Wednesday, November 26, 2008

Magna's Latest Scam

Frank Stronach may have thought that he'd avoid too much press comment by putting out a press release on his latest chimerical reorganization plan the day before Thanksgiving, but, unfortunately for him, the media and the markets were still wide awake.

The plan, in the unlikely event it's actually completed, would leave Stronach firmly in control of the race track company Magna Entertainment, and would take another Stronach entity, MI Developments, and its unhappy minority shareholders, out of the business of sinking ever more money into Frank's flawed vision. But it's a long way from putting out a press release to realizing the plan in practice.

Even though the press release only appeared online at 11:26 this morning, it's already been well reported by, among other, Ray Paulick, the New York Times,the Thoroughbred Times and the Toronto Globe and Mail.  Generally, the story has been presented as a way for the minority shareholders in MI Developments, who have been mightily aggrieved as that company continued to throw good money after bad in Magna Entertainment, to get out and limit their exposure to the race track business.  The stock market reacted very positively, with Magna Entertainment shares up over 40% for the day and MI Developments gaining almost 20% as well.

But in fact, when one starts to look more closely at the plan that Magna announced, it becomes clear that the chances of the reorganization plan's actually happening are virtually nil.  Let's look at the plan in a little more detail and see why that's true.

Step 1 of the plan is for MI Developments to lend even more money to Magna Entertainment, on top of the $310 million or so that it's already lent.  The plan calls for a new $50 million loan for working capital, plus up to $75 million additional to pursue a slots license for Laurel Park in Maryland and build an interim casino if the license is approved.  So MI Developments would be on the hook for over $400 million in total.

And there's no assurance that, in fact, Laurel will get the slots license.  Maryland politics is nothing if not Byzantine, and Stronach may not have the right connections. According to the plan disclosed today, the $75 million for Laurel slots would be guaranteed by Maryland Jockey Club assets (Laurel and Pimlico) and would be repayable immediately if the license is denied, but where would the cash come from at that point?

Magna also convinced the Bank of Montreal to extend the due date on its $40 million loan to the end of March, 2009, in exchange for a $1.75 million fee.  If one adds up all the fees that Magna Entertainment has paid for multiple extensions of this loan, one might well conclude that it would have been cheaper to get the money from the nearest loan shark. At the same time, MI Developments has extended the due dates on its various loans to Magna Entertainment, totaling some $300 million-plus, to the same end of March deadline, in exchange for yet more fees. And, to conclude Phase 1 of the plan, Magna Entertainment made a cosmetic proposal to use "commercially reasonable efforts" to sell some of its reace track properties.

So, all of Phase 1 is actually about pumping more MI Developments money into Magna Entertainment.  Good for Frank, perhaps not so good for other shareholders.

Phase 2 of the plan is where things start to get problematic.  For this phase, approval by MI Developments shareholders is required, but, since Stronach controls MI developments, that's virtually assured.

In Phase 2, MI Developments, which is basically a real estate company, promises to buy Magna Entertainment's non-race track land in Aventura and Ocala, Florida and Dixon, California, plus the land underlying the Gulfstream Park hotel-shopping-condo development, at fair market value.  Wonder who's going to determine what that value is in a free-falling real estate market?  The Magna press release values the land at $100-120 million and says the proceeds will be used to retire the Bank of Montreal debt, but who knows? In addition, MI Developments would extend the due dates on its outstanding loans to Magna Entertainment to December, 2009 and would allow Magna Entertainment to pay off the loans not with cash but with -- surprise! -- Magna Entertainment stock.  Just what the dissident shareholders in MI Developments most wanted for Christmas. In exchange for agreeing to the loan extension and the ability to pay off the loans with possibly worthless stock, MI developments would get a promise from Magna Entertainment that it wouldn't ask for any more money from MI Developments unless the new loan was approved by the minority shareholders in MI Developments.  Such a deal!

In Phase 3 of the plan, we get to the wholly imaginary.  That phase would begin when Magna Entertainment pays off some $295 million in convertible subordinated debt.  Where the money to make those payments, due in 2009 and 2010, would come from is completely unclear, but only if those payments are made would Magna Entertainment pay off its debt to MI Developments (presumbly in stock rather than cash), issue new shares to Stronach and spin off Magna Entertainmnt shares now held by MI Developments to the MI Developments shareholders, who would presumably dump them as fast as possible. At that point, in some parallel universe, MI Developments would be out of the race track business, and Magna Entertainment would be directly controlled by Stronach.

