Lakes Entertainment

Buy Price
Holding Type
Investment Theme
Net Net
Trade Date
December 1, 2013

Purchased mid-December around $7.75 per share ($3.88/sh on a pre-split basis). Lakes Entertainment (LACO) is one of my largest personal holdings and has been for some time now. Shares are off from recent highs but remain up sizably YTD and over the past two years. In spite of its run, I feel the story has de-risked considerably and remains one of the cheaper securities available in the small-cap space today.

LACO was formerly a financier and manager of Native American gaming properties (dating back to its spin-off from Grand Casinos in 1998). Following the wind-down of a few management contracts and development projects, the company has now transitioned to an owner/operator of casinos. As a result of this changing asset base and business model, past results are mostly useless.

At $4.50/share, the stock trades at a slight discount to tangible book value of $4.80/share. However, this metric is misleading as carrying value likely understates the current fair value of several company assets.

The company today consists of the following assets:

  1. Net cash -- Totals $72.6m ($2.70/share).
  2. Investments -- Holds an 8% interest in the Horseshoe Cleveland, Horseshoe Cincinnati, and Thistledown Racino through its holding in Rock Ohio Ventures, LLC. This is recorded at $21m on the balance sheet yet these casinos generate roughly $625m in annual revenue on a combined basis. These casinos do carry some leverage. At 0.7x price/sales, this could be worth $35m or $1.30/share.
  3. Land -- Owns a parcel of land in San Diego adjacent to the planned Hollywood Casino Jamulby Penn Gaming (PENN). This has a carrying value of $1.1m while PENN has the option to purchase the land for $5.5m, increasing 1% annually ($0.21/share).
  4. Note receivable -- Previously lent money to develop a casino in San Diego with the Jamul Indian Village of California. After this plan was abandoned in March 2012, LACO wrote off the ~$60m note ($2.25/share). After a two year hiatus, PENN recently announced its plan to develop and build this casino, thus allowing LACO the ability to re-recognize the receivable, which accrues interest at a rate of 4.25% per annum once the casino opens.
  5. NOLs -- There are $72m in federal NOLs as of 12/31/13. Deferred tax assets of $30.6m are fully reserved at yearend (these would add an additional $1.15/shareto book value).

This all adds up to about $7.60 per share. To recap: we have $7.60 per share in cash and other assets which is nearly 70% higher than today’s price of $4.50. We haven’t even mentioned the recently opened Rocky Gap Resort in Maryland.

Rocky Gap Resort

The company spent $35m to build a resort/casino with 200 rooms, 577 slots, and 15 table games in Cumberland, MD, which opened in May 2013. Management expects to earn approximately 20% cash-on-cash returns from this investment. With a market cap of $123m and an EV of $50m, investors can purchase all of Lakes Entertainment for roughly 1.4x replacement cost of the new casino while also receiving the aforementioned assets.

Through six months in 2014, Rocky Gap generated trailing revenue and EBITDA of $52m and $5.3m. As seen below, outside of the 4Q13 quarter, performance has been quite strong and margins improving. My expectation would be for continued improvement across the board. According to the Maryland Gaming Commission, Rocky Gap revenue gaming revenue was up 19.7% in July.


In light of LACO’s clean balance sheet (i.e. zero debt), Rocky Gap is likely worth somewhere between 8-9x EBITDA. This is somewhat of a premium to smaller casino operators such as ISLE, FLL, and PENN but less than bigger peers like PNK and BYD.


Putting all the pieces together I get total assets worth $7.70 per share or 70% higher than today’s price:


Corporate overhead has been running high at a $7-8m annual run-rate following the roll-off of past management contracts. Management has made it clear this level is much too high for a company of this size and we should see a more appropriate run-rate going forward. I’ve given the company credit for $4m per year in anticipation of cost cuts.

Some might argue that zero value should be ascribed to the note receivable at this juncture as the casino hasn’t opened and hasn’t yet broken ground. Removing the already haircut $30m for the note would still produce upside to $6.60/share. Management has stated on past calls the note will not come back onto the balance sheet until the opening of the Jamul casino (likely in 2016), at which time they would be open to selling the receivable to a more suitable creditor.

This is fine with me, the risk is the casino not opening but as I’ve indicated, the value is there with or without it. Until then, I’ll continue to monitor PENN’s progress on the facility which has yet to break ground. Of the $360m planned cost by PENN, $24.1m has been spent to date.

But what to do with all that cash? Management has said they are looking for attractive acquisitions and would be willing to spend in excess of cash on the books. As recently as last week, the company has hired an investment bank to evaluate strategic alternatives “aimed at enhancing shareholder value.” This includes: potential acquisitions, joint ventures, recapitalizations, asset divestitures, merger, reorganization, or similar transactions. Frankly, it doesn’t matter so much what they do as opposed to simply doing something. Famed 17th century trader Joseph de la Vega once wrote: “The expectation of an event creates a much deeper impression than the event itself.” LACO is not getting full value for its assets as it stands; therefore making any sort of move should be beneficial to shareholders.

A significant acquisition, divestiture, or capital return could breathe life into this company and allow investors to properly value the disparate group of assets. Either way, where I once thought the major risk factor was management not acting, I now see the hiring of an advisor as willingness to do whatever it takes to create value. Consider a scenario, for instance, where management divests its Rock Ohio interest for $50m (1x sales) and uses the proceeds along with cash/borrowings to acquire a business for $120-150m. Under 12-15% returns on capital, that could boost EBIT by $15-20m in addition to the returns generated by Rocky Gap (of which would be shielded by taxes from NOLs).

One other concern is the same management team has been in place since the company was spun off from Grand Casinos in 1998. While the business model is under transformation and the asset base looks compelling, I feel there is enough margin of safety to mitigate this concern. Also, CEO Lyle Berman owns over 16% of shares and has a vested interest in LACO’s prospects. (As a side-note: Lyle has sold a few companies in his past and has won 3 World Series of Poker bracelets, quite an interesting person.)

Prudent capital deployment is critical to unlocking shareholder value but significant cash holdings and assets should provide a nice backstop in the meantime. I truly believe that management has a multitude of directions they could take this company in the future. Don’t discount the ability for activists to come into play here as well. With limited downside, that is a proposition I’m more than willing to bet on.