounted stays, airfare, and room upgrades.  When a rewards member visits a casino, the Caesars Rewards’ algorithms actively monitor their trip in real-time – providing free meals, complimentary tickets to events or spa treatments, and discounts at in-house retail shops based on their daily activity.  The focus is to create both a personalized and memorable visit, greater loyalty, and long-term profitability.  Now that most of their members have the Caesars Rewards app on their phone, Caesars can track each customer’s movement in real-time adding another layer of data.  Casinos have recently recognized that being able to access and analyze their customer’s “big data” may be just as important as their gaming license.  By merging all of Eldorado’s properties and approximately 10 million Club One Members, the new Caesars will have more properties, more opportunities, and over 65 million members to monetize.

Live Gaming

It is fully expected that Eldorado’s management will not only be successful in cutting costs and redirecting investments but will yield a much stronger and more profitable brand with a national footprint and a global presence.  But even with all the benefits this acquisition expects to achieve, there remains an elephant in the room:  The growth of live gaming revenue (table games, but mostly slot machines) is slowing/leveling-off and in some segments of the country, declining.  In 2019, forty-five percent of visitors to Las Vegas consisted of Millennials and the Generation Z demographic.  But unlike their parents’ generation, slot machines and table games are not what is drawing them to the casinos.  Instead, these visitors are coming for an experiential break that provides “adult freedom” in a “judgment-free zone” with their friends.  This new breed of Las Vegas guest is more focused on spending their money on drinks, dinner, entertainment, and at the casinos’ nightclubs rather than on the gaming floor.  Since the acquisition of Isle of Capri back in 2016, ERI recognized this trend and made sure that their casino’s food, beverage, and entertainment segments were a profit center, a mantra that has been reflected in all the casinos they have acquired. 

CZR had also recognized the changes in their visitors’ tastes and began catering to non-gaming entertainment by creating eSports arenas and hosting eSports tournaments.  In 2018, eSports generated around $900 million from endorsements, advertising, tournaments, and merchandise sales.  By 2022, Goldman Sachs expects dedicated viewership to increase to 276 million and generate over $3 billion when media rights are included.  Over 79% of eSports viewership is 35 years old or younger, a demographic that is highly coveted by the gaming industry to build loyalty, collect their data, and monetize for years to come.  It will not be hard to envision eSports being a strong segment of sports betting at some point in the future.  Essentially, the Millennial and Gen Z generations are just as likely to gamble, wager, and bet as their parents’ generation.  But unlike their parents, the type of gambling (sports betting and fantasy sports), where they gamble (mobile platforms), and how they gamble (smartphones) is not restricted to a casino’s gaming floor. 

Valuation

After a strong performance in ERI’s share price over the past few months, the stock has fallen in tandem with the casino sector and other travel and leisure companies, down around 20% YTD.  However, when you look at the last 6-7 trading days in February, Eldorado’s stock has plummeted over 35% from its highs.  Even though most of the combined Caesar's entity will be in the US, the expectation of canceled Las Vegas conventions, lower casino traffic, and the usual uncertainty surrounding a large merger is weighing on the company’s stock.  But the pullback in ERI’s share price is also providing an entry opportunity for the long-term investor.  There are several long-term positive catalysts for ERI.  Front and center is the expected $500 million in synergies.  Most of the synergies will come from cost savings with corporate expenses being the largest segment.  It is well documented that CZR had already begun trimming $100+ million in expenses for CY2020.  The $500 million synergy number does not address the anticipated revenue bump from ERI legacy properties (integrated into the hub and spoke model), the revenue increase from growth in sports betting, or the return on investment from Caesars’ capital expenditure spending in 2018/2019 that is expected to hit in late 2020 and early 2021.  Based on ERI’s management track record, the annual synergy number could easily grow to over $700 million with organic revenue growth adding to the total.  With that in mind, the company could easily achieve a conservative baseline valuation of $67/share ($500mn in synergies & pro forma $3.85bn EBITDAR * 7.75x less $20bn in debt and capital leases or $1.3bn for FCF) on a 1-year run-rate after the close of its CZR acquisition.  The bear valuation would have EBITDAR falling to $3.35bn (decline in EBITDAR and synergies of $300mn) yielding a roughly $40/share valuation.  On the upside, the new Caesars entity achieves EBITDAR of $4.25bn which includes $700mn in synergies and this translates into approximately $96/share.  I do recognize that there will most likely be some headwinds based on lower traffic (Coronavirus) and that could impact a couple of quarters or even lead to a downturn in the casino sector, but I feel those headwinds are temporary and reflected in my conservative valuations.  Given the size of the integration, an investor can rightfully expect there to be some unexpected challenges but over the long run, those challenges will pale in comparison to the upside potential.  When ERI originally announced its acquisition of Isle of Capri in 2016, management guided for $35mn in targeted synergies.  That number has recently been updated to $100 million as Eldorado continues to streamline its operations and monetize its assets. 

Catalyst

• Conservative and Achievable integration synergies of $500mn
• Leveraging Caesars' Rewards loyalty program with a combined 65 million members
• Leveraging Caesars' established Sportsbook & Brand as more states legalize sports betting
• Property sales and FCF to reduce debt