Full House Resorts: A Cheap Entry Into The Recovering U.S. Regional Gaming Market (NASDAQ:FLL)

We have been following this small, regional micro-cap gaming company on SA since April 21, 2016. Here’s our history:

April 16, 2016: Price was $1.50. We called a buy, believing it was a $3.50 stock in hiding.

On September 8, 2016, we maintained our PT. The stock was up to $2,50 and beginning to gain some scattered interest, if my emails from investors were any indication.

On March 10, 2017, we posted on FLL again. The stock was $2.27, and we again guided a buy.

Data by YCharts

Since then, of course, the pandemic has taken its toll on the trade, as it has for the entire gaming sector. When the big, highly visible gaming stocks were getting body slammed, all eyes, of course, were on the Macau big three: Las Vegas Sands (LVS), Wynn Resorts Ltd. (WYNN) and MGM Resorts International Inc. (MGM). On the domestic front, we had the phenomenal flying trapeze act performed by Messers Tom Reeg (CEO of El Dorado Resorts Inc.) (ERI) and Uncle Carl Icahn to wrest the golden, but bruised and undervalued, Caesars Entertainment Corp. (CZR) from its long life under inept corporate management in a massive $17.3 billion merger deal.

Further blurring all the outliers in the sector for attention was the literal nuclear explosion in May 2018 of the US Supreme Court’s striking down the PASPA law, which liberated the sports betting-heavy stocks from pandemic prison. Even those regionals among my favorites like Monarch Casinos and Resorts Inc. (MCRI) found my positive sentiment growing under the imprimatur of consolidation of the US gaming market.

Amid all this gyrating of tailwinds and headwinds, micro-cap gaming stocks like Full House Resorts Inc. (FLL) slipped out of focus for shot takers as well as long-range investors alike. I have gone through the premises that had originally spurred my interest in the stock to see if the company still warranted attention. My conclusion was: Yes, there is an investor story to be told on the stock, even though it has recently reached close to my original call trading today at $3.29. To say that my enthusiasm for the stock at $1.50 was justified but my timing, duration was not propitious is an understatement, to be sure. Apologies for that. But better late than never.

Put bluntly, had you bought into my original guidance, say, buying 5,000 shares back then at $1.50 for $7,500, your long position would now be worth $16,450. As my gaming portfolio was then, and still is, locked into a blind family trust under the management of advisors, I was not able to enjoy the results noted here. (The reason: My policy to avoid potential conflicts of interest with my consulting business.)

Suffice it to say that remains the case, even though I am now raising guidance, post-pandemic, on FLL to $5.45 by 2Q21. My positive case rests on some, but not all, of the catalysts I saw when first recommending the stock.

Background to my call

(Below: Dan Lee, a casino pro with a deep background in the financial space: Source: Full House archives)

In December 2014, current FLL CEO Daniel R. Lee led an investor group that took over the company. It had clearly been mismanaged over time. Its asset base was somewhat shaky, and more importantly, management had no clear idea where to go and how to get there. With the arrival of Lee, his management team got busy fixing all the leaks sprung over time.

I had gone back with Dan Lee from early in the 1980s, when I got to know him when he worked first for Donaldson, Lufkin Jenerette, then onto Drexel Burnham as a gaming analyst. I had found him to be a quick study, boldly candid at all times and professionally sound. This view came closer to home when in 1991, Dan had migrated to the investment banking desk at First Boston. The bank had become one of our advisors at Trump Taj Mahal that year in structuring a pre-packaged bankruptcy filing.

At that time, I was Senior VP of Marketing for Trump. Our C-suite team worked closely with the bankers to get the deal done. And once more, I found Dan’s insights into the business, beyond the standard analyst’s viewpoint, very valuable. From there, Dan and I would chat from time to time when he left Wall Street to join Steve Wynn in the 1990s as CFO of Mirage Resorts, and after that, Pinnacle Entertainment as CEO. Dan’s signature honesty and candor came up against a few disgruntled Missouri legislators on some regulatory issue. He promptly resigned his position in late 2009 to morph into the FLL situation.

With the stock down, generating no heat from Mr. Market, and a ton of leaky policies to fix, Lee and his new team set to work and knowing him, I began to follow the stock.

My outlook as a former industry executive, having spent decades in the trenches of a very tricky business, was this: Before you look at the balance sheet, before you take a gander at the earnings or lack of same, before you break down the plusses and minuses of the asset base and performance, do as deep a dive as you can on the quality of management.

The way for most investors to get a grasp on management effectiveness is, ironically, not always to be found in results. So many factors outside of casino management control can come into play. Hold percentage on table games is one of them.

Yes, gaming companies’ earnings releases all contain columns on “normalized” hold, i.e., what the casino should have held according to mathematically tested, long-term house edges on various games. And if not that column, it’s in the narrative. But sometimes as we say in the business, “the rats eat the cats” and an entire quarter can be decimated by lucky customers. One would think Mr. Market would understand this. But no, Mr. Market in this era reads headlines, perhaps a paragraph or two. And the headlines always, if lucky play destroyed a quarter’s forecasted earnings, is earnings miss. Mr. Market reads “Sell”.

Another part of the narrative is often noting that either rooms have been taken out for renovation and weren’t available, or an entire casino floor is being reconfigured, with lots of disruption, and that impacted slot play. Or of course, weather extremes like snow storms that closed main arteries, hurricanes. Even in the case of Macau, typhoons can destroy a quarter. But nothing has even equally the massive destruction of the pandemic. Yet, these stocks are still being valued by metrics based on pre-pandemic metrics.

