Many Gaming Related Companies Are On Sale

I have written enough about Wynn Resorts (WYNN) in recent years that much more in the way of commentary is likely unnecessary. Investors are once again getting a unique buying opportunity with the shares down a stunning 30 percent on very little news:

Even if they wind up selling their under-construction Boston property prior to opening, the haircut for shareholders would likely be less than $5 per share (a 20% gain on the $2.5B cost is just $500M). Although Macau revenue growth is slowing, the August figures are still well into the double digits.

Other leading gaming related stocks are also selling off and warrant special attention. Two notable ones are lottery and slot machine giant International Game Technology (IGT) and video game behemoth Electronic Arts (EA). 

IGT is a global leader and despite low single digit revenue growth (most markets are mature), the business is minimally cyclical and the company’s valuation seems extremely reasonable at 10 times 2019 earnings estimates and a dividend yield north of 4 percent.

EA has been riding the coattails of a transition from packaged software sales to cloud-based digital sales, and the higher gross margins such a distribution model affords. A recent profit warning, due in large part to a delay in the upcoming release Battlefield 5, has helped the stock fall about 25% from its highs. While not dirt cheap (low 20’s multiple to earnings), continued revenue growth, margin expansion (digital sales still represent less than 70% of the total, which could reach 90% over time), and a stellar balance sheet should be accretive to shareholder value over the intermediate term.

No matter your investing style, and despite the market near all-time highs, there are plenty of gaming investments worthy of consideration right now.

Sports Betting Will Help Many Gaming Companies On The Margins, But Impact Will Likely Be Tempered

Some investors might have thought that last week’s Supreme Court decision that paves the way for legal sports betting in all 50 states would have resulted in skyrocketing stock prices of the largest perceived beneficiaries. And yet, the market reaction thus far has been fairly tame.

Consider Penn National Gaming (PENN), whose pending merger with Pinnacle Entertainment (PNK) will make it the largest regional casino operator in the United States. It stands to reason that from a customer destination perspective, they should benefit immensely from sports bets being taken outside of Nevada. And yet, PENN shares have moved up only marginally (less than 5%) since the ruling was announced:

So why isn’t Penn stock soaring? Won’t there be millions of bets placed at their casino resorts annually once the infrastructure is put into place? Probably, but it is important to keep in mind how much revenue these bets will likely generate for the sportsbooks (hint: it might be less than one thinks).

Americans wager about $5 billion in Nevada sportsbooks each year. It is not crazy to think that the market will be increased by many multiples of that if a dozen or two dozen states take steps to accept bets. With over 200 million Americans of betting age, it is not crazy to think the market could swell by a factor of 10. Annual wagers of $50 billion in total equates to about $200 from each and every American age 21 and over.

However, we must keep in mind that the $50 billion is a gross figure (the “handle” for the betting inclined). In Nevada, the historical hold percentage is around 5%, which is the amount the sportsbooks net after paying out winning bets. As a result, $50 billion of gross bets will generate revenue of just $2.5 billion. Still a hefty sum, but there’s more to consider…

Many states, like New Jersey (which spearheaded the lawsuit that set this entire process in motion), are chomping at the bit to allow sports betting because they see it as a revenue generator. States typically tax casinos heavily in exchange for granting licenses to operate facilities that many constituents would prefer not exist. Those taxes are usually assessed on adjusted gross proceeds (total bets placed less winnings paid out), which eat into casino profit margins quickly. According to this article, while New Jersey taxes casino at just over 9% (among the lowest), most neighboring states charge far more, with New York at 31-41% and Pennsylvania at 16-55%.

So let’s imagine that state legislators decide to tax sports betting revenue at an average of 30%. Now we have gone from $50 billion in “handle” to $2.5 billion of “pre-tax revenue” to just $1.75 billion of “after-tax revenue.” With more than 500 casinos in the country (a Penn/Pinnacle combination would own 40 alone), each stands to generate some incremental revenue ($3.5 million per year, on average), but it will by no means be life-altering for shareholders. Perhaps that explains why Penn National stock is up only a few percentage points since the news hit.

Now, this of course only considers actual gaming revenue from the bets themselves. Resort operators will surely try their best to attract customers to visit frequently and spend some money on food, drinks, and perhaps some slot or table game play while they are there. The tricky part about that strategy, however, is that technology is likely going to play a huge role in nationwide sports betting.