Tech entrepreneur and would-be race track owner Halsey Minor has already criticized the proposed deal as "preposterous," pointing out that Magna entertainment can't possibly pay off the subordinated debt. At that point the whole deal falls apart and MI Developments is left with an even bigger, and unrepayable debt due from Magna Entertainment.

Minor had previously offered to buy up the MI Developments loans to Magna Entertainment, presumably with the intention of foreclosing on the race tracks. MI Developments ignored his offer, and today MI Developments CEO Dennis Mills failed to show up for a scheduled meeting with Minor in Baltimore.  Bad move.  As a review of Minor's career shows, when angered he becomes very tenacious.

Much more to come, I'm sure, but it's late, and I've already found more than enough reasons to conclude that the latest Stronach deal is just more smoke and mirrors, postponing the inevitable.

Sunday, November 23, 2008

Dead Heat at Aqueduct - But Everyone Gets the Same Payoff in the Exotics

Nothing all that unusual about a dead heat in racing. But I suspect there were a lot of Pick 4 and Pick 6 winners at Aqueduct today who were thinking that something was a bit amiss when they saw the payoffs.

Here's what happened: Yield Bogey, at 6-1, and Blues Street, at 15-1, dead-heated for the win in the ninth and final race at the Big A.  The win payoffs were a predictable $7.80 for Yield Bigey and $15.00 for Blues Street; remember, the payoffs are calculated by first subtracting the takeout, then setting aside enough to repay the amounts bet on the winners, then dividing what's left into two equal pots which are then allocated among the winning tickets for each horse, so bets on the horse going off at higher odds will get a higher payout. Similarly, there were two different payoffs for the exacta, tri, superfecta, late daily double and Pick 3, in each case reflecting the different amounts bet.

But when it came to the Pick 4 and the Pick 6, there was only a single payoff.  If you had either horse on top, you got $8,619 for the Pick 4 and $59,832 for the Pick 6.  Nothing to sneeze at, for sure.  But if I had a ticket with 15-1 Blues Street on it, I'd be pretty annoyed.  If the payoffs had been calculated separately for each horse, based on the size of the pools, it's likely that tickets with Yield Bogey on top would have paid something like $5,700 for the Pick 4 and $40,000 for the Pick 6, while the (smaller) number of tickets on Blues Street would have paid perhaps $11,500 for the Pick 4 and $75,000 for the Pick 6, assuming that the pools were divided in roughly the same proportion as the win pools.

I don't know if the Pick 4 and Pick 6 payoffs were mandated by state regulation or were the result of NYRA's own rules.  Whichever is the case, they should be changed to conform with the rest of the exotic bets.  I know NYRA's computers can make the calculations, so it's merely a question of someone having the will ton do it right.

Monday, November 17, 2008

Magna Update: A Shorter Leash

In yet another sign that time is running out for Magna Entertainment, the company announced today that it had secured one more extension of its $40 million revolving credit loan from the Bank of Montreal.  But the real news was that, instead of the one-month extensions that Magna had been able to get the past few months, this one was for only 11 days, until next Friday, November 28th.

For those few days of grace, Magna had to pay another $250,000 in fees, as they have each time the loan has been extended recently. Looking at their balance sheet, I'm not sure where they were able to find even that much spare cash.

Everyone knows that Magna doesn't have the cash to pay off the loan, to say nothing of the $200 million-plus that Magna Entertainment -- the race track company -- owes to its parent, MI Developments.  My guess, and it's only a guess, is that Magna Entertainment's new bankruptcy advisors, Miller Buckfire & Co., have found some asset that they think they can sell off, albeit at a fire-sale price, in the next 10 days.

In a related development, brought to my attention by Terry Bjork on the Derby email list,  the Fort Lauderdale Sun-Sentinel reports that Forest City Enterprises, Frank Stronach's partner in developing what is supposed to be some 70 stores, 500 condo units and a 500-room hotel in what used to be Gulfstream Park's lovely paddock area, is seeking a $2 million tax rebate from the city of Hallandale. Unless the city forks over the cash, the newspaper reports, the development would be "a rather ordinary entertainment center."  Hell, that's better than most things Stronach touches.

