Description

To avoid wasting anybody’s time, I want to note upfront that this is a nanocap company with ~10% of free float (~$3m) and very low ADV. In other words, this one is a PA trade, and even then only for the poorer members of VIC. But it’s a pretty cool little idea, I think, so posting despite the low level of actionability for most members.

I.                    Thesis

I recommend a long position in Trans World Corp (OTCB:TWOC) at $3.12/share. TWOC is a Nevada company headquartered on fifth avenue in Manhattan, that owns three small but profitable casinos and a four star hotel in the Czech Republic, on the borders of Germany and Austria. At $3.12/share, investors are paying 3.95x LTM aggregate EBITDA, and just 2.56x European/casino-level EBITDA after stripping out the cost of the US management team, which is largely (completely?) superfluous. The price also represents ~76% of TBV, suggesting that there is a margin of safety in the form of significant hard asset coverage.

Normally this business would be an immediate pass at almost any price but as it so happens, two small cap activists (Wynnefield Caiptal and Lloyd Miller III) collectively own ~50.4% of the business, and just came to an agreement whereby they will effectively control the company after the forthcoming annual meeting, and are bringing in some directors with significant experience in the space. I believe that the new directors will take a series of steps which will unlock and enhance value for all shareholders over the long-term.

II.                  Business overview

Not much to say here. Three casinos on the Czech border, one with an attached hotel. Collectively 52k ft2 of gaming space, 85 hotel rooms, 61 table games, and 342 slot machines.

III.                US management team and pro forma valuation

One might wonder why a company with no operations in the United States continues to be managed by a highly paid executive team in New York. Specifically, the U.S. management team (in combination, presumably, with some public company costs) costs shareholders ~ $2.9 million/year. Until a restructuring of the company’s management fee in FY13, the cost of the US management team wasn’t even tax deductible in the Czech Republic, such that the US pretax loss was a one-to-one after tax reduction to net income. So for example, net income generated in the Czech Republic in FY12 was $4.5 million, but net income available to TWOC shareholders was just $1.6 million after factoring in the cost of the U.S. management team. There is a large NOL at the US level due to years of such losses, though I doubt shareholders will ever benefit from that NOL.

~$830k of the $2.9 million is compensation to CEO Rami Ramadan (who owns just $250k worth of stock including unvested RSUs after over a decade at the company). Another $500k - $1m is compensation for employees with titles that are either (i) redundant with comparable title in Europe; (ii) oriented towards new development (despite no material ongoing development activity); or (iii) with titles that companies of this size and simplicity just don’t need. The remainder is audit/tax expenses (~$250k), manhattan office lease expense (est $150k) and various unknowable administrative expenses (third party IR firm, travel to and from Europe, etc).

Importantly, there is a real and largely autonomous management team in Europe that is by all accounts capable of managing the existing operations without the added layer of overhead in NYC.

I think it’s a fair assumption that the new controlling shareholders will clean do some house cleaning here. They may not cut out 100% of the US management team but certainly I have to believe there are significant cost reductions forthcoming. Aggregate LTM EBITDA to shareholders was $5.4 million after a US Pretax loss of ~$2.9 million, suggesting that actual EBITDA generated by the European assets is $8.3 million (thus the 2.56x European/casino-level valuation).

Of interest, D&A is ~$1.6 million vs. ~$600k of annual maintenance capex requirements. And the Czech corporate income tax rate on casinos is 19.1%. So if the new board cares to unlock the value here, we are talking about ~$7.2 million of casino-level unlevered free cash flow, implying a pro-forma ufcf yield ~34% at prevailing prices. I’m not going to sit here and tell you these casinos are the most attractive assets in the world, but there is no question that at such level investors are being well compensated for the risk of investing in subscale Czech casino properties.

IV.                Borrowing Capacity

The controlling shareholder also have options to create/unlock value via the balance sheet. I spoke with some friends who have lent into the European gaming industry and this company could easily support $15 million of senior debt on attractive terms, even with no reduction of US mgt costs. Whether this capacity is used for a dividend or the purchase of additional casinos in Europe (there are no shortage of assets available) is up to the controlling shareholders, but either way, prudent capital allocators should be able to return or enhance value. I think this company has $20+ million of dividend capacity and $30+ million of acquisition capacity given current financials and credit markets.

V.                  Property overview

If anybody is iinterested in learning more about these properties I am happy to discuss more in the comments section. But quick overview of each with revs and local market position:

Ceska Kubice: This is the worst casino in the portfolio with ~$7m of sales, down from ~$8m 5 years ago due to a softer market for European gaming as well as several new entrants into the local market. Ceska is the 2nd largest casino of 7 total casinos in its regional market.

Route 59: This is TWOC’s best casino, with ~$14 million of sales. The property results have grown in a relatively stable way from ~$4m in ’00 to present. The casino is collocated on a property with a unique shopping mall called Excalibur City (worth googling) that gets around 1m visitors per year. There is a second casino on the other side of the mall operated by Novomatic (largest regional casino owner in Europe), as well as a second Novomatic about a mile down the road. Route 59 is also collocated with hotel savannah, a four-star hotel and spa developed by TWOC that really nicely highlights the US development team’s capital allocation skills (~$15.5 million of development expense, but just $2.2 million of sales in 2013. Nice!). That said, the hotel does look nice (http://www.hotel-savannah.com/uvod/)

Route 55: I would describe route 55 as completely adequate. It does ~$12m of sales, which has been relatively flat since the casino reached maturity in FY08. This is by far the largest and nicest of three casinos in its market… The other two casinos in the area look terrible based on info I have been able to find online. One of them actually looks like it’s out of business (Classic).

VI.                Adjusted financials

The way that casinos were taxed in the Czech Republic underwent an unfavorable change in 2012. In the below summary income statement I show the last few years pro forma for that tax change (as if the current tax regime had always been in place).

VII.              Catalysts

Sale of the company (4x-5x casino-level EBITDA?); dividend recap; reduction of US management team expenses dramatically enhancing fcf.

Catalyst