Wise Fools have long known that a big company doesn't guarantee the biggest return. Check Commerce Bancshares versus Citigroup (NYSE:C), or Stifel Financial versus JPMorgan Chase (NYSE:JPM).
Investors reeling from giant casino companies must be wondering if the smaller-is-better philosophy works for the gambling industry. Is Isle of Capri Casinos (NASDAQ:ISLE) -- with properties in over a dozen U.S. cities including Caruthersville, Mo. and Waterloo, Iowa -- a better long-term bet than Wynn Resorts (NASDAQ:WYNN), which caters to crowds in Las Vegas and Macau? Is a long-term investment in Century Casinos (NASDAQ:CNTY) -- with casinos in Colorado, Canada, Poland, and on cruise ships -- wiser than playing balance sheet roulette with MGM Mirage (NYSE:MGM)?
The answer, to paraphrase the old TV car-rental commercial, is "Not exactly."
Theoretical benefits, real risks
Small caps offer the bet that niche-market properties can produce better results, especially if there's little or no competition.
The thinking goes like this: Visitors come from nearby areas for what the industry likes to call "stay-cations," an easier, cheaper trip than a destination vacation. Small-caps' ambitions usually don't extend outside the U.S., meaning that they won't be snared by unpredictable foreign government regulations.
However, they aren't immune from recession-induced cuts in consumer spending, which hit lower- and moderate-income visitors harder than the high rollers and international tourists who prefer Las Vegas. The small caps with properties in Las Vegas and/or Atlantic City have struggled, too.
Small caps aren't absolved from sensible debt management. Their balance sheets can look as ugly as those of MGM Mirage and Las Vegas Sands (NYSE:LVS). And because there's little sell-side coverage for most small caps, investors must be more rigorous in conducting their own research.
Big disappointments
Like big-cap companies, the cap on small-cap companies was bigger in the recent past. Shares for most are down substantially over 12 months.
Riviera Holdings was trading in the high $30s in mid-2007. The stock is now below $1, and Riviera will pre-emptively de-list it later this month because it can't meet an exchange's compliance standards. Riviera, which owns one casino in Las Vegas and another in Colorado, will trade as an over-the-counter bulletin board stock.
With a negative net worth of $59.6 million as of March 31, Riviera has defaulted on a $245 million credit facility. Riviera reported in its 10-Q filed with the SEC that there is "substantial doubt" it can remain a "going concern."
Trump Entertainment needs little introduction, but lots of help. De-listed from Nasdaq in February a few days after it filed for bankruptcy reorganization, Trump's shares now trade on the pink sheets. Two years ago, Trump's stock was in the mid-teens. Now, mid-teens refers to cents rather than dollars. Meanwhile, reorganization isn't going smoothly. Trump just canceled a deal to sell one of its three Atlantic City casinos.
Beware of balance sheets
Even better-performing small caps can exhibit scary balance sheets. Just look at Isle of Capri; its stock is up more than 50% in 12 months. It just posted fourth-quarter earnings, excluding special items, of 16 cents a share, thumping the Wall Street consensus forecast of a three-cent loss. However, Isle has $1.29 billion in long-term debt versus $228 million in stockholders' equity.
So far, investors aren't running for the exits. Despite the huge debt, a recent report by Stifel Nicolaus notes that no debt payments are due until 2013.
To improve their balance sheets, Isle of Capri and several other small caps are emulating their bigger brethren by selling assets. In April, Isle of Capri sold its United Kingdom casino. Last month, it said it would sell its property in the Bahamas. Meanwhile, Century Casinos has departed the Czech Republic and is exiting South Africa. And MTR Gaming Group sold two casinos and one harness racing track last year.
Let's hope they all keep their promises about seeking a strategic focus rather than waiting to reload on another buying spree.
Other peoples' money
If you don't like the small-caps' strategies, the odds are you won't have much influence. For many companies, a majority or large plurality of shares are held by an individual, family members, and/or a handful of investors.
If you have a complaint about Dover Downs Gaming & Entertainment or the OTC bulletin board-traded Archon, you're out of luck, because the top executives control more than half the shares. At Isle of Capri, you'd have to convince four family members to change their minds. At Monarch Casino & Resort, three family members, including the two top executives, own 43.6% of shares.
Investors shouldn't be surprised. After all, Kirk Kerkorian is the dominant shareholder of MGM Mirage, while Sheldon Adelson and his wife are the major shareholders of Las Vegas Sands.
Investors also shouldn't be surprised that small-cap companies pose similar risks as their big brothers, which just goes to show that small isn't necessarily beautiful in the gambling business.
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