Stay tuned.

Sunday, November 16, 2008

Churchill Downs Inc. v. Magna -- By the Numbers

I'm not particularly a fan of Churchill Downs Inc.; their take-no-prisoners war with the owners and trainers over the division of online wagering revenue hurts horsemen and chases away potential bettors.

But, in contrast to the other major players in racing, one has to give Churchill credit for knowing how to run a business.  Compared to NYRA, just emerging from bankruptcy, and Magna, whose every financial report brings it closer to collapse, Churchill has a solid balance sheet, enough cash on hand so that not only can it be sure of opening the doors every day, but, mirabile dictu, there's even a profit for the shareholders. However, the way that Churchill earns its profit makes an important statement about the state of racing today.  Increasingly, Churchill's profits are coming not from live racing but from internet wagering and slot machines.

To see how profits are shifting, we need to loook at some numbers from Churchill's latest quarterly financial report, filed with the US Securities and Exchange Commission on November 5th. Along the way, I'll make some comparisons with Magna, whose quarterly report, about which I've already commented in some detail, was filed two days later.

Churchill owns and operates four major tracks: Churchill Downs itself, Calder, the Fair Grounds, and Arlington Park. That gives the company a solid, though by no means overwhelming, presence through the spring, summer and fall, but Churchill takes a bit of a back seat to Magna in the winter, when the latter has the prime meets at Gulfstream and Santa Anita. In addition, Churchill operates 21 OTB locations in Kentucky, Illinois and Louisiana, and slots and video poker in Louisiana. Over the past few years, Churchill has sold Hollywood Park and two minor-league tracks, Hoosier Park in Indiana and Ellis Park in western Kentucky. And, most important for its future, Churchill operates Twin Spires, Inc., an advance deposit wagering (ADW) system that has absorbed BrisBet, WinTicket and TSNBet, along with the handicapping-data operations of Bloodstock Research (BRIS) and TSN.  It appears that the accountants, lawyers and marketers in charge of Churchill (only four of the company's 12 directors, and none of its principal executive officers are what one would call racing people) have decided that their future lies in these internet businesses. One suspects that corporate management regards its live racing operations as nothing more than a necessary evil -- something that exists only to supply "product" to the online world.

Let's start with Churchill's balance sheet.  In contrast to Magna, which hadliabilities equal to 78% of its total assets as of September 30th, Churchill's total debt was equal to only one-third of total assets.  That's a pretty healthy ratio for any company. In fact, over the past 12 months, Churchill actually paid down some $31 million of long-term debt.

Churchill's total assets as of the end of last quarter were $609 million. As is true of most balance sheets, however, not all of that is real stuff that could be sold. Included in the $609 million  is some $115 million in "goodwill," which basically represents the excess of what they paid to acquire other companies over the fair market value of those companies' assets.  That goodwill is about evenly divided between race track properties and the online operations of BRIS and TSN.  By way of comparison, Magna's balance sheet reports $110 million in "racing licenses," which are pretty much comparable to goodwill, in the sense that, if a track ceases to be a going concern, its license isn't worth much.

With regard to earnings, it was a tough quarter for Churchill, as it was for the entire US racing industry.  But, unlike Magna, Churchill did report a quarterly profit -- and a bigger profit than a year ago -- $2.5 million, compared to $818,000 in the same quarter of 2007.  For the nine months to September 30th, Churchill's corporate profit was $32.6 million, well up from the previous year's $21.9 million.

The 2008 profit figures, by the way, represent improving profit margins compared to revenue.  Net revenue for the third quarter of 2008, in fact, was slightly lower than for the same period in 2007, but Churchill nonetheless managed to triple its profit.  For the nine months to September 30th, revenue increased only 8%, but profits jumped by 50%.  Churchill has found a way to wring more profitability out of essentially flat revenue.

Thanks to what little remains of government regulation, we can see where the profits are coming from and what's driving Churchill's profitability.  Churchill, presumably at the direction of its outside accountants, has divided its financial report by business segments: (1) racing, (2) online businesses (i.e., Twin Spires), and (3) gaming (slot machines and video poker).  While all those segments were profitable this year, the growth is all in the online business and in gaming.  Here are the details:

Net earnings from racing were $4.7 million in the third quarter of 2008, down from $7.7 million in the same period last year.  Churchill, like most other racing entities, began to feel the country's economic crisis seriously in that quarter. For the first nine months of 2008, racing earnings were $61.1 million, up from $51.6 million in the same period in 2007. But the trend in racing earnings is downward. 

