Full House Resorts: A Cheaper Price Helps, But More Progress Is Needed – Full House Resorts, Inc. (NASDAQ:FLL)

The problem with Full House Resorts (FLL) of late has been that the execution on the ground hasn’t quite matched the attractive story supporting the stock. Veteran gaming executive Dan Lee joined the badly mismanaged company in late 2014 after an activist effort. Both Lee and CFO Lewis Fanger were heavily incentivized to fix up the somewhat odd portfolio of assets and sell the business to a larger operator.

To their credit, the two executives have had no shortage of ideas to improve the business. Fanger cut costs by renegotiating the company’s health care plan. Lee floated an idea to build a casino near the Indianapolis airport, then tried to enter the smaller Terre Haute market in that state. The Rising Star property in southern Indiana was turned into a “Christmas casino”, while Full House designed and built a ferry. The company acquired a property in Cripple Creek, Colorado, and invested $10 million in various growth projects across the rest of the portfolio.

But as I’ve argued of late, most recently in August, performance actually hasn’t been that good – and certainly not good enough. Given the Colorado acquisition and the $10 million in capex, profit growth is disappointing. Earnings remain well below Lee’s past targets.

That said, however, FLL is starting to look a bit more intriguing. A sell-off in the second half of 2018 has brought valuation more in line. Q4 results late last month were a step in the right direction. Hopes for a new facility in Indiana expansion look close to dashed – but a win in New Mexico and an expansion in Colorado could provide inorganic growth and jumpstart the story here.

I’d still like to see a bit more here, however. And there’s increasing concern as to what the endgame will be – and could be. Back in the low $2s, FLL is more reasonable from a valuation standpoint. But there’s still work left to do.

Broad Concerns

Again, the core issue here is that growth simply hasn’t been good enough. Adjusted EBITDA did rise 7.2% in 2018, with margin expansion. But Full House benefited from reasonably easy comparisons – and should have seen some ROI from the capital spend funded by a 2016 equity offering.

Even with the year-over-year increase, the 2018 total of $17.65 million in Adjusted EBITDA simply isn’t getting it done. Margins under 11% are well below publicly traded peers. As I’ve pointed out before, Lee some three years ago, on the Q4 2015 conference call, said the portfolio (including the acquisition of Bronco Billy’s in Colorado, which hadn’t yet closed) was at a run rate of about $20 million. A year and a half later, on the Q2 2017 call, he said the company could get the figure to $25 million. Obviously, it’s nowhere close.

The company has called out weather as a factor, but it’s already lapped one impacted quarter in Q4. Lee said on the Q4 2018 call that the two quarters (Q4 ’17 and Q1 ’18) combined had a hit of about $3.4 million in EBITDA; if that’s the case, ‘normalized’ run-rate still probably is in the $19 million range three years after supposedly being at $20 million. And given that Full House operates casinos in the mountains of Nevada and Colorado, on the storm-prone Gulf Coast, and on a Midwestern river, weather often is going to be an issue, not something that can be backed out of ‘normalized’ figures.

In a strong economy which has helped move casino earnings (and casino stocks) higher, even $19 million isn’t good enough. Full House did $14 million in EBITDA in 2015; it added roughly $5 million from Bronco Billy’s and expected to add another $2-3 million in ROI on the growth spend. Even hitting $20 million in 2019, as appears possible assuming help from the easy Q1 comparison, suggests at best minimal and at worst negative earnings growth on an underlying basis. That’s particularly true outside of the flagship Silver Slipper in Mississippi – which presents a serious problem for the M&A case here.

Property by Property

Mississippi

The good news here is that the Silver Slipper, in Bay St. Louis, Mississippi, had a strong 2018. The Silver Slipper is the most important property in the portfolio, driving over half of property-level EBITDA last year. And – at least at the moment – it’s the only Full House casino big enough to be of interest to one of the major regional operators or a REIT like Gaming & Leisure Properties (GLPI) or Vici Properties (OTC:VICI). Given potentially significant capital needs going forward, performance in Mississippi is key to the near-term story.

That performance got notably better in 2018. Revenues have been rising steadily – but Full House was paying for its growth. Property-level EBITDA basically had been flat in 2016 and 2017 excluding a one-time insurance benefit in the latter year. Those results were particularly disappointing given that Full House opened a hotel at the property in the second half of 2015, which Lee had projected would provide $2-3 million in incremental EBITDA.

At $12 million-plus, 2018 EBITDA remains a bit disappointing given that spend along with smaller investments in an oyster bar and a pool. But the figure did grow 20% last year (again, excluding the one-time benefit). The easy, weather-affected, comparison helped: Q4 EBITDA increased 74%. But the property also has managed through competition, with the Scarlet Pearl in D’lberville opening in December 2015 and the Island Pearl (according to Lee on the Q3 call) adding a $75 million expansion this year.