So, in my judgment at the time, Lee had accumulated the practical smarts, the financial savvy and hands-on operational decision-making apparatus to rebuild the company and set it on the right path to a solid record of performance.

Still another management issue is a clear picture of where the company is headed. From earnings calls, interviews and the public statements of executives, are you getting the usual patent medicine man hustle of gobbledygook? Or do you hear a candid appraisal of where the company has set its sails for the future? Is it covetous for mergers or acquisitions? Is it happy with its current portfolio? Has it jammed up its corporate office with belt-and-suspenders types who lord it over operations executives at the property level? Or does it give property managers the leeway they need to compete and produce solid results relative to their markets?

Full House: Remodeled and perhaps ready for a buyer?

(Above: The Silver Slipper Mississippi, which scored a 10% increase in 3Q20 revenue as pandemic woes slowly began to moderate. Source: Full House Resorts archives)

In the six years under the Lee team, FLL has improved the performance of the company’s two flagship properties, The Silver Slipper in Mississippi and the Rising Star in Indiana. It continues to hold on to its two northern Nevada satellite properties if you will in Grand Lodge at a Hyatt Hotel and Stockman’s in Fallon. But the company’s biggest roll of the dice has been in Colorado. In the Cripple Creek market, feeding from Denver metro, it bought street property Bronco Billy’s.

By any measure, that market was room inventory short prior to the pandemic. FLL’s plan was to reconstitute the casino floor, put a better customer reward system in place and build first a garage and downstream, then add a 200-room hotel. The pandemic has brought both the Bronco Billy’s garage and hotel expansion plan to a screeching halt due to the financial constraints. Post pandemic, we believe it’s fairly probable that FLL will resume development, with a realistic arrival date probably by 2022 or so. This is one of several reasons we continue to believe that a transaction may be in the offing before that time. FLL shareholders might well benefit from a deep-pocketed suitor coming to call.

(Below: The proposed Bronco Billy’s expansion in Colorado, put on hold due to pandemic-related financial limits. Ideal for a deep-pocketed acquirer to step in and resume construction of the garage, then a 200-room hotel. Source: Full House Archives)

FLL is already in on the sports betting business with all six authorized skins that will migrate to all its properties. This is of particular interest in Colorado, where the customer demo is younger and more passionate about sports. In its 3Q20 earnings release, the company noted that in line with the partnership deals it has made with sports betting platforms, it expects to generate ~$7 million in revenue over the next year as a guarantee from its partners. The company’s margin on this business will be huge, since it has effectively become a landlord collecting rent.

FLL has clocked $700,00 in sports betting revenue to date. Unlike many competitors in the booking business, it does not have to spend millions to court new sign-ons for its apps.

During 3Q20, the company generated $42 million in revenue, showing a net income of $7.7 million, or $0.28 a share. Adjusted EBITDA was $12.5 million, up 115.8% y/y. Much of this was related to accounting for fair market value of outstanding warrants and loss on extinguishment of debt in 2018. The company presently shows ~$34 million in cash and cash equivalents on its books.

With development projected postponed, and no major capex ongoing, FLL should weather the rest of the pandemic storm in fairly good shape financially. Beyond that, the company has revived its bid to the state for a casino at Waukegan, Illinois. That prospect is a long way off, and there are many bidders. But the point is that FLL clearly has a vision to grow going forward. It will continue growing its two flagship properties in Mississippi and Indiana, moving its Colorado property toward profitability well before it can resume expansion and always, with eyes wide open if and when a deal possibility pokes a head through the door.

A deal mentality: The landscape

Lee has personal skin in the game, having acquired a large chunk of FLL stock during a warrant offering. He was a denizen of Wall Street far too long not to recognize the valuations of casino properties post pandemic, even ones as small as FLL. Its 2019 revenues were $165 million, producing a loss of $0.22 a share.

Again, as noted above, part of the loss was attributable to adverse hold. But we think that post pandemic, FLL has sound strategic value to a possible acquirer with nice-sized footprints in three good markets: Indiana, Mississippi and Colorado. They are already inching into a recovery phase.

The overall US regional gaming landscape continues to suggest to us that the days of micro-casino operators remaining independent is lessening. With the Caesars merger, we now effectively have three regional giants. Besides CZR, there’s Boyd Gaming (BYD) and Penn National Gaming (PENN). But you have other fairly substantial operators clearly looking beyond the borders of Nevada. One natural buyer could be Red Rock Resorts (RRR), the Vegas local operator which seems actively looking to move in ever more markets. There are others like the aforementioned Monarch – they like to go at it alone – but FLL would be a very good fit.

At what could be a relatively modest premium, a buyer with considerably deeper pockets than FLL could restart the Bronco Billy’s expansion sooner and add credibility to the company’s bid in Illinois, and, of course, consider expansion in existing properties in Indiana and Mississippi.

Dan Lee is a fisherman. He knows where to cast his lines when he believes the time and price is right. With most of the downside risk we can realistically measure now already baked into the gaming sector, we see FLL as a buy at its current price with a nice upside. The icing on the cake could be a deal in 2021. Or failing that, I could definitely see Lee summoning the financing gods if and when a merger partner appears.

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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.