Movie theaters and restaurants are already trying to figure out how to coax customers out to their properties when Netflix and food delivery services are just a few clicks away. The same will be true for the sports betting industry. MGM already has a mobile app for Nevada residents that allows in-state players to place bets from home (or anywhere else). Such capabilities will surely expand to other states now, so why not just watch from your couch and bet on your smartphone?

What is probably a slam dunk, though, is that engagement with sports teams should increase. That is good news for Disney (DIS), whose stock has firmed up lately despite worries about cord cutting and ESPN subscriber losses. ESPN viewership should increase (as can ad rates) as regular games have more importance to the average fan who might throw down twenty bucks on the outcome.

With engagement set to rise, there will be more money attached to these teams and franchise values should continue to rise, perhaps even faster than currently (if that is possible). In addition to Disney, stocks like Madison Square Garden (MSG), which owns the Knicks (NBA) and Rangers (NHL), could see increased investor interest.

All in all, this is an interesting time to be sports fan and market watcher. While there will be billions of dollars generated from legalized sports betting, it is likely that with so many players in the industry set to split the pot, outsized winners are less likely in my view. As a result, there might be very few pure plays from a stock market perspective. Instead, take a company like DIS or PENN or MSG, all of which have dominant franchises already, and assume that sport betting will help them at the margins increase shareholder value over the long term.

Big Question Mark for Facebook: Profit Margins (Not Advertiser Behavior or User Engagement)

There has been a lot of commentary in recent days about how user engagement will change, if at all, in the wake of Facebook’s user data privacy hiccups, as well as how advertisers will react and whether they will shift dollars to other social media platforms. I actually do not think either one of those metrics will materially change in the coming months. What is more important in my eyes is how Facebook’s margin structure could be permanently different in 2018 and beyond.

Sure, there will be some users who stop using Facebook and blame the recent issues, but those users were probably not using the platform much to begin with, and as with most things, people tend to have a short memory. Diners typically return to restaurant chains even after illness outbreaks and shoppers did not abandon Target or Home Depot after massive credit card data breaches.

I also would not expect material advertiser migration. It reminds me of the NFL ratings drama over the last season or two of professional football. Television ratings have declined, in part due to an abundance of games (Monday, Thursday, Sunday), more viewing options that are not easily tracked by Nielsen (streaming services, mobile apps, etc), and more competition for eyeballs (Netflix, etc), but the NFL is quick to point out that despite lower ratings, NFL telecasts still get more viewers than most every other television program. As a result, if you want to allocate ad dollars to TV, the NFL will remain one of the best ways of doing so.

The same should be true with Facebook. If both the user base and the average time per day spent on the app drop a few percentage points, Facebook will not lose its spot as one of the best ways to reach consumers on social media.

The bigger question from an investor standpoint is what Facebook’s margin structure looks like going forward. More specifically, how much expenses are going to rise and whether those costs are on-time or permanent. I suspect they will rise dramatically and will be permanent. After all, up until recently the company really just built the platform, turned it on, and let anybody do pretty much whatever they wanted with users and their data. It is obvious now that in order to maintain trust and their dominant position in the marketplace, they are going to have to [police the platform on an ongoing basis and limit the exposure to bad actors. This will cost money, lots of it, and will not bring in any incremental revenue. As a result, profit margins will fall and stay there, in my view.

This is critical for investors because the stock’s massive run-up in recent years has been due to a growing user base leveraging a scalable cost base. Facebook’s EBITDA margins grew from 48% in 2013 to 57% in 2017, and the stock price more than tripled. That margin expansion is likely to reverse beginning this year, to what extent remains unknown. Could those 9 points of margin leverage be recaptured by rising expenses of running the platform? I don’t see why not.

In that scenario, investors may no longer be willing to pay 10-11x forward 12-month projected revenue for the stock, which has been the recent range. If that metric instead drops to 8x (~$149 per share), it will have implications for the stock (currently fetching $160) even if advertisers and users stay completely engaged with the platform.

Full Disclosure: No position in FB at the time of writing, but that may change at any time

Facebook Could Become Solid GARP Play If Near-Term Pressures Continue

Facebook (FB) stock debuted less than six years ago at $38 per share and went through two very distinct sentiment shifts. The current environment, as the company faces pressure from multiple sides to better control use of its massive platform, could very well mark yet another shift.