Legalized sports betting has provided a small bump – about $200-$300K in profit in the second half, according to the Q4 conference call. A smoking ban at casinos in Baton Rouge has provided some help as well. Still, in the context of expanded competition and ahead of one more easy comparison, 2018 performance looks quite solid – and a noted improvement in the multi-year trend.

The solid results in Mississippi do de-risk the story here somewhat. Net debt at the end of 2018 was $78.4 million; in a worst-case scenario, Silver Slipper probably could be moved for something close to that figure. 7x TTM EBITDA values the property at $85 million. The better performance also makes it more likely that Full House could go to GLPI or Vici to raise capital for its moves elsewhere.

That said, the Silver Slipper alone doesn’t support the story here. The coastal Mississippi market isn’t one of the more attractive out there: per Mississippi state figures, 2018 GGR in the Coastal category was actually modestly below that of 2008 (which, obviously, was a very different economy). More growth, particularly after Q1, may be tough to come by.

Indiana

In Indiana, meanwhile, the news looks concerning. After the airport proposal (which was a longshot) was rejected, Full House in 2017 offered to move some of its unused slot capacity to a satellite casino in Terre Haute, west of Indianapolis. That bill died in committee.

But, evidently, legislators liked the idea of a casino in Terre Haute. Two casino licenses in Gary are being moved as part of a new development there. And a Senate bill passed in January would move one of those licenses to Terre Haute. Those licenses now belong to a company owned in part by Rod Ratcliff, the former owner of Centaur Gaming in the state and someone Lee called “kind of our nemesis” after Q3. As the Indianapolis Star put it last month, “for now, Full House Resorts is cut out of a future Terre Haute casino.” For that to change, Full House will have to beat out the politically connected Ratcliff – which seems unlikely to happen.

Making matters worse, the Senate bill also allows for live dealers to come to two Indianapolis-area racinos (formerly owned by Centaur before their sale to Caesars Entertainment (CZR)). That wasn’t supposed to occur before 2021 – and it adds another competitor to Full House’s existing Rising Star property.

That property already is hanging on by a thread. EBITDA in 2018 did rise almost 5%, thanks mostly to a strong Q4. But Full House also put some $6 million into the property, including a new RV park, a ferry across the Ohio River, improvements to the entrance, and a new restaurant. EBITDA rose just $128,000 year-over-year. Margins are under 6%.

The ferry, launched in September, doesn’t appear to be moving the needle. Revenue declined in Q4. Indiana state figures show a 10% drop in casino win in January, followed by a flat February. It’s possible returns will improve as spring shows up and more potential users become aware of the ferry (which has uses beyond casino visitation). But those returns could be swamped if Indianapolis racinos take any market share; and margins at this point are so thin that Full House really can’t afford any further revenue declines.

Sports betting could be a help – but Ohio is moving toward legalization as well, with a bill sponsor in that state saying the odds were “better than 50/50“. Rising Star simply seems boxed in. With Terre Haute unlikely, and more competitive pressure on the way, Full House might be out of options in that market. And it’s exceedingly difficult to assign any value to the property at this point.

Northern Nevada

I’ve thought for a while that the two properties in northern Nevada – the Grand Lodge in Lake Tahoe and Stockman’s in Fallon – were an underappreciated part of the story here. Back in 2016, they represented almost 20% of property-level profit. Stockman’s had hopes of benefiting from growth in the Reno metro, while the Tahoe property had room for improvement, particularly after a $5 million renovation in 2017.

In that context, the two properties (whose results are reported on a combined basis) are exceedingly disappointing. 2014 Adjusted EBITDA for the segment was $4.47 million; the figure four years later was almost 25% lower. That’s with the $5 million spend in Tahoe (most of which was funded by Hyatt (H), who owns the property) and $1.5 million going into Stockman’s.

Profits did grow in 2018 – but against a weather- and construction-challenged 2017, with most of the improvement coming in Q4 against a very easy compare. The long-term trend under the new management has been consistently negative – and that’s a real problem. If the case here more broadly was based on the fact that operations would improve, the Northern Nevada was the simplest test case, as it hasn’t faced the external factors of other properties. (Weather is inconsistent, but the Tahoe property is in the mountains, and is going to be affected by snowfall and visitation every year.)

The disappointing results here don’t break the story – but they don’t help, either. The path to $20 million-plus required the segment to grow. Reasonable ROI on the investments into both properties should have moved cash flow over $5 million. Instead, it’s under $3.4 million. That’s a fundamental problem – but the trend also raises questions about execution more broadly.

