I’ve been meaning to really look at Evergreen Gaming for a while. It looked cheap enough superficially, but between a few other opportunities, and the gradual deleveraging I’ve been trying to do, I hadn’t felt the need to do a very deep dive on Evergreen (TNA).
But a reader asked me about it, and it snowed approximately a foot here last weekend, so I had some time and finally got around to looking closer.
Evergreen Gaming Corporation operates four casinos in Washington state. The casinos seem to only offer card tables and pull-tabs, which appear to be the same thing as the lottery tickets of the same name. So the casinos can’t quite be compared apples to apples with casinos which have slot machines.
Evergreen is quite profitable. Through nine months of 2017, Evergreen had earnings of $2 million. Annualized, these results would equal about 2.1 cents per share, meaning Evergreen is trading at just 8x P/E. Both revenue and earnings are up year over year, despite having shut down a casino in February 2017.
The company just recently completed the sale of a full casino, The Palace Tukwila, which was realized to be either unprofitable or untenable in some way. According to the Q3 MD&A:
The Company did operate a fifth casino, the Palace Casino in Tukwila, but that property was closed on February 4, 2017. The Company has entered into an agreement to sell the real property where Palace Tukwila was located for $1,950,000. The buyer has made a $50,000 earnest money deposit and the sale is supposed to close on or before November 30, 2017.
The property was sold for almost $900,000 more than the mortgage balance and $515,816 over its value on the balance sheet. This indicates to me that we can consider the rest of the balance sheet conservative.
Excluding goodwill completely (not necessarily fair, but works as a margin of safety) and including the Tukwila sale, book value is $0.08 per share. On book value then it doesn’t look cheap. But there’s almost $0.06 of unrestricted cash on the balance sheet (there is also restricted cash, which is held in case of a large jackpot).
It’s clear to me that there’s no business reason to be holding this much cash, so it ought to be returned to shareholders in some way. If this guy is to be believed, the chairman’s preference is paying down debt with the possibility of a share buyback in the future. The debt is low interest, with a favourable maturity schedule, so my preference would be the buyback.
I really can’t claim to have any idea of the future prospects of Evergreen, there’s a few balls up in the air and I don’t have a firm grasp in what direction the company will be steered.
As an example of “balls up in the air”, Washington is in the process of increasing its minimum wage significantly in the next few years. The company issued a prediction of how it will affect profitability:
The present minimum wage increased from $9.47 in 2016 to $11.00 in January 2017, and in future yearsthe wage increases to $11.50 in 2018, $12.00 in 2019 and $13.50/hour in the year 2020. The increasesto the minimum wage will also impact hourly wage rates for employees with greater experience andresponsibility. The cumulative effect on wages, including payroll taxes over the four year period isprojected to be $1,394,000, $2,041,000, $2,690,000, and $4,327,000 respectively.
This is obviously a large hit to a company with less than $3 million of earnings. The good news is that in 2017 the increased earnings already reflect the increased labour costs. It’s more of an economic debate whether the increased minimum wage will lead to higher revenues. For the time being, the company has managed to navigate this hurdle, but it’s an undesirable headwind.
A tailwind that will partly offset the wage hikes will be the corporate tax cut implemented in the US. Through nine months of 2017, the company had set aside 35% of earnings, over $1 million, for income tax. In 2018 the company stands to save ~$400,000 in taxes.
Those don’t quite balance out (the business earns less than if neither happened). Another thing that has me hesitant on Evergreen is the end game. There are a few paths forward from here that I can see.
I’m not sure how likely Evergreen pursuing a growth strategy is. Dawn Mangano has been the CEO since June, and she has grown a chain of casinos in the past. I also can’t make any guesses at the growth prospects, how many small casinos are available to be acquired or built, or how profitable they would be. For significant market expansion though, this is the path Evergreen will need to take. I don’t want to pretend I know what this growth would look like, or how it would affect the target price of Evergreen, so I’ll just ignore the possibility. Keep in mind that Mangano, may choose to grow the business, and that could offer significant upside.
Insiders own 78% of the stock and I believe the most likely end game for Evergreen is a buyout so the insiders can get their liquidity event. If I were going to buy into Evergreen, it would be in the hope of Evergreen being taken over.
For a rough guess at a buyout multiple, let’s say Evergreen can improve earnings to $3 million annually, which should be close to $4 million EBITDA. I’ll also assume that half of the debt is paid down, and there’s $6 million net cash on the balance sheet. For a sleepy little company like this, I would consider 10x EV/EBITDA to be a fair multiple. A buyout under these circumstances would come to $0.34, 100% upside to today’s price. While the stars look aligned for a buyout offer to come, I don’t want to invest/speculate on it.
Steady As She Goes
There’s also the possibility that Evergreen continues business as usual. I believe the new leadership can extract a lot of value in the short term, hence my prediction that $3 million in earnings isn’t that far down the road. But without any new levers to pull, the growth is capped at a certain point. I’m not sure that Evergreen deserves much more than a 10x P/E multiple once growth slows down; n two years, earning $3 million and growing 5% per year, this would equate to a $0.24 target price.
If I were just looking to buy a basket of undervalued stocks, Evergreen would certainly be in the basket. I’m tempted to buy TNA, as I see the downside as very low. I imagine the customers are pretty sticky, and with the current valuation I’m not sure the share price can reasonably go down much. But I also don’t believe that just because a stock is cheap compared to other stocks that the share price deserves to increase. Evergreen’s business should command a below market multiple, in the absence of any changes (growth strategy, dividend/share buyback, etc). Maybe in today’s market that could be a 12x P/E, indicating more upside, but the margin of safety isn’t enough for me. If I had to bet on the most likely return for shareholders going forward, it would be 5%-10% if a buyout doesn’t happen. I’ll be keeping my eye on TNA, as I have been for a while. I’d probably jump all over it at $0.12, and would maybe start a small position at $0.15.
Disclosure: No position in Evergreen Gaming (TNA)