In May 2012, Facebook IPO’d and flooded the market with stock, so much so that anyone could buy shares at the offer price. Investors were skittish that the company could move quickly to capitalize on the move from desktop to mobile usage and the stock quickly fell into the teens. That turned out to be one of the best growth stock investment opportunities in recent memory, because back then very few people understood just how much money the company would earn in just a few short years.

For instance, what if you knew that Facebook would grow revenue from $5 billion in 2012 to $27.6 billion by 2016, and that free cash flow would go from negative to $4 per share that year? Well, the stock probably never would have traded under $20 and I would bet that investors would have gobbled up every IPO share they could at $38 each.

That was very reminiscent of the Google IPO, which many people thought was wildly overpriced, only to be shocked a few years later when the company’s profits made the IPO price look like an enormous bargain (in hindsight only, of course).

As a result of huge profit growth, sentiment in Facebook has shifted dramatically in recent years and the stock had surged to $176 per share by the end of 2017, as free cash flow reached nearly $6 per share last year. While not overpriced necessarily, the bar has certainly been reset quite high, and therefore Facebook is more susceptible to near-term problems, such as how they are controlling the use of their user data and advertising platform.

The chart above shows the entire history of Facebook’s public stock performance and therefore the recent decline barely registers as a blip. If we look at the last year, we see that the shares have largely been moving sideways, and the recent drop is only about 15% from the highs:

So are the shares getting close to an attractive level? It likely depends on two factors; what valuation methodology you use, and whether you think the company can continue to grow per-share cash flow, or if future growth will be hampered by user base maturation and increased costs associated with policing the platform more heavily.

My base case is that they grow, but at materially slower rates, and margins come down some but remain quite high. As far as valuation, I prefer to use free cash flow per share, but I deduct non-cash, stock-based compensation. That metric for 2017 came out to roughly $4.65 per share (versus $5.91 if you ignore SBC). My estimate for 2018 is roughly $6.50 per share, but I realize there is risk in this figure because we really don’t know how much expenses are going to increase in the face of current political and social pressures.

For Facebook to get into the sweet spot as a GARP (growth at a reasonable price) investment, I would have to see a multiple of 20-25x free cash flow less stock-based compensation. On my 2018 estimates, it equates to $131-$164 per share. The current quote, after a 5% drop today, is $163 per share. In other words, FB stock is arguably now finding itself in GARP territory.

Given that near-term sentiment could very well accelerate to the downside, and considering that modeling 2018 growth rates of 35% in both revenue and free cash flow (the current consensus) are probably skewed to the aggressive end of the spectrum, I would probably want to pay less than the current price. However, if the stock reaches the midpoint of my 2018 range ($150-ish), it could very well make for a strong GARP investment from my vantage point.

Full Disclosure: No position in FB at the time of writing, but positions may change at any time 

 

New CEO Moving Quickly To Stabilize Wynn Resorts Shares

In the three months since my last post on Wynn Resorts (WYNN) a lot has happened. Steve Wynn has resigned as CEO and Chairman of the Board amid sexual misconduct allegations, long-time executive Matt Maddox has taken over the CEO role, two other directors of the company have vacated their positions, the board increased the annual common stock dividend by 50% (to $3.00 per share), and the company announced a settlement agreement to bring to a close a long-time litigation.

As you can see from the chart below, WYNN shares have found some support and are in the midst of climbing back, as Mr. Maddox settles into his new role and tries to turn the page:

In what turns out to be fortuitous timing, I began to trim back my WYNN positions in late January (around $195) as the stock approached my conservative $200 fair value estimate. Just days later the Steve Wynn news broke, which complicated matters with what to do with the rest of the shares.

Since then I have been sitting tight, waiting for more clarity as to the company’s next steps. Recent days has brought some insight on that front, but two big questions remain in my mind. One, how are Wynn Las Vegas bookings shaping up in the weeks since the news reports made national headlines? And two, what is the fate of the under construction Boston Harbor project?

