Handicapping Magna Entertainment
Handicapping the future of Magna Entertainment Corp. (Nasdaq: MECA) is difficult -- almost as difficult as a horseplayer trying to pick a winner from the cheap claimers running midweek at just about any North American racetrack.
The Canadian company, which is the largest racetrack operator on the continent based on revenue, is a poster child for a business that hasn’t figured out what it takes to pick the pockets of gamblers. While the casino industry continues to expand its presence as it reaches deeper into the consumer psyche, the racing industry continues to struggle. Simulcasting has made it easier for horseplayers to get in on the action both coast to coast and on the international front, yet the racetrack operators haven’t found the magic formula to parlay increased exposure into fresh fan interest.
Sure, the Kentucky Derby brings out the once-a-year fans, and Magna’s Pimlico Racetrack in Baltimore will garner a fine share of attention this week, as Street Sense bids to win the second jewel of the thoroughbred Triple Crown, The Preakness Stakes. But the host’s owner continues to hemorrhage money, posting a 2006 net deficit of $85.2 million, following three years of $100 million-plus losses. Debt is piling up, and investors are unhappy about a stagnant share price.
Magna Entertainment has a stable of eight racetracks, including Santa Anita in California, Gulfstream Park in Florida and Pimlico in Maryland. It also owns training centers, offtrack betting facilities, the XpressBet account-wagering system, cable channel Horse Racing Television (HRTV), and the maker of totalisator equipment, AmTote.
In recent months, change has started to take place at Magna Entertainment, along with its longtime rival, Churchill Downs Inc. (Nasdaq: CHDN). Both companies have new leadership, and after years of sniping at each other and going head-to-head in bidding to snatch up the prime racetrack properties, they’re working together on multiple fronts. Churchill bought half-interest in HRTV, and moved its racing signal to that channel, following a tiff with the Television Games Network. They’ve also formed TrackNet Media Group, to oversee simulcast operations, both for sending and receiving race signals. Together the companies have been part of one of the groups bidding to operate the biggest tracks in New York state – Belmont Park, Aqueduct and Saratoga.
Still, the stock of Magna Entertainment has hovered near $3 of late, banging into a 52-week low of $2.77 on May 7, which is far from its 52-week high of $6.39.
What really has made it difficult to figure out Magna was a March 22 press release. To comply with Nasdaq Marketplace rules, the statement pointed out that in analyzing its books for 2006, independent auditors Ernst & Young had issued a “growing concern qualification,” about its survivability. The statement said that its future depends “on the company generating cash flows that are adequate to sustain the operations of the business, renew or extend current financing arrangements and maintain its obligations with respect to secured and unsecured creditors, none of which is assured.”
Still, the stock did not react much to the press release, but in this cautionary age a red flag might pop up for some investors. The company’s previous annual reports contained similar warnings, and other publicly traded companies also routinely include them in their regulatory filings.
This year has started out better, but not by much, for Magna Entertainment. In the first quarter ended March 31, it posted a profit of $2.5 million, or $0.02 a share, after three losing quarters. In the first quarter of 2006, it also posted a profit of $0.02 a share, from $2.2 million in net income. This year’s results were boosted by the addition of slot machines at Gulfstream Park, as well as corporate cost-cutting programs.
On the recent conference call with analysts to discuss those results, company executives said that in order to improve its debt picture, it was looking to dispose of $400 million to $700 million in property not related to its core business. It’s been shedding golf courses and other property, and recently announced plans to ditch a small thoroughbred track in Muskegon, Mich. Chairman and founder Frank Stronach, who brought in former EchoStar president Michael Neuman as CEO in February, also indicated on the call that Magna Entertainment would hire someone from the gaming industry to run its slots operations.
The disappointing results led some of the handful of analysts who cover Magna Entertainment to adjust their expectations downward.
BMO Capital Markets trimmed its share price target to $3.50 from $4.50. Analyst Peter Sklar did maintain a market perform rating on MECA, while noting that first-quarter EBITDA from its tracks was “significantly” weaker than expected. Sklar also pointed to deteriorating earnings from Gulfstream Park, despite the arrival of slots last November.
GMP Securities sounded the same warning signal, in cutting its price target from a now-seemingly optimistic $6.05 to $5, also citing a “disappointing” profitability out of Gulfstream. Analyst Anoop Prihar, who maintains a buy rating on Magna Entertainment, said in a report that he was surprised by the south Florida track’s weakness, suggesting that the company does indeed need better gaming management and improved marketing.
Brean Murray analyst Ryan Worst reiterated a buy rating, while adjusting his target price to $6. He also speculated about a possible sale of Gulfstream Park, in order to reduce the company’s debt.
Indeed, the first-quarter report led to some speculation from industry observers about whether the company might be sold, or if it might seek out a partner or perhaps some private equity investors. While the rumor mill grinds away, there has been no indication that the company is headed in that direction.
If the name Magna sounds familiar, its former parent, Magna International, was talking up in recent weeks a takeover of the Chrysler Group from DaimlerChrysler, which decided instead to sell a controlling interest to private equity firm Cerberus Capital Management. Magna Entertainment was spun off from Magna International in 2000, but it has remained entangled in the giant auto parts maker. Stronach, who is a thoroughbred breeder and owner, was interim CEO of the track operator for about a year following the retirement of Jim McAlpine.
There’s no sure thing in horse racing, and betting on Magna Entertainment’s future is difficult. If other states where the company has tracks decide to approve slot machines similar to Florida, Magna Entertainment would be sitting tall in the saddle. Or should the company decide to sell itself, or some of its prime properties, its fortunes could rise, and its stock could sprint to the finish like a quarterhorse in the final hundred yards. Investors betting on Magna Entertainment just have to ask themselves if they’re feeling lucky.
