Description

 

"An event is only random when no one cares to predict it."

 

William Poundstone, 'Fortune's Formula'

 

 

 

Activists have taken control of casino owner and operator Full House Resorts (ticker: FLL).  There are three possible outcomes to this story, and the ultimate outcome should be known in the next 18 months or less.

 

1.  Activists will fix the Company, and then they will sell it for a price that is higher than the price you have to pay to own the shares today.

 

2.  Activists will fix the Company, use it as a platform to roll up smaller operators, and thus create a ton of value that far exceeds the price you have to pay to own the shares today.

 

3.  Activists will be unable to fix the Company, yet they will still be able to sell it for a price that is at or above the price you have to pay to own the shares today.

 

We predict that shares of Full House Resorts are at least double from their current share price with additional upside should macroeconomic factors such as gas prices stay low and consolidation in the casino industry take hold.  Investors have the opportunity to participate in a turnaround led by a deep bench of both casino industry veterans and activist investors who have made a career out of creating stockholder value.  Downside protection resides in the hard asset values and licenses of the properties that Full House owns or controls.  Furthermore, shareholder and management interests are properly aligned by virtue of insiders' significant ownership of the Company and reputationial risk inherent in this type of undertaking.

 

 

Background

 

Formed as a Delaware corporation in Jan 1987, Full House Resorts, Inc., owns, operates, develops, manages, and/or invests in casinos and related hospitality and entertainment facilities.  For the 12 month period ending in Dec 2014, 2015, the Company had $109.5m in sales and around $10m in EBITDA.

 

The Full House Resorts portfolio currently looks like this:

 

 

(1) Silver Slipper Casino is expected to open its hotel in the first half of 2015.

 

(2) Includes a 190-room hotel that we own and operate, and an adjacent 104-room hotel that we lease pursuant to a 10-year capital lease.

 

(3) Under the Facilities Agreement dated June 29, 2011 with Hyatt Equities, L.L.C. we have the ability to provide rooms to our guests at the Hyatt Regency at Lake Tahoe upon mutually agreeable rates, as well as other amenities and services that cater to our guests and support our operations.

 

SOURCE: Form 10-K filed Mar 25 2015

 

 

 

A Brief History

 

Full House had its NASDAQ IPO in 1993, raising a total of $8m.  Barely public for just over a year, in 1994 legendary businessman Alan Paulson bought a 17.5 percent stake in the Company and became its chairman and CEO.  Paulson is best known for founding Gulfstream in 1978 by acquiring aircraft assembly plants originally built by the Grumman Corporation.  Many will recall that Chrysler acquired Gulfstream in 1985, during Lee A. Iacocca's tenure as chairman.  Few will remember that in 1990, Paulson bought it back along with Forstmann Little (and would later sell it again). 

 

When Paulson took the reins of Full House in 1994, Iacocca acquired a 12.2 percent stake in the company, receiving shares in Full House in exchange for land he owned in Branson, Mo., and his portion of an agreement to help Indian tribes develop casinos in Michigan.  Full House Resorts issued 1.25 million shares to Iacocca and 500,000 shares and a $375,000 promissory note to two Iacocca partners who owned 45 percent of Omega Properties Inc., of which Iacocca owned the rest.  Iacocca would later join the Board and remain there until his resignation in Sept 2013, citing his 89th birthday and desire to spend more time with his family.

 

Paulson served as Chairman and CEO until his death.  When Paulson passed away at the age of 78 in July 2000, his shares were left to a Trust and Alan Paulson’s son, Michael Paulson, took over as Full House Chairman.  The Trust, which at one time held over $250m in assets, from real estate to race horses (including 'Cigar', noted for being the leading earner in Thoroughbred racing history) was so poorly managed by Michael that the family would later sue in 2009 to have him removed as Trustee.  The judge’s decision would read that Michael Paulson “Put his own personal interests ahead of the interests of the trust beneficiaries, misused trust assets for his own personal benefit, and used his position as trustee to harm, or seek to harm, other beneficiaries.”

 

Andre Hilliou appointed by Michael Paulson in 2004 was nothing short of awful as CEO, and in retrospect, this is not much of a surprise.  This was not the first time that Hilliou had his issues running a public company.  In 1999, Hilliou was forced to resign as Chairman, President and CEO of American Bingo & Gaming Corp. under tenuous circumstances.  American Bingo’s 10-K read: “Mr. Hilliou was unable to forge and execute a strategic vision for the Company and was further unable to inspire the Board of Directors to work effectively together. After almost a year of internecine warfare, six members of the Board of Directors and the Management team resigned in mid-1999 shortly after the Company's Annual Meeting.”  The December 2000 10-K of Littlefield Corp, another bingo operator run by Hilliou in the 90s, categorized the leadership of the company under his stewardship as “chaotic”.