Although I do not think the company’s Macau business will be impacted, the U.S. market is a different story. As long as Steve Wynn’s name is on the door, even if he is no longer with the company, I could see convention business contract materially, as well as tourist bookings. As far as Boston goes, it would be surprising to me if they put the Wynn name on that property when it opens in the middle of next year. So that begs the question, will they sell it, or get to keep their gaming license and simply rebrand the property?

The answers to these questions are likely to take several quarters to be crystallized. Wynn reported 2017 free cash flow of $942 million, which included roughly $650 million of construction costs for the Boston project. If the company can really generate free cash flow of $1.6 billion from its existing three properties, the stock today remains a great value ($19.3 billion equity value) and could easily fetch $230 per share (15x normalized free cash flow). And that does not even include Boston (the worst case scenario there would probably be them having to offload it at cost). Of course, that assumes that the Las Vegas business stays strong despite the negative headlines, which is a big unknown. I will be watching the data closely on that front in the coming quarters.

There has been speculation that the company may be up for sale, or that Steve Wynn might try to take it private. I think it really depends on whether he plans on holding onto his shares or not. He is 76 years old and could very well decide to retire from the business. If he was open to selling his shares I think the company would look to maximize value for shareholders and auction off the entire business to the highest bidder (and there would be plenty of interest).

If Mr. Wynn wants to hold onto the stock, then Mr. Maddox will have to figure out how to preserve the business value. That would possibly mean taking the Wynn name off of the door (if business does suffer here in the U.S.), or maybe even a more bold move (selling the U.S. assets and focusing on Macau and future growth opportunities like Japan).

In either case it looks like there are plenty of levers for the company to pull to realize full intrinsic value for the business. In that scenario, holding the stock and waiting for even more clarity will probably work out quite nicely. Heads we win (the company is sold and the resorts rebranded), tails we win (they rebrand it themselves with Steve Wynn nowhere to be seen).

Full Disclosure: Long shares of WYNN at the time of writing, but positions may change at any time

 

Not All Media Companies Are Created Equal: A Closer Look at Charter, Comcast, and Disney

A client reached out to me after reading my past post regarding the media industry landscape to point out that Comcast and Charter, while both in the business of providing video, data, and voice services to customers, are far from equal when it comes to revenue diversification.

This is a point that is certainly true. I probably should have been more specific in my prior post that my comments were meant to be focused on the TV business. With Comcast’s NBC Universal acquisition about eight years ago, the company became far more than just a cable company offering triple play packages to mostly residential customers.

Along those lines, Charter is a far more one-sided investment bet than Comcast is these days, and would be more susceptible to people who are cancelling their cable service and instead opting for Netflix and/or Prime Video.

Since these companies, along with Disney, have various business segments, I thought it would be helpful to illustrate where each gets its revenue from. The answers are a bit surprising.

Below is a chart that shows the percentage of total revenue that each media company gets from various businesses. Since Disney’s 2017 fiscal year is already over, I am showing data for their latest 12 months. For Comcast and Charter, only the first nine months results for 2017 are publicly available.

 

 

 

 

 

 

 

In my mind, there are a few notable things about this data:

  1. Disney is the most diversified of the three, as one might expect. More than 55% of their revenue comes from sources other than television.
  2. 40% of Charter’s subscriber revenue comes from TV packages. This is comparable to, but lower than, Comcast’s non-NBCU division (44%).
  3. Because of Disney’s large parks/resorts segment (33% of revenue), they have less exposure to cable despite owning ESPN. Still, it is a large portion of the company at roughly 30%.
  4. If you want to play increased broadband adoption and higher speeds/prices over the longer term, Charter is actually the best option, as 34% of their subscriber revenue comes from high-speed internet services. The comparable figure for Comcast is just 17% (28% if you exclude the NBCU division).

As with any publicly traded security, price should play a material role in drawing conclusions about the merits of an investment. When I look at the valuations, Charter trades at a similar level to Disney, despite having no content library or dominant consumer franchises. Comcast trades at roughly a 10-20% discount to them, even though one might expect it to trade at a premium to Charter given the diversification of their revenue stream in an uncertain and ever-changing media landscape.

As a result, my personal rankings considering valuation, revenue diversification, and franchise positioning, would be 1) Disney, 2) Comcast, 3) Charter. If I was into the paired trade strategy, long Comcast/short Charter would look interesting over a multi-year period. Of course, the big question is whether Charter will make a play for a content business, or wireless provider, or something else to expand their horizons. In that scenario, the outlook would really depend on who they bought and how much they paid, not surprisingly.

