Description

Short Recommendation - WPT Enterprises, Inc.

Poker? but I barely even know her...

OK, seriously, if you know who Phil Helmouth, Doyle Brunson, Howard Lederer, and Phil Ivey are, or if you have ever been burned on the river by some tourist holding 3-7 offsuit, you can skip this brief introduction to WPTE and move straight to the short case. If you are new to Texas Hold 'Em and the World Poker Tour, here's what you need to know.

Poker is the generic term applied to any traditional-deck card game utilizing the rank order of hands that we're all familiar with. A pair beats ace-high, two-pair beats a pair, and a straight flush is like... unbeatable... (shameless Honeymoon in Vegas reference). You get the idea. Within the generic class of games called poker you have variations where your hand consists of combinations of "up" cards, cards everyone can see, and "down" cards (or hole cards), cards that only you can see. The World Series of Poker was started at Binion's Casino in downtown Las Vegas with a few now-notorious gamblers including Amarillo Slim and Doyle Brunson. The variety of Poker chosen for the World Series was Texas Hold 'Em. This game consists of two down cards and five community up cards. The player with the best five-card poker hand wins. Within the last few years, Texas Hold 'Em has increased in popularity as a direct result of ESPN's broadcast of the World Series of Poker and the Travel Channel's broadcast of the World Poker Tour. A novel technique used at the World Poker Tour is the placement of a "down" card camera, which reveals these cards to the viewing public. This gives the World Poker Tour a reality TV feel and has been a catalyst for its popularity.

WPTE Business Overview -

Steven Lipscomb started the company in 2002. He was CEO until the company became public, then relinquished the title and now retains presidency of the company. The CEO is now Lyle Berman, former Grand Casinos chairman. Mr. Berman is also Chairman and CEO of Lakes Entertainment (LACO), a publicly traded company that runs tribal casinos. LACO owns 64% of the outstanding shares of WPTE and also performs G&A services such as treasury, HR, accounting, and marketing. WPTE compensates LACO for these services. Lipscomb had the idea to film professional poker players playing Texas Hold 'Em in a reality TV format. The Travel Channel gambled on the series and won big, scoring extremely high ratings for a cable TV series.

Operating segments

WPT studios:
The studios segment produces and licenses the World Poker Tour television episodes. WPT has entered into agreements with the Travel Channel to exclusively broadcast Seasons One and Two of the WPT in the U.S. and options to acquire similar licenses for the episodes comprising each of the Seasons Three through Seven, the last of which will be in 2009. These licenses accounted for 83% of total company revenues since inception. In May the Travel Channel exercised its option with respect to Season Three for which the company expects to receive $10.8 million in license revenue. International license fees have generated an additional $500k to date.

WPTE Consumer Products:
The company licenses the WPT brand to playing card and poker table manufacturers. This segment accounted for about $200K in revenue so far.

Other:
Host fees from casinos, memberships and sponsorships should account for a little over $2 million in additional revenue in 2004.



The Short Case
I need to start by admitting that I love to watch the WPT. I also love poker. But the fact is that WPTE is a TV producer with a popular new reality show and is subject to the ebbs and flows of viewer interest. Management was hoping to create, and is pitching the company as, the next NASCAR Winston cup series or NFL season with their WPT franchise. But the low capital requirements of producing a TV poker game almost insure viable competitive threats like the ones we are already seeing from Championship Poker at the Plaza, a 26 week television series broadcast on UPN, and BRAVO's Celebrity Poker Showdown. Harrah’s has recently purchased the rights to The World Series of Poker and has already flexed some of its marketing muscle in promoting it.

I can't help but think we may be at a point of maximum optimism for WPTE shares given the popularity of the TV series and poker in general. (my MBA interns all play poker online instead of reading up on their Graham and Dodd). The market is currently pricing in overly optimistic growth projections. While WPTE is a profitable licensor with attractive economics, at 115 times earnings, they would need to grow large and grow quickly to catch up with its current valuation. I believe that this scenario is unlikely.

Financials:

MV $260 million
Cash+ST inv $30 million
EV $230 million

2004E REV $16 million
COGS $9 million
SG&A $5 million
NET In $2 million
EV/NI 115x

Even if the company deserved a 25x multiple (a generous assumption), the company should be generating at least $9 million in run-rate earnings to be appropriately priced. How could the company get there?

The largest piece of the business by far is the domestic WPT studios division, which we know from company filings will only generate $10.8 million in total revenue and perhaps $5 million in GP contribution in the next year. Total company SG&A growth should push 2005 higher than the 2004E of $5 million. Applying total SG&A against the domestic studios division leaves us at essentially zero. Considering the studios division is 83% of the business, in order to get us to the desired $9 million we would need that much in revenue from the other 17% of the business -

segment revs in MRQ revs past 9 months
International TV $345,000 $510,000
Product Licensing $159,000 $212,000
Host Fees $50,000 $850,000
Memberships $42,000 $510,000
Sponsorships $28,000 $205,000
PPT - see below 0 0
$624,000 $2,287,000

The total contribution from these segments would obviously have to triple to quadruple for current valuations to be close reasonable.

Looking out past 05, the Travel Channel would also have to markedly increase the amount it was willing to pay per episode (if it decides to exercise its option at all) in order for WPTE to get more juice in its core business. In fact, the licensing arrangement with the Travel Channel can be viewed like a royalty trust if you operate on the premise that WPT does not become the next NFL and instead goes the way of the dodo in the years down the road.

The company is spending in an attempt to replicate the success of the WPT by launching the Professional Poker Tour. There is certainly the possibility of financial success with the PPT, but cannibalization and fragmentation are likely to occur. I believe that there is enough 'margin of safety' built into current prices for the PPT to be a success and have investors still make money on the short side.

Lastly, LACO (64% owner of WPTE) generated no revenues as of last year and disclosed that it needs $12 million in corporate costs to be covered along with $10 million in development costs for one of its tribal casinos. It only has about $15 million on the books and will most likely need to source additional funds. A likely candidate would be sale shares if WPTE.


Risks:
The company has a relatively small market cap and even smaller float, so the usual risks/problems apply when shorting.

Catalyst

LACO share sales after lockup expires
Competitive threats increase
Profits fail to materialize