GDEN - Golden Entertainment: Room Renovation And Expansion Make The Stock Undervalued

Summary

• With ten casinos under its management distributed between Minnesota and Indiana, Golden Entertainment also offers its clients the infrastructure to install, manage, and launch entertainment establishments.
• If management continues to report more renovation of rooms, the number of visitors will likely increase.
• The planned expansion in our Distributed Gaming segment will likely bring further business growth.

Golden Entertainment, Inc. ( GDEN ) recently announced the STRAT renovation, and continues to report its intention of expansion in the Distributed Gaming segment. In my view, considering the current database of players, cross selling opportunities could arise from big data assessment. Even taking into account risks from regulators and the total amount of debt, I believe that the company's stock price could be significantly higher in the market.

Golden's Business Model And Future Catalysts

With ten casinos under its management distributed between Minnesota and Indiana, Golden Entertainment offers its clients the infrastructure to install, manage, and launch entertainment establishments, mainly casinos and gaming spaces, as well as other devices such as machines emulating casinos.

Golden provides lodging services and other facilities for the stay and common casinos with gastronomy and beverage services. The company has also franchised taverns and bars, such as Sierra Gold and Saint Patrick's, located mostly in Las Vegas.

Among the different business catalysts reported by Golden, in my view, the most relevant are the potential benefits that the STRAT renovation could bring in 2023, 2024, and 2025 . Besides, in my view, if management continues to report more renovation of rooms, the number of visitors will likely increase.

I would also highlight potential increases in royalty payments that we already saw in 2022, which may trigger further revenue growth. Besides, the planned expansion in our Distributed Gaming segment will likely bring further business growth. The company made some small references in recent reports about these initiatives.

The increase in other revenues was primarily driven by proceeds from the buyout of royalty payments under certain of our agreements and recoveries under certain of our insurance policies.

Preopening expenses for the three and nine months ended September 30, 2022 and 2021 primarily related to our planned expansion in our Distributed Gaming segment. Source: 10-Q

Finally, if management successfully continues to develop its loyalty programs, cross selling opportunities could arise from big data assessment. Let's keep in mind that Golden reported a database of close to 6 million players all over the country.

Balance Sheet

As of September 30, 2022, Golden reported cash of $170.486 million, accounts receivable worth $20.951 million, prepaid expenses of $18.357 million, and inventories of $6.705 million. Additionally, assets held for sale were equal to $41.210 million, and total current assets were $266.014 million, close to 2x the total amount of current liabilities. Considering the current amount of cash and the current assets/current liabilities ratio, I believe that Golden has a considerable amount of liquidity.

Property and equipment was equal to $841.870 million with an operating lease right of use assets close to $156.920 million and goodwill of $158.396 million. Intangible assets were equal to $91.372 million with deferred income tax assets of $17.585 million and total assets of $1.547 billion.

Considering the amount of property and equipment reported, I believe that it is fair to take a close look at the type of property owned by Golden. According to the last annual report , management noted that most of the property is represented by buildings and improvements of the casinos.

The liabilities included a current portion of operating leases of $43.953 million together with accounts payable of $18.834 million, accrued payroll of $24.514 million, and accrued liabilities worth $40.882 million. Total current liabilities stood at $139.084 million. Finally, with long term debt of $926.540 million and non-current operating lease worth $129.255 million, total liabilities were equal to $1.195 billion. The asset/liability ratio stands at more than 1x, so I would say that Golden's financial position is quite stable.

The Share Repurchase Program Could Bring Demand For The Stock

I would highlight for the new inventors that Golden promised long term ago to repurchase shares from time to time in the open market. In my view, further repurchases of shares could bring certain stock demand, which may lower the cost of equity, and push the company's stock price up.

Share repurchases may be made from time to time in open market transactions, block trades or in private transactions in accordance with applicable securities laws and regulations and other legal requirements, including compliance with the Company's finance agreements. Source: 10-Q

Management Is In A Position To Acquire New Casinos

During 2019, Golden Entertainment bought Edgewater Gaming and Colorado Gaming. In this way, the company acquired two casinos for its portfolio of entertainment assets, both located in Nevada.