Content Providers Take Leadership Role in “Unbundling” of Cable

As we head into 2018, one of more interesting sectors among those I watch closely would have to be the media space. This year has seen a huge amount of deal activity (both discussed and completed), as well as a continued secular shift in the way content is distributed and purchased.

For years consumers and industry watchers contemplated if and how the cable bundle would come undone. The idea of paying for 100 or 200 channels, while only actually watching a dozen or so, seemed like an obvious target for disrupters, but for a long time nothing changed. The cable and satellite pay-TV providers would have been obvious candidates to initiate a change in how content is sold, which easily could have increased satisfaction scores and retention rates among consumers, but they balked at potentially bringing down their “monthly ARPU” (monthly average revenue per user). Now with so-called “cord-cutting” becoming a reality, it appears that perhaps that lack of action was a mistake.

The blossoming of Netflix shows just how much “unbundling” was the right move. It turns out that the content players have now taken a leadership role in doing away with the expensive, voluminous TV bundle. If you think about the Netflix service it really is just “a skinny bundle.” Rather than pay $75 or $100 for 100-200 channels, Netflix provides enough content for consumers to be happy (I am just guessing, but perhaps 5-10 traditional cable channels worth of content library?) for $10-$12 per month. Given what industry watchers have been predicting for what seems like decades, it should not be surprising that Netflix has been a runaway success, Amazon Prime Video was created, and HBO is flourishing with its over-the-top streaming service despite more competition.

What is surprising is that the cable and satellite companies have been so slow to react. Leaders like Comcast and Charter have yet to answer with their own competing products. DirecTV did launch a $35 streaming service featuring a more limited channel line-up, so we’ll give them credit for taking the plunge.

The big question is how the Comcasts and Charters of the world are going to compete as the content companies try and eliminate them as middlemen. HBO, Netflix, and Prime Video are sold direct to consumer and other content producers are now accelerating M&A activity to gain scale in content. I recently made a list of 60 top TV channels to see exactly how the concentration of ownership has been shifting lately, especially after three recent deals were announced; Discovery buying Scripps, AT&T buying Time Warner, and Disney buying much of 21st Century Fox. Assuming all of those deals close, below is the breakdown:

Disney/Fox: 12 channels
Comcast/NBC: 11 channels
Discovery/Scripps: 10 channels
AT&T/Time Warner: 8 channels

Out of 60 channels, it is entirely possible that just 4 owners will control a whopping 42, or 70% of them, within the next 12 months.

And more deals could be ahead. A remarriage of CBS and Viacom has been long-rumored and combined they own another 9 channels. A company I am invested in, AMC Networks, owns 3 channels on my list.

To me is seems pretty clear what is going on here. The infrastructure players have been slow to adapt to suit consumers’ needs. The legacy content companies see Netflix and Amazon spending billions on content and realize that if they are not careful, those two companies could offer so much programming that households might no longer need to watch any of their shows. So rather than stand by and watch, they are getting bigger through M&A and will have enough selection to offer their own streaming service, cutting out the cable and satellite providers completely, while also becoming increasingly crucial for those who stick with a bigger bundle. Disney specifically is going to be in great shape given that they also have an unmatched movie collection that can be offered alongside TV programs.

If this is the internal corporate strategy, we can expect more M&A to be announced in 2018. From an investor standpoint, there are attractive opportunities outside of the profitless Netflix and e-commerce juggernaut Amazon.

AMC Networks trades at about 10x free cash flow, 8x EBITDA, and has been buying stock aggressively. In an age of scale mattering, they would seem to be a logical M&A participant. The post-merger Discovery trades at less than 10x free cash flow, has plenty of synergies to exploit with Scripps, and is internationally diversified. Their focus on non-scripted reality shows keeps production costs low and profit margins high. Disney is building a Goliath in the space and is probably the most likely candidate to create a service that can become as valued as Netflix or Prime Video in many households. At roughly 20x free cash flow and 11x EBITDA, the stock no longer trades at a premium to the market (based on ESPN viewership issues), but arguably should given their unmatched franchises.