 

At FLL, Hillou would preside over string of expensive acquisitions followed by suboptimal performance of the properties featuring multi-year declines in revenues and poor capital allocation which left shares to languish into the very low single digits, prompting the attention of activists.

 

Activists show up 

 

In October 2014, a group led by activist investor Bradley Tirpak dubbed "The Concerned Shareholders of Full House (CSFH)" showed up in white knight fashion and initiated their campaign to gain control of the Board.  The group purchased the bulk of their shares in FLL in May 2014 and had built a 6.2% stake in the Company.  Tirpak brought with him a substantial team including former Pinnacle CEO, Steve Wynn protégé and former Bellagio head, Daniel Lee.

 

Bradley Tirpak, is a portfolio manager with about 20 years of experience who formerly worked at Credit Suisse First Boston and for Bruce Kovner at Caxton Associates. Tirpak has several small funds, and has been a small cap activist at several other under-performing companies, but this investment appears to be only his personal funds.

 

Dan Lee was a Wall Street analyst at Drexel and CS First Boston. He was then CFO of Mirage, CEO of Pinnacle, Developed the Golden Nugget in Lake Charles, and then CEO of the Palms.

 

Daniel Lee’s creativity and savviness are well known.  When Lee left Pinnacle, the Company had just forfeited its last gaming licenses in Louisiana. Lee was able raise $12m and acquire the project, a $500m development in Lake Charles.  Before construction ever began, Lee sold the licenses to Ameristar in March 2012 for around $32mm. Ironically, when Pinnacle bought Ameristar in Dec of 2012, they had to divest themselves of the project.

 

Amongst the typical list of activist gripes such as excessive Management compensation and poor share price performance, Tirpak's group pointed out several key failures of the existing Board in their filings that made a very strong case for change.  Some highlights included (source: Oct 28, 2014 CSFH Letter to Fellow Stockholders (paraphrased):

 

Poor Capital Allocation

 

In January 2014, with the shares hovering around $2.65, the Company filed an S-1 for the proposed sale of $46m worth of common stock, ie the equivalent of around 17.3m shares, or nearly 90% dilution without even providing shareholders with any information about what the capital would be used for.

 

The Company spent $157m for its three major acquisitions, then spent $8m a hotel expansion and spent half of the approx $18m cost of a hotel being built in MS.  As of June 30, 2014 the Company had $67m of long term debt and its equity was valued at $1.41 per share for a total enterprise value of only $80m.

 

Fitz Tunica deal falls through – Company loses almost entire deposit

 

On March 24, 2014, the Company announced that it had entered into a contract to acquire the Fitzgerald's Casino in Tunica, Mississippi for $63 million, plus expenses, operating cash and working capital and indicated that it would fund an additional $7.0 million in required renovations.  Inclusive of funding of the operating cash, working capital, deal expenses and the renovations, we estimate that the Company needed approximately $75 million to consummate this acquisition and expansion – a sum that exceeds the approximate $69 million enterprise value (market cap plus net debt) of the entire company at September 30, 2014.  On August 8, 2014, when the Company was unable to complete the purchase, the seller of Fitz Tunica sued the Company, alleging damages for a breach of contract by the Company.  The actual contract apparently did not include a clear clause that the contract was contingent on financing. On August 21, 2014, the seller and the Company entered into a settlement agreement under which the Company forfeited $1.7 million of the funds held in escrow and the Company received only $50,000.  In addition to losing more than 97% of the $1.75 million escrow, the Company incurred approximately $300,000 in professional fees associated with the Fitz Tunica transaction.

 

Financial Peril

 

On March 31, 2014, seven days after announcing the acquisition of Fitz Tunica Casino, the Company exceeded the allowable total leverage ratio and the first lien leverage ratios under both of the Company's Credit Agreements.  Although the Company eventually received waivers from its creditors for compliance with these ratios as of March 31, 2014, we believe it was reckless of the Board to allow management to commit to major capital outlays at a time when its financial footing was uncertain. 