In contrast, Churchill's online operations recorded a profit of $2.1 million this year, up from $724,000 last year.  More striking, online profits for the first nine months of 2008 were $4.4 million, compared to a loss of $1.5 million in the same period last year.  And gaming operations produced a $4.4 million profit in 2008's third quarter, compared to $1.9 million in 2007, with gaming profits for the first nine months of 2008 at $13.8 million, more than an 80% increase over the same period in 2007.  Now that the permanent slot machine facility is in place at the Fair Grounds, with video poker terminals in Louisiana and slots at Calder still to come, it looks like gaming is the biggest growth sector in the Churchill portfolio. (For those who might be checking my figures, yes, there is a  difference between the sum of the sector profits and Churchill's overall corporate profit for the quarter; that reflects one-time charges for discontinued operations and for expenses at the corporate level.)

A look at actual handle, both at the race tracks and online, confirms the shift away from racing as the primary profit center for Churchill.  In the third quarter this year, handle at all four of Churchill's tracks declined compared to the same quarter last year: Churchill Downs dropped 20%, Arlington 6%, Calder 27% and the Fair Grounds (betting on simulcasts) 19%.  In contrast, online handle through Twin Spires was 62% higher than in 2007.  The overall handle decline was 12%, even more than the 10% nation-wide drop, but the online platform was definitely a bright spot.

When you combine the growth in Churchill's online betting with the fact that Churchill as a corporation retains a much larger share ofr the online revenues than it does from money bet at the track, one can see why it's so adamantly opposed to giving horsemen afair share of the online revenue.  Overall, the corporation returns 9.1% of its online handle to the originating racetracks.  If we assume that money is split 50-50 between purses and the track, then the contribution to purses from Churchill's online betting is about 4.5%.  Assuming a blended takeout rate of about 20-21%, the national average, that leaves a lot of money on the table for Twin Spires.

Owners and trainers at Churchill's tracks, represented by the Thoroughbred Horsemen's Group (THG) are seeking an equal three-way split of online wagering takeout.  That would raise the percentage that Twin Spires pays into purses from 4.5% to, say, 7%, an increase of roughly 55%.  Not enough to make racing a profitable proposition for most ownersand trainers, but every little bit helps.

In many contexts, the idea of a progressive tax is accepted as being patriotic and civic-minded.  As your income increases, it's reasonable to pay an increasing share of the growth in taxes, or in payments to the people who make yor profits possible. If Churchill took such a view, it would be saying, thanks for letting us keep expenses low when we were starting out in our online business, but now that we're up and running and making a profit, sure, we can pay a fair share to the horsemen.  But Churchill's management seems to share the view of Sarah Palin, that a progressive tax system is somehow unpatriotic. So far, they're not willing to share one more cent of their rapidly increasing online revenues.If their position prevails, and if total handle declines or even stays flat, while the share of that handle represented by online betting continues to grow, then Churchill's profits will continue to climb at the same time that purses decline. Given the shaky economics of owning and training race horses, that's simply unacceptable.

I've seen lots of comments on horseplayer blogs to the effect that it's all the fault of the greedy horsemen for cutting off simulcast signals where they don't have an agreement for a fair division of the revenue.  Well, we can't go on strike, since we're not "employees" of the tracks. And we can't do much else in the way of collective action lest the tracks and the ADWs sue us for antitrust violations -- something Churchill is already doing in Florida and Kentucky.  But federal law does give us (except in New York) the right to shut off the signal.  So if that's the only weapon we have, then that's the one we'll use.  Churchill, as we've seen, could afford to pay a little more into purses. Unlike Magna, the can't claim that giving the horsemen a fair deal would bankrupt them.  Oops, sorry, Magna's already bankrupt, fair deal or not. But even Magna, in its sorry state, is willing to negotiate about online revenue.  Maybe if all those non-racing people on Churchill's Board of Directors and in its executive suite spent a little more time with horses and a little less with their spreadsheets, they'd see their way to doing the right thing. 

