The Real Issue with GamehostMy family and I have been at the cottage since July 1 and the weather has been spectacular. Unfortunately, today is the exception – rainy on and off and bigger rain later in the day.
I’ve taken a break from my usual 40-hour work week that I put in on researching and studying businesses and have settled into a temporary 21-hour work week for July and half of August. I’ve done the odd purchase here and there but I’m keeping my larger buying for September and October.
For my time at the cottage, I get up at 6:00am and head out for a 3-hour hike in the woods. I love this time. It’s so quiet and the air is fresh. I walk for the entire 3-hours and just think about business problems and situations and doing rough calculations in my head. It’s just me, my thoughts, nature and the odd little wildlife creature. I do this 7-days a week and this is my 21-hour work week for the summer.
Last week, I got to thinking about GH on a few of my treks. Wonderful operations and wonderful operating managers.
I don’t think there is anything new in this post that I haven’t said before – well maybe a few things are new – but I just wanted to communicate this to shareholders as I feel this is at the core of the perpetual undervaluation of the stock.
I want to start off by saying that Darcy Will and Elston Noren are not only outstanding operating managers but are outstanding individuals. We are lucky to have them operating our business. GH is the superior asset in gaming in the province of Alberta. I’ve had some communication with Darcy via email over the past few months and he is a high-quality individual. Again, we are lucky to have him.
It is very rare in business to find a high-level manager that can master operations or accounting or investing. It is almost impossible to name more than a very small group of CEO’s that master all 3 at the same time. For this reason, I don’t want the following to sound like criticism of management – constructive criticism, yes but not full-blown criticism with its negative connotation. This is just honest talk from a guy who has analyzed the Company in great detail and has thought issues threw and has solutions to propose. Criticism without any solutions to propose is just a waste of time and accomplishes nothing other than having the two parties become further apart in their thinking.
What are the strengths of management? Clearly the strengths of management are in the area of operations. Three fantastic sites have been selected for our casinos. In fact, it is the location of our casino’s that is our competitive advantage.
An analysis of GH’s margins – more specifically free cash frow margin – since the Company has been public demonstrates how good management is at operating this business. It is unlikely that there is another casino operator in Canada that has better margins that what GH puts up consistently.
Management has detailed knowledge of the industry and has superior execution skills and its conservative use of debt – too conservative? – is a hallmark of its operating style and has allowed the Company to weather all storms.
GH management is the superior operator in Alberta and Canada.
What are the weaknesses of management? Capital allocation.
Capital allocation encompasses 5 areas:
- Paying down debt
- Making acquisitions
- Reinvesting in operations
- Buying back stock
- Paying dividends
GH’s debt is not an issue. Making acquisitions is difficult as there are only so many casinos that exist. The number of quality casinos that are profitable are even smaller. The number of casinos with a good location are even smaller and those that are available for sale at a reasonable price are likely almost non-existent. We can’t fault management for not having made sensible acquisitions in the past.
Management regularly reinvests in its operations and this is a necessity to maintain our competitive advantage.
So far, so good.
Where management drops the ball is by having a history of paying way too much in dividends instead of buying back its stock. From 2011 – 2019, GH has returned more than 78% of all of its free cash flow to shareholders via dividends.
This would not be an issue if its stock was overvalued but has been deeply undervalued. A golden opportunity to create massive shareholder value has been consistently squandered.
When you can buy $1.00 of a great asset for $0.58 - $0.66 as is currently the case, and you pass this up to give the cash to shareholders via a dividend, you have passed up an incredible opportunity to make your shareholders richer.
Why is GH perpetually undervalued? Management’s poor capital allocation skills – paying way too much as a dividend when the stock is very deeply undervalued – has been noted by the Street and is viewed as a place where cash goes to die instead of creating additional shareholder wealth.
The NCIB and its daily repurchase of 1,100 shares is too little. The odd repurchase of 50,000 shares or so is also too little. Our stock is undervalued by 34% - 42% and so repurchases need to be done in a major way. An SIB coupled with a larger NCIB would be warranted given massive undervaluation.
Put another way, GH’s current market cap is approximately $185M. To be fairly valued, its market cap should be in the range of $281M - $322M. Why are we paying out a dividend instead of buying back our company?
If management found a casino for purchase that consistently has superior free cash flow margins, a strong competitive advantage of long duration that was conservatively financed with the best management around to operate it in a province that has tailwinds due to the structural lack of oil supply for at least 4 or 5 years and could buy the operation for somewhere between 34% to 42% below the price a rational well informed buyer would be willing to pay for it and did not proceed with this acquisition and instead paid out over 78% of its free cash flow every year to shareholders, you would say they are either incompetent in terms of capital allocation and investing or insane.
I can tell you from experience that the Street does not like poor capital allocators and will not pay a fair price for its shares do to the view that all future free cash flow will not be put to good use and will not created shareholder value. That company’s stock will trade at a discount to its intrinsic value.
This is the reason for the perpetual undervaluation of GH.
Revenues and free cash flow will be strong in 2022 and will grow over the next few years unless we see something totally unexpected with a future COVID variant.
Science informs us that all future variants should be more and more contagious but less and less severe in terms of the health repercussions. The logic behind this is that the virus does not want to die. The virus wants to live and so will learn over time not kill its host body. It wants to co-exist.
The future is bright for our operations but management needs to wake up to the reality of GH’s perpetual stock undervaluation and allocate capital in a more productive way that will enhance shareholder value and cease in destroying it.
The Board of directors are the ones who approve capital allocation practices. The Board approves dividend payments, stock purchases and all other capital allocation practices. They need to hold management accountable for its actions and for the Company’s stock price over a period of 10 years.
Shareholders must hold the Board accountable for all capital allocation decisions. An underperforming stock over a period of 10+ years is not acceptable when the main reason behind the underperformance is not having bought back your stock when it was deeply undervalued – which is all the time – thereby showing investors that you cannot create value and are not acting in their best interests.
What may happen – if this continues – is that an investor may launch a proxy fight. That investor may outline in a letter to all shareholders his detailed views about stock buybacks being the best way to elevate GH’s stock price to its intrinsic value and asking for shareholders to vote to have him elected unto the Board of Directors to attempt to influence the decision making process at that level.
Management and the Board must act with the best interest of all shareholders and not a select few. Shareholders own the Company and want to make money. This is not a charity event.
David Rubenstein asked Sam Zell – co founder of EOP office properties – why he sold his company for $39B when he was deeply attached to it and it was his baby?
Sam Zell responded “I’ve always felt that the day you take the publics money there’s a definition of who you are obligated to. When you’re investing your own capital in a private situation you’re indebted to yourself. The moment you go public and take in public capital that’s the moment where the publics interest should govern your decisions.
It was an easy decision for me (to sell the company) even though it was my baby that I started from scratch.
If I wanted to own it forever I should have kept if private.” Enjoy the rest of your summer!