CZR - A Joe's Pros Interview

Joe

Good afternoon. It's August 31st, 2021, welcome to Joe's Pros and thanks thanks for joining me today. I know you want to talk about Caesars (CZR), so please go ahead, outline your thesis and we'll get going with questions from there. 

Pro

Sure thing. Yes, we like Caesars, one of the largest gaming assets. The company’s stock is just above $100 right now, 208MM shares outstanding, so it’s got a $21B market cap, lease adjusted net debt is going to be somewhere between $18B - $19B, so you’ve got like a $40B enterprise value. The thesis here is really twofold. Number one, this continues to be a COVID recovery story. As revenues and earnings bounce back, the company continues to realize the synergies from its recent ERI merger and the earnings profile just probably exceeds consensus. And then number two, we think that the digital gaming asset is significantly undervalued and actually has negative value right now in the sum-of-the-parts and we think Caesars is going to be a major player there. I can walk through how we look at valuation for the stock and how things are tracking against the two tenets of the thesis. 

Joe

That sounds good. Why don't we start with the Delta variant in the short term and your ideas around that vis-a-vis the base business and then maybe put a little bit of time into how we got here out of bankruptcy, ERI, etc.? 

Pro

Sure. I guess just stepping back, Caesars went bankrupt. The company was overlevered. It was run by the guy who, incidentally, screwed up Hertz as well, and went through a bankruptcy restructuring process. The assets were purchased by Eldorado Resorts, who's been led by CEO Tom Reeg, who's been a tremendous value creator in the space. And so they bought the Caesars assets, integrated them with the ERI regional assets, and they've continued to capture and up the synergies. So now, the portfolio, in the land-based, includes what should be about $4.5B of steady state EBITDAR split about $2B in Vegas and $2.5B in regionals, and the company owns about 50% of its underlying real estate split pretty much equally between the two segments. This is actually pretty important because we've seen a variety of transactions that sort of shed light on owned EBITDAR (the core metric here) in the segment with EBITDAR valuations in the high-teens. So when I run you through the sum-of-the-parts on this, we're putting pretty conservative valuations on each of the segments. 

So land-based, you've got a portfolio of Vegas casinos that people are pretty familiar with. The number one that everybody knows, obviously, is Caesars Palace. There's a couple others in there, The Linq, The Cromwell, etc. So this is going to generate about $2B of EBITDAR annually. And what we've seen is a continued recovery in Las Vegas. And I know the stock went from just over like $110 down to $80 with concerns about the Delta variant screwing up travel. What the company has continued to say, they had a blowout Q2-- like every company in the sector, I think they beat by like 30% - 40%-- but the message was, “Look, Vegas continues to be like sold out on the weekends.” So far, the Delta variant hasn't been a major concern here. We've actually seen the cases begin to peak and decline in Florida, and I think that's kind of a leading indicator to things continuing to get better. I think that will help the sentiment of the stock, but Vegas is knocking the ball out of the park. What the company has said is that Q3 numbers are actually tracking better than Q2. Q2, they did just under $1B of EBITDAR, Q3 it looks like Street is actually sub-$1B so if they’re telling you things are better, our expectation is that the numbers are definitely going to have to come up across the board. But getting back to the course, it's roughly $4.5B of run rate EBITDAR. I think consensus is modeling this somewhere in the 2023 - 2024 time period, I think it's probably going to happen in 2022. Overall, you can put about 10x multiple on that. The owned stuff is selling for like 16x - 17x, you just saw the MGM transaction. Caesars is actually committed to selling one of their biggest assets and based on where the market is, I think you're going to get a pretty good mark on that, which is going to give people comfort that that 10x EBITDAR valuation for the brick-and-mortar portfolio is reasonable. Just to get down to the nitty-gritty, I put 11x on Vegas and about 7.5x on the regionals, and that gets you to about the same spot, (plus) there's some cats and dogs of other stuff. So that gets you to about $45B of value for the brick-and-mortar alone, which is $125 a share after you net out the $18B - $19B of lease adjusted net debt. So that's $125, the stock is at $100 right now, so I think there's $25 of upside just on the core. And then that doesn't even consider their digital opportunity. 