 

For the quarter ending March 31, 2014, the Company paid $50,000 to obtain a waiver for breaching the leverage ratios in its Second Lien Credit Agreement.  On July 18, 2014, the Company paid a further amendment fee of $100,000 to amend the Second Lien Credit Agreement and agreed to raise the interest rate on the Second Lien Credit Agreement from 13.25% to 14.25%.

 

***

 

 

Support from other holders

 

In an unusual demonstration of support by a Trust, the Alan Paulson Trust issued a public press release on October 20th voicing their support for Tirpak's group.

 

The letter was written by Co-Trustees Crystal Christensen and Vikki Paulson.  Vikki is the widow of James Paulson, who was Alan’s son (Michael’s brother).  Crystal Christensen is Vikki’s daughter.

 

“Throughout the years, we have followed closely all Company decisions and communications, and have communicated separately with members of the Board and management.  On October 9, 2014, we received a letter from a group of stockholders of the Company announcing their intention to seek to call a special meeting of the stockholders of Full House Resorts.  As a stockholder with a long history with the Company and after careful consideration, we have determined at this time that the Allen E. Paulson Living Trust will support the call to convene such a special meeting.  While we are reserving judgment on the merits of the various proposals put forward by this group for consideration at the requested special meeting, we do believe it is important that the stockholders and the Company have an open dialogue with respect to its management, and to gain some transparency with respect to the Board's and management's plans for the direction and prospects of the Company on a going-forward basis.  We look forward to receiving additional materials from the Company and from this group of stockholders in the spirit of fostering such a dialogue and maximizing the Company's potential and its value to its stockholders.”

 

***

 

After the typical playbook back and forth letter public letter writing campaign, the Concerned Shareholders of Full House claimed victory on December 1, 2014.

 

The Board increased from five to nine members and the Company accepted the resignations of Andre M. Hilliou and Mark J. Miller as directors and entered into Separation Agreements with respect to their employment.

 

 

 

To fill the resulting six vacancies, W.H. Baird Garrett, Raymond Hemmig, Ellis Landau (retired former CFO of Boyd Gaming), Daniel R. Lee, Bradley M. Tirpak and Craig W. Thomas were appointed to serve as directors.  Daniel Lee replaced Hilliou as the Company’s CEO.

 

Regime change had come to Full House.

 

Let Change Begin

 

The first time that Daniel Lee spoke to the market was on March 17, 2015 when FLL reported earnings.  For those of you who follow activist turn-arounds, Lee's remarks on this call were one of the most informative and straightforward presentations I have ever heard a new CEO make.  Lee was open and honest about what the problems at FLL were (and are today) and specified how the new team was going to address each of them.  The new team's plan is focused on several major areas including expense reduction and operational efficiencies, increasing traffic and refinancing expensive debt.

 

For the 12 month period ending in Dec 2014, 2015, the Company had $109.5m in sales and around $10m in EBITDA.  Over the last few years, the EBITDA margin decline was due to two main factors, 1) the old management team’s inexperience in operating properties as owners 2) the legalization of gambling in Ohio, which drove EBITDA down at the Rising Star from $10m to $2m.

 

Make no mistake.  Each of the properties has posted declines in sales and profitability and will likely never get back to the absolute peak earnings that they enjoyed in years past.  This does not mean that they are not ripe for some low hanging fruit type fixes to stabilize performance.

 

Rising Star hurt by competition

 

Despite the opening of a new hotel in 2013, performance at the Rising Star (just under an hour by car from Cincinnati) has been lackluster due to new competition in the surrounding area.  Many potential customers must pass one of two competing properties in order to get to the Rising Sun simply due to geography and the path of the Ohio River.  That having been said, the new management team is now lapping the Ohio casino openings that have hurt  them.  In addition, data from the Indiana Gaming Commission shows that trends are moving in the right direction as Full House’s property was up for the first time in over 24 months during January.  The old Management team paid over $40m for The Rising Star.  It could potentially be worth some small fraction of that to the other competing properties to shut it down, ie it is worth more dead than alive.  Net of closing and disintermediation costs, The Rising Star's ultimate value remains a question mark.  Management seems optimistic that access and traffic can be improved, and the casino is still profitable.  This analysis gives them the benefit of the doubt.  

