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Morningstar | Caesars Loyalty and Ongoing Investment Not Enough to Warrant a Moat; Shares a Touch Undervalued

We are initiating coverage of Caesars Entertainment with a no-moat rating and fair value estimate of $10.30. Trading just above 10 times 2019 enterprise value/EBITDA we see shares slightly undervalued. For those seeking gaming exposure, no-moat MGM trades at a wider margin of safety to our $38 valuation.

We think Caesars' Entertainment will sustain its competitive positioning in the lower-growth lower-barrier Las Vegas (57% of estimated 2019 EBITDAR) and other U.S. regions (45%). (Caesars' managed and international properties are forecast to generate slightly negative EBITDAR in 2019). Despite increasing competition from new casino supply and peer investment into existing assets, we see Caesars maintaining market share as it continues to allocate capital into renovating current properties and opening new development facilities (such as its Las Vegas convention center in 2020), which have the opportunity to leverage the company's 55 million loyalty membership base (larger than MGM's 26 million program) and marketing efficacy efforts.

That said, Las Vegas and other U.S. gaming regions do not contribute to a moat for Caesar. U.S. gaming demand is lower than in Asian regions such as Macau and Singapore, where the propensity to gamble is much higher. Also, the 1,000 commercial and tribal casinos in the U.S. that have a total population of 325 million represent gaming supply well in excess of the 41 and two casinos found in Macau and Singapore, respectively, despite a Chinese and Singapore population of 1.4 billion and 5.6 million, respectively. Further, we expect supply growth in U.S. gaming to increase over the next five years with two resorts opening in Las Vegas that add a mid-single-digit percentage to market room supply and expansion of state gaming facilities. This compares with negligible additions in either Macau (we expect only one integrated resort to open the next 10 years) or Singapore (we see no additional licenses for the foreseeable future).

We see Caesars' ability to develop a competitive advantage as limited. We see a low probability of Caesars gaining license exposure to higher ROIC overseas markets that have higher barriers of entry, as we expect only a few such opportunities to become available with the winners likely being operators with stronger operational track records (over the next 10 years we expect there to be no new awards in Macau or Singapore with just two urban licenses in Japan won by narrow-moat Las Vegas Sands and no-moat MGM). The low probability of Caesars receiving an Asian gaming license is supported by the company's outsize leverage position, which could present a risk to those officials in charge of awarding licenses to gaming operators.

As of April 2019, activist Carl Icahn owns around 18% of Caesars shares outstanding and controls 4 of the 12 board seats, including new CEO Anthony Rodio's spot. Icahn is also exploring a potential sale of Caesars. While an acquisition could bring cost synergies to the combined entity, we don't envision it altering Caesars' competitive positioning enough to warrant a moat rating change, given the most likely tie-ups (El Dorado and Golden Nugget) offer further exposure to U.S. gaming facilities that we see offering no sustained competitive advantage.