Given the state of the balance sheet and the total amount of free cash flow generation, Golden could acquire new establishments in Nevada or elsewhere. Considering the expertise of the company in the M&A markets, we should not rule out this opinion, which may bring significant inorganic growth.

My Income Statement Model

My expectations for 2025 include gaming revenue of $770.904 million, food revenue of $204 million, and beverage revenue of $204.213 million. Revenue from rooms would be $167.141 million.

My revenue didn't include significant sales growth, but I did make some optimistic assumptions about Golden's expenses growing a bit less than that in 2022. In my view, if inflation decreases, the company's margins will likely increase. I included 2025 gaming expenses of -$492,239 million together with food and beverage of -$191,212 million. 2025 Expenses related to rooms would be -$66.304 million with 2025 SG&A of -$258.737 million, depreciation of -$85.298 million, and 2025 operating income of $133.728 million.

Cash Flow Model

I assumed 2025 net income of $75.214 million, share based compensation of $3.45 million, deferred income taxes of -$12.504 million, changes in accounts receivable of -$3.074 million, changes in prepaid expenses of -$6.451 million, and changes in accounts payable of $2.353 million.

Additionally, with changes in other liabilities of -$0.770 million, I obtained 2025 net cash provided by operating activities of $144.665 million. If we also assume purchase of property and equipment of -$43.254 million, the free cash flow would stand at 101.411 million.

Valuation

With 2025 FCF of $103.436 million, 2024 FCF of $108 million, and 2023 FCF of $131 million, the net present value would stand at $293.750 million. With an EV/EBIT of 16x, the terminal value would be close to $2.5 billion with a NPV of $1.993 billion. I believe that a valuation of 16x EBIT is quite conservative. The company traded at much more than 16x EBIT between 2016 and 2020.

Let's keep in mind that I used a cost of equity of 11.45%, cost of debt of 7.10%, and a WACC of 8.6%. My results would include an enterprise value of $2.287 billion, an equity of $1.53 billion, and a target price close to $54.

Competitors And Risks

The tourism and entertainment market is a highly competitive market. Golden Entertainment competes with various brands with greater recognition and greater resources. It not only competes with entertainment facilities but also with hotels and different services for tourists. Let's remember that Golden operates in one of the areas with the greatest influx of people in the United States such as Las Vegas.

Golden Entertainment also competes with small businesses and all tourist service providers in the area. Besides, some states are considering legalizing casino activities, which would lead to decentralizing the market. Finally, in my view, we must add the large number of digital offers from video game casinos and online betting houses, which also generate competition.

I dislike that Golden Entertainment business is highly concentrated in a single region. Any change in the legislation or non-compliance with the requirements in this regard may lead the company to face adverse business conditions.

Finally, some investors may dislike the total amount of debt and potential agreements with debt holders. Covenant agreements may reduce the options for Golden. Debt holders could stop transactions, or reduce the amount of risks that management may be willing to take. Besides, debt holders could also stop room renovations if they don't offer sufficient financing to Golden. Management offered certain explanations in this regard.

Any such renovations and capital improvements usually generate little or no cash flow until the projects are completed. We may not be able to fund such projects solely from cash provided from operating activities. Consequently, we may have to rely upon the availability of debt or equity capital to fund renovations and capital improvements, and our ability to carry them out will be limited if we cannot obtain satisfactory debt or equity financing, which will depend on, among other things, market conditions. We cannot assure you that we will be able to obtain additional equity or debt financing on favorable terms or at all. Source: 10-k

Conclusion

Golden Entertainment recently reported the STRAT renovation, plans to expand its Distributed Gaming segment, and delivers significant free cash flow generation. Besides, I would be expecting business improvements thanks to the company's loyalty programs and new cross selling opportunities that could arise from big data assessment. Under a very simplistic financial model, I obtained a valuation close to $54 per share, which appears larger than the current market price. Even considering risks from competitors, new regulations, or the total amount of debt, I believe that the company is undervalued.

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