 

Small, medium and larger projects to fix each of the casinos

 

Near term:

 

-          Hotel opening at Silver Slipper

 

-          Cut in corporate overhead (already cut $1m run rate per year)

 

-          New marketing hires to drive traffic

 

-          Ferry service for the Rising Star to bring additional customers in- this in addition to lowering rates at the hotel

 

 Longer term:

 

-          Explore value of their underutilized licenses

 

-          Refinance the debt

 

-          REIT one of more of the properties

 

-          Sell the Rising Star entirely

 

 

 

 

Levers to create shareholder value

 

There are several 'ways to win' under the new Daniel Lee-led Full House Resorts:

 

(1) Command an improved operations / multiple 

 

(2) Enter into a REIT transaction 

 

(3) Refinance the debt 

 

(4) Roll up other casinos

 

Improve EBITDA by rationalizing operations and get a market EBITDA multiple:

 

This is the least interesting of the revaluation methods and is thus where I will start.

 

Full House has $10m in ttm EBITDA.  Here is the bridge to EBITDA improvement:

 

Operating contribution by casino (source: public filings / due diligence)

 

Silver Slipper Casino (MS): $9m

 

Add operational improvements: $.5m

 

Add hotel opening*: $1.5m (contemplates 129 rooms at 60% occupancy)

 

Total operating profit Silver Slipper: $11m

 

Rising Star Casino Resort (IN): $2.2m

 

Add operational improvements: $0.8m

 

Total operating profit Rising Star: $3m

 

Stockman’s Casino (Fallon NV): $1m

 

Grand Lodge Casino (Lake Tahoe NV): $3.5

 

------------------------------------------------------

 

Total Operating Profit: $18.5m

 

Less Corporate Overhead ($3.5m) (midpoint of estimate from CEO and reduced from $4.6m)

 

= EBITDA: $15m

 

x 7.0x market multiple (low range of GS Apr 2015 report on gaming - mid cap operators) = $105m EV

 

TEV: $105m

 

Less: $52m net debt

 

Equity value: $53m

 

Shares: 18.9m = Value per share: $2.80  (versus $1.45 today)

 

REIT Scenario

 

A cursory look at Casino REIT Gaming Leisure Properties (GLPI) reveals a very simple formula for buying and leasing back casinos to operators.  It is called "2x".  GLPI looks for rents that are 2x covered by casino level EBITDA, and then assigns a cap rate to that rent figure of 7-8%.  One must assume that GLPI and Dan Lee know each other well from the industry.  Lee referenced the REIT idea on the last conference call:

 

 “What we are looking and trying to do is a sale leaseback transaction of some of the key properties where we would keep control of the properties, lease them back from a REIT, and trigger large tax losses on the sale because the impairment charges you take for GAAP do not result in anything for tax purposes, you have to actually sell something to get the tax loss.”

 

GLPI would likely be most interested in the Silver Slipper property, given its size and cash flow.

 

An illustration of a deal with GLPI for this property could look like this:

 

Operating Profit: Silver Slipper Casino (MS): $9m

 

Add operational improvements: $.5m

 

Add hotel opening*: $1.5m (contemplates 129 rooms at 60% occupancy)

 

Total operating profit Silver Slipper: $11m

 

2x coverage would mean a rent of $5.5m

 

$5.5m at a 7.5% cap rate = $73.3m in proceeds for the property to Full House.  This would pay down all of Full House’s debt.

 

Post REIT deal, the Company would be left with:

 

Silver Slipper $11m less $5.5m in rent = $5.5m

 

Rising Star Casino Resort (IN): $2.2m

 

Add operational improvements: $0.8m

 

Total operating profit Rising Star: $3m

 

 Stockman’s Casino (Fallon NV): $1m

 

Grand Lodge Casino (Lake Tahoe NV): $3.5

 

--------------------------------------------------------

 

Total Operating Profit: $13m

 

Less Corporate Overhead: $3.5m

 

= EBITDA of $9.5m

 

x 7.0x market multiple = $66.5m equity value

 

$66.5m / 18.9m shares out = $3.51 per share (versus $1.45 today)

 

(note that I am ignoring the excess cash left over after paying down the debt that the proceeds would bring.)

 

Play around with this scenario in any number of ways.  Even if The Rising Star is a zero, the shares are still worth $2.40

 

 

 

Debt refinancing

 

Full House’s second lien is expensive money, and Lee has committed to getting it refinanced.  A refinancing will save a substantial amount of interest expense.  Each 1% reduction in the Second Lien’s stated interest rate equates to $200,000 of savings.  This savings would have a large multiplier effect on the share price.

 

 

 

Current Rate	Potential Rate	Interest Expense Savings	Per Share Savings pre tax
14.25%	10.00%	$850,000	4.5c
14.25%	9.00%	$1,050,000	5.5c
14.25%	8.00%	$1,250,000	6.6c

 

 

 

From the last conference call:

 

“And then we have started talking to our banks and refinancing, I think across the board they've said they are interested in just rolling their debt into a new deal, so we are working on that and hope to have that done on the first half of the year and I guess that's it. And I don't know where we will go from there, we will go one step at a time.”

