Gamehost will have its annual meeting on Tuesday May 10
th and first quarter earnings will also be released at this time.
While I never put too much emphasis on any quarterly earnings of the companies that I invest in, as the reality of any business differs from the steady flow of progress that all investors wish for, it will be interesting to find out to what extent our customers are coming back and how the renovations, that were started at Grande Prairie this spring, are progressing.
It will also be interesting to hear any news concerning any possible plans for growth other than the expansion and renovations of our current casinos.
Here is a brief discussion of the Company’s competitive advantage, its operating management and its fair value. I’ll then briefly discuss ways that we can expand on this fair value and why they should be seriously considered and on areas where the Company can improve.
What makes a successful investment? In my view, for an investment to be considered successful, it must satisfy three criteria. It must have a competitive advantage. It must be operated by honest and competent management and it must be purchased at a price that makes business sense. An investment will not beat the market averages, over time, if any of the above three criteria are not present.
A competitive advantage is very important. Without one, a company cannot earn a high rate of return on its capital employed as competition will reduce your margins to industry averages.
You need your management to be competent and honest. If management does not execute, due to a lack of competency, again your margins will suffer thereby reducing your free cash flow per share and your stock valuation. If management in not honest, they will manage to pad their own personal accounts at the expense of shareholder gain.
If you pay too much for a stock, in relation to its free cash flow, you will make an inferior return, or even worse lose money. Price matters.
Our investment in Gamehost meets all three criteria.
Gamehost’s competitive advantage GH has a strong competitive advantage, which is the location of its three casinos:
- The Deerfoot Inn & Casino is located in the deep south-east quadrant of the city of Calgary at a significant distance from all other casinos. It is the only casino in the deep south-east quadrant of the city. The casino is located in Ward 12, which is the most populated Ward in the city.
- The Great Northern Casino is the only casino in Grande Prairie. Evergreen Park is a REC on the outskirts of Grande Prairie that offers VLT’s and 99 slot machines.
- The Rivers Casino & Entertainment Center in Fort McMurray has no other gaming competition in the Regional Municipality of Wood Buffalo. VLT’s are not permitted in the municipality leaving Gamehost slot machines as the only electronic gaming option other than bingo.
GH’s Fort McMurray location has no competitors. Its Grande Prairie location has almost no competition and its Calgary casino is in a great location far away from the other Calgary casinos.
The AGLC has recently removed the moratorium on the issuance of new casino licenses. While it is true that competition will not appear overnight, it is equally true that where competition is allowed to form, competition appears. Capitalism sees to that.
Our competitive advantage is still strong but its duration is diminishing because of this new development. This must be taken seriously and action is required. If nothing is done, our margins will fall and will result in diminishing free cash flow as a percentage of revenue and our stock price will be negatively impacted.
The time to call the fire department is not after your house has burned to the ground.
Operating management Clearly, management are good operators. This manifests itself in the margins, free cash flow as a percentage of sales, debt levels and regular upkeep of our fixed assets.
You can’t focus on a one or three year period, as luck, both good and bad, play a role in the short-term. A longer-term analysis is needed to form an accurate opinion of all past actions.
From 2011 – 2019 (2020 and 2021 were excluded by design as COVID made all analysis meaningless), and based on free cash flow (ex-working capital items). GH had the following averages:
ROIC: 16.3%
This metric measures the free cash flow as a percentage of all capital used by the Company, including net debt. 16.3% is a very good percentage.
Free cash flow as a percentage of revenues: 29.0%
This measures the percentage of free cash flow produced for every dollar of revenue. In this case $0.29 of free cash flow is produced per dollar of revenue. This is excellent.
How many years of free cash flow to pay back all debt assuming no dividend is paid: 1.5 years. This is a very conservative level.
Anything under 3 years has a built in security buffer for bad times.
Free cash flow: $21,337,000
Free cash flow per share¹: $0.94
¹Based on current shares outstanding of: 22,657,848
Management has continuously put money towards maintenance and growth of its properties and those properties are well maintained.
All of the above speak to the competency and good managerial execution but also to a very large extent to the competitive advantage that the Company enjoys.
The Company would not be able to produce the above financial results with a weaker competitive advantage. This is why it is important to take any possible erosion seriously and an offsetting strategy must be implemented sooner rather than later.
Intrinsic value Based on conservative assumptions and a conservative discount rate, Gamehost has a fair value of $11.50 - $13.25 per share.
This does factor in the current very accommodative oil environment and the completed expansion work at the Deerfoot, the Rivers and the current work being done at the Great Northern in Grande Prairie.
It does not take into account any future growth initiatives the Company may engage in or any material stock buyback.
Gamehost at a crossroads For years, GH’s customers have remained the same. Over time customers age and must be replaced by new customers if you want to maintain financial performance.
For a long time, the newer customers were very similar to the older customers and so the Company has not had the need for a different vision and strategy. What worked, worked. Tried and proven and the results were good.
