One Small Cap Gaming Company Is Worth a Look

Source: Monarch Casino

Bigger is not necessarily better. While Monarch Casino and Resort , a small cap gaming company, isn't as well-known as its larger peers like Las Vegas Sands and MGM Resorts , it isn't inferior as an investment candidate.

Monarch is the owner and operator of the Atlantis Casino Resort Spa ("the Atlantic"), a hotel/casino facility in Reno, Nevada, and the Monarch Casino Black Hawk ("Monarch Black Hawk") in BlackHawk, Colorado. These properties contributed 69% and 31% of its 2013 EBITDA, respectively. Monarch's acquisition of the casino in Black Hawk in 2012 and its increasing share of non-gaming revenues suggest exciting future prospects for the company.

Focus on niche markets that are less competitive
Monarch is a tale of two companies. In contrast to the more favorable competitive environment in Black Hawk/Central City, Monarch's the Atlantic in Reno, Nevada faces stiff competition and a weak economic environment. Notwithstanding the challenges, Monarch's the Atlantic has more than quadrupled its market share from 3% in 1996 to 14% in 2013. Looking ahead, Monarch has plans to grow Monarch Black Hawk's market share in Black Hawk/Central City, where market conditions and the competitive environment are much more positive.

Monarch Black Hawk is the fifth largest casino in the Black Hawk/Central City area gaming market, based on slot positions. The Black Hawk/Central City area faces limited gaming competition from tribal casinos, Native American casinos that are regulated by the National Indian Gaming Commission and/or the government of the appropriate tribal community. The nearest competing tribal casinos in the vicinity are in Southwest Colorado, more than 350 miles from Denver. Historically, proposals to develop tribal casinos have been rejected by either the state's electorate or legislature. This helps to shield Monarch Black Hawk from further competition.

More importantly, Monarch Black Hawk has an edge over its competitors, as it has the best location in the area, being the first casino encountered when customers enter Black Hawk/Central City from Denver via Colorado State Highway 119. Furthermore, given the lack of suitable parcels of land zoned for gaming, Monarch Black Hawk's excellent location at the edge of the gaming zone is unlikely to be challenged in the near term.

The results speak for themselves. Monarch Black Hawk has almost doubled its EBITDA from $8.9 million in 2010 to $16.5 million in 2013. Since taking over Monarch Black Hawk from the previous owner Riviera, Monarch Black Hawk's market share has increased by 96 basis points since April 2012 to 8.9%. Going forward, Monarch Black Hawk should take further market share at the expense of its competitors with better management and an advantaged location.

Similarly, Las Vegas Sands has exploited the competitive environment in Macau to its advantage by putting the emphasis on certain market segments. While the Macau market is competitive, Las Vegas Sands has put more effort in conquering the mass market segment, as opposed to its competitors. As of end-2013, Las Vegas Sands generated as much as 30% more mass table and slot revenues than its nearest competitor in Macau, making it the market leader in the space.

Both Monarch Black Hawk and Las Vegas Sands Macau have benefited from operating in niche markets and segments.

Source: Monarch Casino

More than just a casino
While the Atlantic is already a full-fledged resort, the Monarch Black Hawk is still in the process of transformation. In April last year, the Black Hawk City Council granted the relevant zoning approvals to Monarch for its expansion plans for the Monarch Black Hawk. A 507 room hotel tower, a resort quality spa and pool facility, four restaurants are part of the masterplan for the Monarch Black Hawk.

As an illustration, Ameristar Black Hawk, a competing casino development in the area, grew its EBITDA eight-fold from $7 million in 2005 to $59 million in 2012, following the construction of its hotel. Athough the Monarch Black Hawk's construction timeline isn't finalized at this point in time, the growth potential is tremendous.

Diversifying into non-gaming operations provides both earnings upside and downside protection for both Monarch and MGMResorts. MGM Resorts generated only 30% of its Las Vegas Strip revenue from gaming, while room revenue, food and beverage sales, and entertainment and retail operations contributed the remaining 70%. As a result, MGM Resorts is less reliant on gaming revenues compared with its peers.

Furthermore, MGM Resorts' non-gaming businesses can leverage on Las Vegas' positioning as a meetings and convention hub. For example, Las Vegas' convention attendance hit a five year high of 5.1 million in 2013. These delegates may not necessarily gamble, but they will need accommodation, food & beverages, and some non-gaming entertainment.

The numbers that matter
Monarch grew its 2013 revenues and EBITDA by 15.6% and 34.1%, respectively, with its EBITDA of $48.5 million a record high. In comparison, both Las Vegas Sands and MGM Resorts achieved good results, but delivered lower EBITDA growth rates of 26% and 21%, respectively. With respect to valuation, Monarch is the most undervalued of the three trading at a EV/EBITDA of 7.3 times, while Vegas Sands and MGM Resorts are valued at EV/EBITDA ratios of 16.3 and 11.9 respectively.

Foolish final thoughts
Despite its size relative to other gaming giants, Monarch offers plenty of upside with a well-located casino in a protected market (Black Hawk) and a potentially larger share of non-gaming revenues in the future. Moreover, it is significantly cheaper than its larger peers on a EV/EBITDA basis.

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