The media space is not without investor fears, and it certainly is not a popular group for the current bull market, but there are plenty of strong, cash flow generating machines in the public markets whose share prices are quite attractive due to concerns that Netflix and Amazon will crush everyone and that young people simply don’t watch TV. The financial results from these companies in recent years, even as all of this industry change has been afoot, disproves those theories. Additionally, further M&A will only serve to boost competitive positions and generate accretive returns for shareholders.

Full Disclosure: Long shares of Amazon, AMC Networks, AT&T, Discovery, Disney, and Time Warner (hedged with covered calls) at the time of writing, but positions may change at any time

A Year-End Update On Wynn Resorts

While value investing in 2017 has not been an easy task, one constant bright spot in my managed accounts this year has been casino operator Wynn Resorts (WYNN), which has been on an absolute tear.

My last update was back in May when I outlined how my conservative $150 fair value estimate was likely going to prove to be just that… too low. Since then the shares have continued their ascent, rising from $125 to $165 each. My prognosis from eight months ago ($160 by 2019) is therefore outdated.

While I have been trimming my WYNN positions as the stock has continued higher, the company continues to impress from a financial results perspective. My original $150 fair value figure was based on 15x annual free cash flow of $1 billion, which seemed to be very achievable once the company’s second Macau property, Wynn Palace, opened last year.

Despite ongoing construction in the area, which has limited street access and visibility for the new resort, WYNN’s numbers have been staggering, as cannibalization of their legacy property in the region (Wynn Macau) has been far less than many analysts expected. In fact, over the last 12 months for which we have reported financials (Q4 16-Q3 17), Wynn has posted operating cash flow of more than $1.5 billion. If we assume maintenance capital expenditures of $300 million annually, my $1 billion free cash flow target for the three resorts now open will prove to be be too low to the tune of $200 million or more. I would say $180 per share is probably closer to the right number for the core properties, and that assumes no future growth from those assets.

And then of course we have the Boston resort currently under construction (due to open in mid 2019), as well as phase 1 of the company’s Paradise Park expansion project in Las Vegas which could be open within a year. I continue to see those two projects adding $16 per share to my valuation, which means WYNN stock could see $200 per share without being aggressive in one’s underlying financial assumptions. In gaming parlance, it probably makes sense to reduce your bets but I am not getting up from the table completely just yet.

Full Disclosure: Long shares of WYNN at the time of writing, but positions may change at any time.

Wynn Resorts Coming Up Aces For Investors

It has been about 18 months since Steve Wynn purchased more than 1 million shares of his own company’s stock, Wynn Resorts (WYNN), at prices in the low to mid 60’s. While he had better timing than I did (I initially started buying earlier in 2015 at higher prices), which would be expected, his insider purchase has been immensely profitable.

WYNN shares surged this week after the company reported strong earnings, breaking through the $125 level for the first time in more than two years. Bargains hunters like me who bought at multiple times on the way down have had to be patient, but buying great companies at discounted prices often works out very well for those who are willing to wait.

Now that Wynn’s second Macau resort has opened (last August) and is ramping up nicely, I thought it was a good time to revisit the investment. My thesis since 2015 has been that with the addition of two more resorts (the aforementioned Wynn Palace and the forthcoming Wynn Boston, set to open in mid 2019), WYNN’s free cash flow would move materially higher and justify a stock price of at least $150 per share (a relatively conservative 15x multiple on $1 billion of annual free cash flow).

Wynn’s recent results do nothing to shake my confidence in that investment thesis. In fact, it may very well turn out to be too conservative. Based on recent numbers for the company’s Macau properties, it is entirely possible that WYNN could be looking at reaching that cash flow goal before their Boston property opens.

Considering that the company could reasonably expect a 10-15% return on both its $2.4 billion investment in Boston, as well as the recently announced Las Vegas expansion (a golf course that earns $3 million of profit per year is being replaced by a $500 million development project that could earn $50-$75M per year), there appears to be nice upside potential to my price objective. For instance, an incremental $350 million of EBITDA at a 12x multiple would equate to $4.2 billion of added value, compared with estimated construction costs of just $2.9 billion. Tacking on $1.3 billion to Wynn’s valuation would equate to roughly $13 per share, making a stock price of over $160 distinctly possible by 2019.

As an investment manager position sizing is always a consideration, but that aside, I remain intrigued by Wynn stock even after its recent rise. As they say at the tables, I am likely going to “let it ride” for quite a while longer.