Friday, November 7, 2008

Magna: the Gory Details

As I noted last night, Frank Stronach's Magna Entertainment Corp. has posted another large quarterly loss.  For the quarter that ended on September 30th, Magna lost $48.4 million, bringing its accumulated losses over the last decade to a staggering $626 million total (over $300 million of those losses incurred just in the past three years).

Now that I've had a few hours to analyze the latest quarterly reLinkport, it's more apparent than ever that this is an enterprise on serious life support.  The distressing outlook for Magna that I discussed when their mid-year report came out in August has, if anything, become even worse.

In a sign of increasing desperation, Magna announced that it had hired the investment banking firm Miller, Buckfire & Co. to advise on restructuring, sales of assets and possible joint venture options.  Miller, Buckfire isn't your ordinary investment banker, doing whatever kind of deals it can put together.  No, these guys specialize in salvaging failing companies; their motto is "creative solutions for complex problems," and they've won something called the Turnaround Management Association's Transaction of the Year Award twice for their work with other distressed companies. Hiring this particular advisory firm is definitely a sign that even Magna's own management recognizes they're in dire straits.

Frank Stronach's comments on the quarterly results show at least some awareness that all is not well:

Although MEC has a strong asset base, we remain burdened with far too much debt and interest expense. Our previously announced debt elimination plan has been negatively affected by the weak real estate and credit markets, which have impacted our ability to sell non-core assets. As a result, we are evaluating MEC's core operations with a view to possibly selling or joint venturing one or more of MEC's core racetracks in order to strengthen MEC's balance sheet and liquidity position.

That's putting it mildly.  Magna needs to raise cash. Now. And it's trying to do that in the face of the worst US real estate and equities market in decades.  It'll need all of Miller, Buckfire's magic to turn this around.

The "core assets" that Stronach referred to are Santa Anita, Gulfstream, Laurel and Pimlico. When he starts talking about selling these tracks -- something that, in the face of lucrative offers, he has resisted up to now -- we can guess that even Frank is seeing the handwriting on the wall. He may, however, be seeing it too late; it's unlikely that, in today's depressed real estate and thoroughbred racing markets, anyone would offer today the same amount that they might have a couple of years ago, whether the prospective buyer intends to keep operating the properties as race tracks or "develop" them into condos and shopping malls.

Here are some of the highlights, and lowlights, of the latest quarterly report.

  • While overall revenue remained flat, at $81.5 million for the quarter, this masked some differences arising from specific operations.  Revenue was down in Maryland (Laurel and Pimlico) and at Lone Star Park, but up at Gulfstream (from slot machines, not live racing) and Golden Gate. But the latter two increases resulted from one-time events, so the increase doesn't really represent a long-term improvement. At Golden Gate, there were 10 more racing days than last year, so the total improved, even though the daily average fell.  And at Gulfstream, there were more slot machines than last year, as well as simulcasting that wasn't available in 2007.
  • Magna spent $2.4 million during the quarter promoting a yes vote on the slots referendum that was approved by Maryland voters on Tuesday. Magna will be applying for a racino license for Laurel, although the Baltimore casino will apprently be built downtown, and not at Pimlico, and so Magna wouldn't get as great a benefit as would be the case if the slot machines were part of a Pimlico racino.
  • Magna's balance sheet shows that its available cash as of September 30 was only $21 million, compared with $34 million at the end of last year. That's very low for a company of Magna's size.  In addition, Magna continued to carry "racing licenses" on its books at a value of $109 million, even as the value of those licenses continues to decline.
  • Although Magna has reduced its accounts payable from $65 million at the end of 2007 to $41 million at September 30 (I can hear the grateful sighs of various suppliers from here), overall indebtedness continues to rise. Total liabilities as of September 30 were $420 million, up from $390 million nine months ago.  The lion's share of that debt is owed to Magna's parent company, MI Developments, another member of Stronach's corporate empire.
As Stronach has admitted, Magna's much-publicized "debt elimination plan," announced just over a year ago, has failed.  No significant assets were sold in the third quarter of 2008, and earlier this week, the prospective buyers of Magna's 500 acres of land near Ocala FL backed out of their deal to take the land off Magna's hands for $16.5 million. In the current real estate market, it's hard to imagine that Magna's assets can be sold for anything approaching what Stronach paid for them.

