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Morningstar | SkyCity Offloads Darwin Casino for a Fair Price, No Change in our FVE

SkyCity Entertainment has finally secured a buyer for the Darwin casino. Delaware North, a U.S-based global food service and hospitality company, will purchase the business for AUD 188 million, on a cash and debt-free basis. The purchase price represents a multiple of 7 times our fiscal 2019 EBITDA forecast. While this multiple is below the 9 times (forecast) EBITDA the group currently trades at, we think this is a fair price considering the structural challenges facing the business, and a good outcome for shareholders. Despite the sale price exceeding the book value by around AUD 8 million, the impact on valuation is negligible. Accordingly, we maintain our NZD 4.20 per share fair value estimate (AUD 3.80 at current spot price).

We believe shares in SkyCity are slightly undervalued at the current price. We are attracted to the company’s portfolio of monopoly casino licences, which underpins its narrow moat rating. However, the company is in the middle of multiple major capital projects, and it is unclear as to whether the Adelaide expansion will earn sufficient return on the AUD 330 million investment given its lacklustre track record. We are positive on the outlook for Auckland and expect the new convention centre to be a major foot traffic driver.

We expect the sale to complete by the start of fiscal 2020, and we have cut our earnings estimates from fiscal 2020 through to 2022 by around 9% per year on average. From a strategic standpoint, we think the decision to sell is the right move. The Darwin casino has never recovered from the additional competition in the Northern Territory, with its EBITDA declining by around 11% per year on average during the four years ending fiscal 2017. This follows the government permitting a 75% increase in the number of machines outside of the casino. We think the proceeds from the sale would be better utilised if directed towards the core Auckland facility, or to assist in funding the Adelaide project. Further, we believe the management team has its hands full with the current pipeline of major projects, without the hassle of trying to revitalise the Darwin property.

Upon completion of the transaction, we expect net debt to fall to around 1.9 times fiscal 2020 EBITDA, compared with 2.2 times excluding the sale. While we are comfortable with the firm’s balance sheet health, we think below 2 times EBITDA is a more desirable level.

SkyCity will continue to own and manage the casino until Delaware North obtains regulatory approval from the Northern Territory Government. The sale is conditional upon: financing approval; no material adverse change in the business prior to completion; and the Little Mindil property being retained by SkyCity. We believe the transaction is likely to proceed and have factored this into our assumptions.

SkyCity and Delaware North plan to enter a joint venture to establish an online casino business from the Northern Territory, in the event online gambling is legalised in Australia within the next decade. At this point, we believe this is an unlikely scenario and have not factored this into our earnings assumptions.