Full Disclosure: Long shares of Wynn Resorts at the time of writing, but positions may change at any time.

CEO Steve Wynn’s Huge Purchase Reinforces That Wynn Resorts Stock Is Dramatically Undervalued

Wynn Resorts (WYNN) announced on Tuesday evening that its Founder, Chairman, and CEO Steve Wynn purchased more than 1 million shares of stock on the open market between December 4th and 8th, bring his total ownership to more than 11 million shares (about 11% of the company). The stock reacted well today to the news, rising $8 to around $70 per share.

I posted earlier this year about my belief that shares of WYNN are very undervalued. After peaking at $249 in March 2014, I began to get interested below $110 in the spring and have been averaging down my clients’ average cost basis during the stock’s swoon.  Wynn’s purchases this month took place when the stock traded between $60 and $66. This insider buy is interesting on multiple fronts. Let me touch on some that come to mind.

1. Owner-operators like Wynn typically sell their shares over time

Founders who continue to run their companies often have large equity stakes. In most instances these folks will sell shares steadily over time for diversification purposes. What makes this transaction so notable is that Wynn already owned 10% of the company (worth nearly three-quarters of a billion dollars) and yet he still bought more stock. This is rare. Think of the times we have heard about the likes of Bill Gates, Mark Zuckerberg, or Jeff Bezos trade in their company’s stock. They almost always sell.

2. Most insider buys are small

Although it doesn’t happen as much as one might hope, when CEOs buy shares in their own company (in the open market with their own cash, not via exercising stock options) the buys are typically relatively small compared with their actual compensation. These kinds of trades are seen by many investors as merely token purchases made for the sake of optics (as opposed to a large financial bet). If a CEO who makes $5 million per year buys $500,000 or $1 million worth of stock once every 5 or 10 years, that hardly signals to investors that they really think it’s a great investment. Wynn’s purchase of 1 million shares is unusual in this respect as well. He spent more than $60 million of his personal funds. That is a lot of money (even for Wynn, who is much wealthier than the average CEO). Think about all of the things he could have bought with $60 million. While it is clear speculation on my part, I think Wynn actually made this move with financial motivations first and foremost.

3. What does this move say about the intrinsic value of WYNN stock?

So why did Wynn buy stock now? After such a huge drop (75% from the peak less than two years ago), should we assume he didn’t think it was undervalued until now? Why not buy at $150 or $100? Did he think the shares were fully valued at $75 or $80? Again, this is pure speculation, but if you buy into my argument that he already has plenty of shares, even if he wanted to signal a vote of confidence he could have done so with a far smaller buy (even $5 million would have been far more than most every other CEO purchase). I would guess that Wynn made this particular move because he thinks the stock’s decline had simply reached “ridiculous” territory. If he is making this investment simply to make money, and he thinks the stock price now is irrational, then why not make a big bet on that view? Conversely, if he was simply trying to stem the stock’s decline with a headline, why not do so after the stock fell by $100 per share? What about after it fell by $150? Instead he waited until it dropped by nearly $200 per share. Why? My guess: because it’s just too darn cheap to ignore, even when you already own 10 million shares.

4. How does my view of the stock change with this news?

It doesn’t. I thought the stock was materially mispriced the day before the news hit and I feel the same way the day of the announcement. Will I load up on even more shares now that Wynn is buying? Probably not anymore than I would have already. While his confidence is a positive signal, it’s pretty hard to objectively argue that the stock has not been undervalued for quite some time. The fact that Steve Wynn likely has the same opinion should not come as a surprise.

5. Should investors jump in now, based on this news?

Wynn stock popped 13% on this news, probably mostly due to short covering. In most instances moves like that are short-lived, either because the news is forgotten in a matter of days, or because the next material news item for the company will likely be deemed more important. I would guess that the stock gives up much, if not all, of this pop over the coming days and/or weeks. After all, the next big catalyst for the stock is the opening of the new $4.1 billion Wynn Palace property on the Cotai strip, which has been pushed back from the end of Q1 2016 to the end of Q2 2016. Until then, the same concerns that have plagued the stock for the last year (the huge slowdown in Macau gaming revenue) are unlikely to abate.

Full Disclosure: Long shares of WYNN at the time of writing, but positions may change at any time