MI Developments has continued to sink money into Magna Entertainment.  But, as Ray Paulick has pointed out, its minority shareholders are becoming increasingly restive.  The MI Developments board of directors has ignored an offer from internet entrepreneur Halsey Minor to purchase the Magna Entertainment debt -- which would put Minor in a position effectively to foreclose on Magna Entertainment and realize his dream of becoming a race track operator.  I don't claim to be an expert on the corporate law of Ontario, where MI Developments is headquartered, but it's hard to imagine that the board's turning down an offer to buy up Magna Entertainment's junk-quality debt for its full face value could possibly be seen as acting in the best interests of all shareholders, as opposed to the interests, best or otherwise, of Frank Stronach.

Magna Entertainment's loan obligations are once again coming due -- $40 million to the Bank of Montreal on November 17 and nearly $200 million to MI Developments on December 1.  These loans have been extended month-by-month during the past quarter, but if either the bank or the thus-far supine directors of MI Developments ever decide to pull the plug, the next stop is bankruptcy.

These race tracks are too important to be in the hands of a bankruptcy court -- or of someone like Frank Stronach, who has already proven his inability either to turn a profit or to provide a decent experience for the racing fan.  It's time, in fact it's long past time, for a change.

Wednesday, November 5, 2008

Magna - Another Day, Another Loss

Magna Entertainment Corp., Frank Stronach's vehicle for running racetracks, has just posted its third quarter results (cleverly released at 10 pm, so as, I suppose, to minimize public attention).

The good news, such as it is, is that the level of quarterly losses has more or less stabilized. Magna lost $48.4 million in the quarter ending September 30, 2008, compared to $49.8 million in the same quarter last year.  I guess that's progress.  For 2008 to date, though, through September 30, Magna's total loss is $116.1 million, compared to $70.8 million for the first nine months of 2007.

The quarterly report is filled with lots of detail, shedding some light on how long Magna can hold out without giving up its "crown jewels at Gulfstream, Santa Anita and Maryland. It's too late in the evening for me to decipher the teeny tiny print on my screen right now, but I'll take a longer look at the numbers tomorrow.

Belmont Trend Continues on Downward Path

The New York Racing Association has just released the final numbers for the recently concluded Belmont meet.  As one would expect, they're  all down from the same meet last year, at least when calculated on a per-day basis. This year's meet had four more racing days than in 2007, so some of the aggregates are higher, but that doesnt hide the negative trend.

According to the NYRA press release, the average all-sources daily handle for the Belmont meet was 8.3% below last year's figure, coming in at $9.63 million per day.  NYRA did not say how much of that handle was bet on-track or through NYRA's own phone and internet account system; those are the bets that contribute the most to NYRA and to horsemen's purses. Off-track bets, whether through OTBs, other tracks, internet sites, etc., pay much less of the takeout to NYRA.  Trends around the country suggest that on-track wagering is falling at a faster rate than total handle, so the hit to NYRA's bottom line could well be more than the reported 8.3%

Searching for a positive spin, NYRA reported that the daily handle decline at Belmont  was actually lower than the 10.2% decline registered at this year's Saratoga meet.  But Saratoga had three weeks of horrendous weather to open the meet, while Belmont benefitted from near-perfect weather.

Daily attendance dropped even further.  On an average day at Belmont this fall, only 3,987 hard-core fans passed through the turnstiles, compared to 5,001 last year.  That's a drop of more than 20%, once again suggesting that the on-track betting handle was probably the worst-performing part of this year's Belmont betting mix.

Average daily purses also declined, although somewhat less than the decline in betting handle.  The daily average for the stakes-heavy Belmont meet this year was $574,036, a 7.7% decline from last year's daily average of $622,116.  Purse adjustments generally lag behind developments in handle and attendance, and NYRA responded to the decreases at Belmont by significantly cutting purses for the Aqueduct fall mett, which started October 29th.

The new NYRA Board of Trustees will be meeting soon to set the 2009 stakes schedule.  It would be prudent to take a chunk out of the stakes budget, in the hope of keeping purses at least at their current level.  The Phippses and Maktoums may be doing fine, and I'm happy for them to add to their trophy collections. But the everyday working New York horseman and woman is having a tough time making a go of it in this very expensive milieu.  If overnight purses decline much further, it'll be hard for many of them to stay in business.