So, as part of the bankruptcy reorganization, Caesars acquired William Hill (see 10/22/2020 call w/ former CEO of WMH LN). William Hill was their sports betting partner in the United States, where they had a 50/50 JV. Now Caesars owns 100% of it. And then they are and have divested all of the William Hill legacy assets, so they basically just bought it at a very, very low multiple to get access to the US sporting gaming opportunity. You saw MGM tried to acquire their partner, Entain. And what Caesars is now saying is like, “Look, we have the right digital portfolio, we've got the right product in place, we have the right branding (they just converted all the branding from William Hill to Caesars, which is a very well-known national brand), and we've got the right marketing campaign.” They just introduced a campaign with JB Smoove, who everybody recognizes from Curb Your Enthusiasm. Where I think the market is sort of underpricing the digital opportunity, we actually just saw the first week of downloads following the new marketing campaign & Caesars went from having 5% - 7% share the prior 6 months to capturing 21% of new app downloads, so this should be like a top-of-the-funnel indicator that Caesars is going to be a major player in digital sports gaming. People are looking at DraftKings, Barstool/Penn, BetMGM, and they were just assuming Caesars was going to be like a bit player. And you see estimates on the Street, maybe 5% - 15%. I think Caesars is going to have like 15% - 20% of the market. And so if you just look at general consensus estimates for what the digital gaming and sports betting market is going to look like, guys like BetMGM and Entain are estimating that it could be upwards of $32B by 2025 (please see ENT LN - Long - 6/16/2021 from another presenter). They've told you that Entain thinks they can get like a 20% share of the market, driven primarily by their relationships with players in local markets. They're saying, “Look, we have these player portfolios, people know us, they're in our loyalty programs. We're going to leverage that for online.” Well, Caesars can do the exact same thing. BetMGM has told you they own their underlying technology system, well, Caesars owns theirs too, so they should be able to get pretty attractive margins. So the way I'm looking at the digital opportunity is $32B in 2025 on the topline. Caesars, let's say they can conservatively get 15% share of the market. Then 20% EBITDA margin-- MGM is telling you they can be 30% - 35%, DraftKings is indicating 30%+. A 15% market share and 20% EBITDA margin gets them to just under $1B of EBITDA in 2025. Put a 10x multiple on that, which is extraordinarily conservative, then you get sort of baseline digital of $38 a share on top of the $125. 

That may be a conservative case. You could estimate that their share is maybe a little bit higher, the multiple that people are ascribing to online is a little bit higher. You can get a digital valuation as high as $76 a share based on 20% market share and 30% EBITDA margins, which gets you to over $200 a share all in. So that's kind of your blue sky scenario, and the thesis in a nutshell. And I think what you're going to see is continued strength in the Caesars digital gaming portfolio, you're going to see continued strength in Vegas, these guys are going to beat numbers, people are going to be increasingly excited about what the picture looks like in 2025. The stock should continue to rerate.

Joe

Can we just put a pin in that for a second? You said they're going to beat numbers. What is the timeframe that you're expecting these beats to occur? And more importantly, could you address your comfortability with margins in digital given there's numerous competitors staking out a large percentage of the business in digital? And are you worried about anyone taking a much bigger share or anyone coming in to compete that you didn't see coming or just doing it more successfully, and what does that do to margins?

Pro 

Sure thing. So I guess on the numbers front, just on my latest glance at consensus numbers for Q3, if the company said they're doing a little bit better than Q2 and Q3 numbers are down for Street, I think that they're definitely going to beat there as long as everything doesn't change. But if I look longer term, just the ability to generate $4.5B of EBITDAR in the business, consensus expectations doesn't even have that in 2023. I think that's going to be a 2022 phenomenon considering they're already run-rating at about $1B per quarter, $4B annually and things are continuing to strengthen. So I think that we see near-term upside to consensus estimates. And then as people pull forward the numbers to 2022 - 2023, you get to that more normalized $4.5B. 

