This year is turning out a little better than last year, although it’s far from making up for 2022’s losses, making stock selection critical. The Dow Jones U.S. Gambling Total Stock Market Index has been rising steadily for the last three months, so some investors might be considering some gambling stocks.
As luck would have it, at least two hedge funds have featured gambling stocks in their letters to investors. Among the stocks mentioned were Golden Entertainment
In fact, Performing Capital had a 20% industry position in gambling operators and suppliers in the fourth quarter, while DG Capital has been holding several gambling-related stocks for quite some time.
Performing Capital reported that shares of gambling operators generally rallied about 20% in the fourth quarter, while slot suppliers lagged. However, the risk-on rally has driven shares of both operators and suppliers higher this year, with MGM being a particularly strong performer recently.
The bull thesis for gambling stocks
In his fourth-quarter letter to investors, Performing Capital’s Howard Rosencrans presented the bull thesis for owning gambling names. His experience has been that gaming operators and, to some degree, suppliers often become over- or undervalued.
Rosencrans notes that gaming stocks became “wildly overvalued” in 2021 due to a sharp increase in euphoria around online sports betting and its poster child, DraftKings. However, he added that online sports betting is a low-margin business that requires massive marketing and promotional efforts, which have resulted in “mind-boggling” losses for the companies involved.
According to the fund manager, the market “turned viciously against the space” starting about a year ago, sending nearly all gambling stocks plummeting, even those not exposed to online sports betting. He added that recession fears exacerbated the downturn, and gaming suppliers fell as well.
However, the investor also said that gambling has proven to be a recession-resistant business, and gaming suppliers are even less cyclical. Slot machines are generally leased, creating ultra-high cash flow streams over many years. He added that Everi and PlayAGS have recurring revenue amounting to about 70% of their sales, giving them improved visibility.
DG Capital started buying gambling stocks as a reopening play stemming from the COVID-19 lockdowns, and many of those holdings have performed exceptionally well off and on over the last three years.
Everi Holdings, a leading supplier of slot machines and the number one player in fintech kiosks for casino operators, has been highlighted in letters from both Performing Capital and DG Capital. Rosencrans said Everi represents 7% of their fund equity and is their largest gaming position. He described the company’s turnaround as “highly impressive,” adding that the company is “significantly deleveraged.”
Since it announced record third-quarter results against a challenging comparison, The fund manager believes Everi is “firmly established in growth mode both as a slot supplier and fintech player.” The company also affirmed its guidance for another record year while continuing to buy back shares to return capital to shareholders.
Everi has been quite active in M&A via small “tuck-in” deals to complement its offerings and enter new markets. Additionally, he highlighted the company’s “cashless” gaming and other solutions. Only 12 to 18 months ago, investors were ascribing at least $500 million or $5 per share to that business alone.
However, Rosencrans now believes no premium is being applied — even though the company continues to penetrate new casinos and jurisdictions. He sees cashless adoption as inevitable among all major gaming operators. As a result, heexpects Everi to enjoy another record year in 2023 as it continues to generate significant cash flow, warranting a “sharply higher multiple.”
DG Capital has highlighted Everi Holdings in several of its past letters over the last few years, and it remained a top long position with a 5.3% weighting as of the fourth quarter. While Everi has been a long-term winner for the fund, it was listed as one of its biggest detractors during the fourth quarter.
Although DG has been buying Everi since at least 2020, fund manager Dov Gertzulin restated his bull thesis in his third-quarter letter for 2021. He said the company was gaining market share in slot machines, which made up 10% of its new shipments that year, up from 6%. He also said the company was enjoying better economics in its premium games, in which it earns a share of the casino operator’s daily win totals.
Other positions of note
DG Capital reports that its gaming investments in Caesars, Everi and Inspired Entertainment “have increased rapidly in price” during the first quarter. Gertzulin cites their robust financial results and progressing business transformations as the primary drivers of their strong performance.
Although the fund has reduced the sizes of these positions as their stock prices have increased, it maintains “meaningful exposure given their excellent fundamentals, low valuations and upside potential.” Dov also lists Caesars Entertainment as a top holding with a 3% weighting as of the fourth quarter.
He’s also highlighted Caesars off and on over the last few years. In the third quarter of 2021, the casino operator was one of DG Capital’s top positions and a top contributor since the fund started buying shares in the second quarter of 2020.
Along the same line as Caesars, Performing Capital also highlighted MGM Resorts, although MGM has a significant presence in Macau, which is just opening back up and should provide near-term upside. Rosencrans believes new CEO Bill Hornbuckle is a significant change from the previous mismanagement.
He added that MGM shares dominance of the Las Vegas Strip with Caesars, with the two casino operators controlling almost the entire Strip. Howard described MGM’s casino portfolio as “the largest scale of ‘trophy’ gaming properties in the world.” Additionally, MGM management sold nearly all of the companies underlying domestic real estate to REITs at premium valuations, leaving the company deeply discounted.
Full disclosure: I used to work for Howard Rosencrans as an equity analyst before he started Performing Capital.