Colorado

At this valuation, the opportunity in Cripple Creek probably is the hinge for the bull/bear case. To Lee and FLL bulls, the proposed expansion of Bronco Billy’s is a potential game-changer. Cripple Creek is one of the last untapped regional markets – one in desperate need of hotel rooms that will drive the entire market and narrow the per capita revenue gap with Black Hawk (west of Denver):

source: Full House December presentation

Indeed, optimism toward the Cripple Creek expansion appears to have been a significant factor in the gains in FLL during the first half of last year. But I’ve been a bit more skeptical, as I wrote back in late 2017, due in part to questions about the market. The drive from Colorado Springs to Cripple Creek is longer, and much tougher, than the one from Denver to Black Hawk. Hotel rooms are needed in the market – but Bronco Billy’s isn’t the only property adding supply.

So far, the news here has been disappointing. Lee said on the Q4 call that a new parking garage, the first step in the project, would begin “shortly”. He said a year before that “we hope to finish” the garage by the end of 2018. Building in the mountains is notoriously difficult; with the garage not yet started, and expected to take about ten months per the Q3 call, the timeline of late 2020 seems ridiculously optimistic. And the commentary so far seems yet another example of the point I made back in August: Lee has developed a habit of overpromising and underdelivering.

Making matters worse, current performance is underwhelming. 2018 EBITDA was under $4 million; the property was running at $5 million when Full House agreed to buy it in late 2015. On the Q4 call, Lee highlighted an accrual for marketing expense, more leasing of slot machines (as the company will be renovating the casino, and doesn’t want to buy machines only to put them into storage), and technical state gaming tax issues as key factors. But the total – $200K+ for slot leasing, $400K in comps, taxes up $150K – don’t cover even the entire year-over-year profit decline of $840,000.

Even adding that back and giving some credit for another weather complaint (a snowstorm ahead of New Year’s Eve), Bronco Billy’s still is seeing profits decline. That’s with some contribution in Q4 (presumably) from a new, year-round Christmas Casino.

At the moment, Bronco Billy’s seems like a microcosm of the case for FLL as a whole. There’s an intriguing plan to target an underserved market and create a second legitimate asset that might be of interest to majors and/or REITs. But execution has been subpar, and the results are not good enough. Full House still needs to raise $115 million – and it’s not at all clear how it plans to do so with an already-stretched balance sheet. There’s a lot of promise in the project – and more than a few questions as well.

New Mexico

In New Mexico, Full House has submitted a bid for a sixth racino license, proposing a $200 million project. The approval process is on hold, however, awaiting resolution of a lawsuit from one of the bidders.

Lee said after Q3 that he thought Full House had a 30% to 50% chance of winning the project. And there is real potential upside to the project. The racino would be located in Clovis, near the Texas border – and about 1:45 from both Amarillo and Lubbock.

It’s difficult to value the project at the moment – and more difficult still to understand how Full House will finance it. But the project does add some optionality to FLL shares; if an investor thought the stock was reasonably valued at the moment, the potential of a win in New Mexico could be seen as a nice added bonus.

A Show Me Story

With FLL down 40% from its highs, valuation has come in. 2018 Adjusted EBITDA suggests a 7.9x EV/EBITDA multiple – and that figure could drop toward the low 7s assuming a decent Q1 against another easy comparison. That’s actually reasonable, given majors are at 9x-10x and smaller players like Golden Entertainment (GDEN) and Century Casinos (CNTY) are in the 7-8x range.

That said, FLL still is pricing in at least some success with its inorganic opportunities. Challenges in Indiana and a nearly 6x levered (on a gross basis) balance sheet suggest the current business probably merits a discount to even those smaller peers. Interest expense is over half that EBITDA; after maintenance capex, free cash flow is just a few million dollars annually against a market cap of $78 million-plus.

That success is possible, in both Colorado and New Mexico. But the clock is ticking. It doesn’t take much of a macro stumble for Full House’s financing plans to get upended (as was the case when the company refinanced its debt a few years back). The U.S. economy continues to be strong – but won’t be forever. Full House needs to show progress with its expansion efforts – and start improving operations at the existing business (at least outside of Mississippi).

It’s tough to be too confident on those fronts at the moment. And there’s also the ongoing problem that an eventual sale of Full House will have a limited pool of bidders. Mergers in the regional space (Penn’s (PENN) acquisition of Pinnacle, and the Eldorado Resorts (ERI) roll-up) have created giants who simply will not want Stockman’s, Tahoe, or Rising Star. If Bronco Billy’s doesn’t live up to expectations (and double-digit ROI), it may not reach that level either. The endgame here is much more murky than it was – and it’s taking much longer to get there than hoped. Given disappointing growth in the current properties, there seems little reason to rush in.

The upside here still is potentially enormous – on paper, FLL can easily double with success in Colorado, and do better with a win in New Mexico. But at this point, I’d rather wait for signs of progress – and potentially pay a higher price – than risk another stumble. In short, this has become a “show me” story – and outside of Mississippi, Full House hasn’t shown enough.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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