It is my strong belief, that the Company is at or rapidly approaching a crossroads as the younger population is materially different and their tastes, habits and interests are not as compatible to casinos as those of previous generations and that, over time, will hurt GH financially.
I believe this change is happening due to the mass use of social media by the younger generation, made possible by technology.
News, information, and views travel fast today and in milliseconds. Today people are disproportionately influenced by the everyman, everywoman celebrity on social media that has a huge impact and influence on younger people who want to feel part of the “in” crowd. Their tastes, habits and interests are influenced by the social media stars just like a prior generation was influenced by television. This must be acknowledged as being behind the reason that the world in changing and people are changing so rapidly. Technology will make change happen faster and faster over time. That is a fact. This is not bad. It is simply reality.
If GH only caters to its current, typical customer, its bread and butter customer, it will be risking its financial future unless you have ways of keeping its past customers alive forever. Time is our enemy and we must alter our corporate strategy.
Gamehost needs growth initiatives in new areas Gamehost should use the land next to the Great Northern casino in Grande Prairie to build restaurants, using the Fast Casual model that attracts younger tastes and a younger atmosphere. Asian and Mexican and a different breakfast model restaurant need to be considered. This is a proven recipe. You can refer to previous posts for the reasoning behind this.
If this model proves successful in Grande Prairie, it could be rolled out at the Deerfoot in Calgary and possibly at the Rivers in Fort McMurray (although this model may not work in Fort McMurray).
This would help us to attract a new younger customer and one that we can have for many decades to come. It would also allow us to differentiate our product offering and attract the type of customer that a new casino competitor would not be able to attract and therefor minimize the erosion of our competitive advantage when competition appears.
Upon completion, and after our competitive advantage has been solidified and a new customer is being attracted, Gamehost should expand into BC using this casino/food model.
There is no reason why GH cannot allocate some funds towards growth initiatives and grow into new territories and better protect our current ground. If we don’t lay out funds today, for future growth, we will pay the price down the road of having new competition that is targeting our old customers and a disinterested younger generation that we cannot attract.
If we continue to pay out a large portion of our free cash flow in the form of a dividend, we are setting in motion our own obsolescence.
We need to grow in a slow, disciplined and methodical fashion and we must not put this off. After all, the time to call the fire department is when you suspect something is wrong and not when your house has completely burned down.
If we can set in motion some growth initiatives and are successful, we will have much higher free cash flow and a substantially increased intrinsic value.
If the Market does not see some vision and growth initiatives, our stock will continue to trade at a discount and our future competitors and declining customer numbers will hurt us financially.
Our stock will continue to trade like a bond but with substantially more risk attached to it. The worst of both worlds.
Changes in the best interest of shareholders - Stronger Board of Directors.
The Board is responsible for capital allocation strategies, which includes new lines of business. We should have a Board that has skin in the game and owns a meaningful amount of stock. People act in their own best interests and having a substantial amount of stock makes you very motivated to have polices in place that encourages the long-term financial wellbeing and successful growth of the Company.
Do you think the level of interest, desire, focus, and time spent considering a Company’s capital allocation strategy and vision is the same for a Board member that has 200,000 shares of stock as a director that has 1,000 shares? Rephrased in a different manner, would you put out as big of an effort if you were on a Board and had $1,600,000 of your money in the stock as you would if you had $8,000 invested in the stock?
Of course you wouldn’t. You would pay very close attention and ask the hard questions if you had $1,600,000 invested in the stock. But why would you risk losing your director fees of say $25,000 a year if you only had $8,000 invested in the stock?
Yes, skin in the game will affect the capital allocation policies and corporate vision. Both of these will affect how much we make as owners in the Company.
Take a look at the proxy statement for GH and look at the shares held by our independent directors. Three directors have a
combined total of 4,500 shares (investment of $38,000) yet received $87,500 in director fees last year.
These directors are likely, very nice people and very honorable. I’m not suggesting otherwise. What I am saying is that people need to be motivated to do some real hard work and having a substantial amount of stock makes people motivated because they want their investment to produce good results. I think we can all relate to that.
- We would need to have a quarterly conference call set up by management giving owners an opportunity to ask questions, voice their concerns and hear management’s views and description of their corporate vision.
While the AGM is set up for this purpose, waiting 12-months to ask questions or hear how views are or are not changing is too long. More transparency is required. We are owners after all.
- With our stock being so undervalued, GH should explore the implementation of a Substantial Issuer Bird using a modified Dutch Auction. I will write a post about this at a future point in time as it would be too long to do so now.
Conclusion We are fortunate to have good management but we need to explore growth initiatives that would make the Company stronger and more profitable. The world is changing and people’s tastes and interests are also changing. This is happening everywhere and no place or company is immune to this.
These growth initiatives, along with more transparency, would allow the stock price to reach an increased level of intrinsic value, as a result of increased free cash flow and recognition of these factors by the Street.
Again, I would estimate intrinsic value to be between $11.50 - $13.25 currently.
Gamehost can achieve a much higher intrinsic value and stock price by growing via new markets.