 

If you capitalize the saving per share at 10x, you get a range of $0.45-$0.66c in additional value.  Given the low current share price of $1.45, these are not trivial amounts from a total return standpoint, resulting in a price per share that ranges from $1.90 - $2.11.  While this might not seem like a home run, a de-levered Full House should also get a better EBITDA multiple as the financial risk of owning the assets has been eliminated.

 

 

 

Roll-up Strategy

 

How and why would a Company like FLL even consider taking on another property?  Because Lee knows casino operations, and the 900+ casinos in the US need to be consolidated.  In addition, scale would take EBITDA above some crucial bank-friendly hurdles and facilitate an even more attractive refinancing.

 

Say FLL were to buy an operator with $3m in pre-synergy EBITDA for The Outlaw Casino (a made up property).  This would take FLL EBITDA above the $15m mark, increasing the universe of bank lenders that would be willing to refinance all of FLL's debt into one attractive piece.

 

Were FLL to pay 5x pre-synergy EBITDA for The Outlaw, or $15m and finance it 80% debt and 20% equity, the Company would look like this:

 

New EBITDA: $18m ($15m FLL + $3m The Outlaw)

 

New Debt: $12m + $60m old debt refinanced into $72m of total long term debt at 7%

 

Less Interest:: $5m ($72m at 7%)

 

Less D&A: $9m (likely higher with new property)

 

= Pre Tax Income: $4m (Company likely not a tax payer)

 

Less Capex: $4m (publicly stated)

 

Add D&A: $9m

 

= Free Cash Flow: $9m

 

old shares 19m FLL + new shares issued to The Outlaw's owners of 2m ($3m worth at $1.50) = 21m total shares

 

$9m / 21m shares = $0.42c per share in Free Cash Flow  @ 10x this is worth $4.20 per share

 

 

 

Tax Refund an extra ‘kicker’

 

While this is not key to valuing FLL as a going concern, it once again highlighted a prior management deficiency as well as a non-trivial source of cash for FLL.   New management filed FLL’s federal income tax return for 2014 in Feb of 2015.  The substantial tax losses in 2014 have the ability to be applied to taxable income in 2012 according to IRS lookback rules.  In 2012, FLL had a pre-tax gain of $41.2 million on the sale of the management rights and management agreement for the FireKeepers Casino (Battle Creek, MI).  Lee’s group was able to secure a $3m tax refund, but it could have been as much as $10.

 

From the March 17^th Conference Call [paraphrased where appropriate]:  “We had a complete change in fire drill in the last week of the year, because we could have triggered $30 million in tax losses and could have received a $10 million check from the IRS.  We just couldn't find a way to move that fast mostly because of the regulators who said it would clearly take regulatory approval. Frankly, I wish we had had a proxy battle six months sooner. With a few months, we could have done that and got a $10 million check from the Federal government, which would have moved the needle in addition to this $3 million we are getting.  So a little bit of a missed opportunity there.  If you recall the change of management happened, I think the second week of December, and by the time we discovered it, it was just about Christmas and you had to get it done by year-end, it just was impossible.  We are exploring other methods to try to get some of that tax refund, don't think we can get all of it, but we might be able to get some of it. Frankly, when I came in as CEO, I didn't know it existed, it was manna from heaven…”

 

In short, something between zero and $0.37c per share may still be recovered by the Company.

 

 

Insider Buying

Directors Tirpak, Landau and Thomas have recently added to their stakes at the (around) current price of $1.50 per share.

 

In Summary

 

We think that there are multiple ways to win at Full House, and that the Management team and Board are working extremely hard to pull multiple levers at the same time to help this long neglected set of assets realize their true potential.  Downside is protected by the hard value of the properties and licenses to operate.  

 

 

 

Risks

 

Economic downturn cuts traffic to the properties.

 

An uptick in oil (gas prices) interrupts the success that casinos have experienced as of late.

 

The properties languish due to competitive pressures.

 

A refinancing or REIT transaction fails to materialize.

 

Any number of regulatory actions that turn up in this space from time to time.

 

 

 

 

 

Catalyst

Several ways to win.

- Debt refinancing

- Operational improvements

- REIT transaction

- Sale of the entire Company

- Roll-up strategy