To your question on margins in digital, that's a key question here because this is a major land grab situation. You've got companies like DraftKings valued on Price/Sales metric, people are looking at the online business of FanDuel/Flutter similarly on topline, so nobody is really expecting these businesses to generate profit and they can just spend whatever they need to for customer acquisition and sign uneconomical deals with sports media partners, etc. I think what you're going to see in this market is going to be similar to every other developed sports betting market. There's going to be a period of very aggressive market share investments and the margins aren't going to show up for the next 2 - 3 years, and then things are going to normalize and like in every other developed market, we see 20%+ EBITDA margins when you have stable share with ~ four or five players. So I think that's what we can expect here. I think the market is sort of taking the view that that's going to be the 2025 state of play, and that gives these guys, everybody in the sector, a little bit of leeway to invest to grow. Caesars, specifically what they've said is, they're going to invest $1B of EBITDA over the next couple of years in order to grow share in sports gaming. And they've kind of publicly said they expect sports gaming to generate at least $500MM - $1B of EBITDA. I think they're obviously being conservative, they're assuming a figure closer to $1B, but those are the table stakes to put in the ground. But I don't think you're going to see material EBITDA from digital for the next few years. 

Joe

What are the risks you’re most worried about?

Pro

I mean, I think the risks are the market just staying irrational for longer. I think if we fail to see consolidation in online sports betting, I think that will be an issue. If all the kids go back to school and Delta variant blows up and people can't take Vegas vacations, that'll be a major downside for the stock. I don't believe that's going to happen, but that's something you absolutely need to be cognizant of. 

Joe

So you discussed taking vacations in Vegas, and I imagine that's true regionally also. But is the conference business something that you plug in and worry about? 

Pro

So conference is not back, and conference is actually not in the numbers. If you do see conference come back in a meaningful way, I think there will be upside. I think conference will be very, very slow to recover. Just anecdotally, there’s a big ophthalmology conference out in Vegas, I think, every other year, and they actually had it this year. That was one of the first big conferences, I think that actually happened. Look, I think it'll recover slowly. It's definitely not going to come back as strong as it was previously, but ultimately I think that business comes back. People want to have conferences in Vegas, people want to get away. But like near term, it could be choppy in numbers. I think the other thing to recognize is that the regional business has probably peaked out in terms of profitability. So, I do my sum-of-the-parts and put 11x on Vegas, 7.5x on regional, but I'm looking at regional as more peak EBITDA because people are beginning to travel. You don't just have to go to your local regional casino, you can go to resorts. 

Joe

So just for those that might not be following it as closely, you referenced earlier in the opening that we've seen transactions at a multiple of EBITDAR. Do you want to just talk about a couple of those, because it sounds like that's how you build your base case?

Pro

That gave me sort of a frame of reference to think that my 11x estimate for Vegas is probably pretty low. You just saw Vici Properties, which is a big Vegas operator, repurchase MGP and the implied EBITDAR there was around 16x. Also, the Cosmopolitan is publicly rumored to be for sale by Blackstone. I think you're going to see a very high multiple there. And then Caesars itself is telling you they're going to sell one of their Vegas assets, and I think you're going to see a mark that is going to continue to validate that the market for the real estate is extraordinarily high. I do not expect Caesars to unload all of its Vegas real estate because this gives them a massive financing advantage. They can finance these properties for like 3.5% - 4%, so I don't think they would ever give up that optionality. 

Joe

OK, any other points that I may have neglected to ask about? 

Pro

I don't think so, but I'm more than happy to have conversations with people about the company. 

Joe

OK, thanks again for your time and good luck. 

Pro

All right, thank you