This report was originally published on 2/22/10.

We introduced GCA (8.05 ↓0.86%) as a long idea approximately 4-months ago, since that time shares have appreciated more than 20%.  GCA will report its 4Q09 earnings after the market closes on Tuesday, February 23rd.  Overall, we think the company should meet if not exceed current consensus estimates. As the leading provider of cash management solutions to gaming operators, GCA’s revenue growth is highly dependent on traffic to leading gaming destinations and casino win.  Over the past five years, GCA’s SSS have had a correlation to Atlantic City Win, Las Vegas visitation levels, and Clark County gaming revenues in excess of 0.80.

What We Know About the Gaming Environment for 4Q09

The fourth quarter financial performance of most gaming operators can be best described as: “getting worse at a slower rate, but not yet improving”.  Although trends could hardly be characterized as robust, there are some reasons for optimism, particularly in Las Vegas.  We estimate GCA generates approximately 50% of its revenues from Las Vegas, Atlantic City, and Connecticut.  We focus on trends in those markets to gauge the accuracy of our same store sales estimate in any given quarter.  We currently forecast a 7% YOY decline in same store sales for GCA in 4Q09, which appears reasonable, if not conservative given the trends witnessed in key markets during the quarter.  Here are some of the highlights:

• Total visitation to Las Vegas increased 2.8% YOY in the fourth quarter.  This represents the first positive comp for visitation in Las Vegas since 1Q08.  Visitation has increased on a YOY basis for four consecutive months.
• Clark County gaming revenues decreased 2.4% YOY in 4Q09.  This represents the slowest rate of decline since 4Q07.  Clark County gaming revenues have now declined on a YOY basis for nine consecutive quarters. Within the quarter, gaming revenues actually increased in the month of November, but December proved to be weak.
• Win for Atlantic City casinos declined 9.9% YOY in 4Q09.  It’s hard to put a positive spin on this data. Atlantic City faces both cyclical pressures and secular headwinds from increased competition.  Atlantic City casinos have not posted a positive quarterly comp since 4Q06.  Given the expansion of gaming capacity in Pennsylvania, it could be difficult for Atlantic City casinos to generate positive comps for some time.
• In Connecticut, slot handle declined 5.7% YOY for 4Q09.  This represents an improvement from the 10.4% decrease witnessed in 3Q09.  In January, slot handle at the Mohegan Sun and Foxwoods increased 2.2%, which represents the first positive comp in more than a year.  It is too soon to characterize the January comp as a new trend, but it is encouraging.

In the chart below we compare GCA’s SSS comps to the YOY change in Las Vegas visitation, Clark Clark County revenues, and Atlantic City casino win.  We think our (-7%) SSS estimate for GCA for 4Q09 appears achievable.

Source: PAA Research

What the Big Boys Are Saying About 2010

Over the past two weeks four leading gaming operators have reported 4Q09 results.  Wall Street has been less than enthusiastic about the 4Q09 earnings results and 2010 outlook from PNK (8.59 ↓1.60%), PENN(24.79 ↑2.40%), MGM (11.8 ↑1.11%), and LVS (19.57 ↑1.19%).  The four stocks witnessed an 8% decline on average on the trading day following their earnings release.  While this might raise some concerns for GCA shareholders, we would argue the set-up heading into the company’s earnings is far different than was the case for the leading gaming operators (more on this later).  More importantly, we thought it might be helpful to look at some of the commentary offered by senior management of these companies to gain a better sense of what might be in store for 2010.

“We have seen the worst of the downturn…. Passenger declines have slowed…. Airlines are adding seats [more flights to Las Vegas] for the Spring… Auto traffic continues to grow… Our convention bookings in the fourth quarter of 440,000 rooms was four times the level of the fourth quarter of 2008”

Jim Murren, Chairman and CEO MGM

“Finally, let me spend a moment on Las Vegas. The good news is that group business is returning. In fact, our group business was up 20% in the first 40 days of 2010 compared to last year. Forward bookings were also increasing for both 2010 and 2011.”

Sheldon Adelson, Chairman and CEO LVS, Source: Seeking Alpha

“Our January performance in Las Vegas is quite healthy compared to last year, principally due to revenue growth and continued impact of our right-sizing initiatives….our gaming business is relatively healthy with volumes turning above 2008 levels and our costs are down”

Rob Goldstein, EVP and COO of The Venetian & The Palazzo Las Vegas.  Source: Seeking Alpha

“Well, here we are again at the end of another year and I can’t say I’m sorry to see it go. Looking forward as you can see from our guidance, we don’t see a whole lot of reason for enthusiasm in 2010… We don’t have a clue. We really don’t have a clue where this year is going to go. We had some optimism looking back more than a year ago that ‘09 by the latter part of the year was going to be more positive, but now, having been chase by the results of 2009, we don’t see a lot of reason for enthusiasm in 2010.“

Peter Carlino, Chairman and CEO PENN.  Source: Seeking Alpha

Based on these comments from industry leaders it seems reasonable to assume that Las Vegas could generate positive comps over the course of the year, while trends in local markets could continue to remain weak.  GCA has significant earnings leverage to an upswing in gaming traffic and dollar drop.  It appears a significant upturn could occur in the second half of 2010, at the earliest. Fortunately, these assumptions have already been factored into consensus estimates.

PAA Reserach 4Q09 and 2010 Estimates vs. Consensus – The “Bar” Appears Achievable

We think GCA could deliver modest upside to current 4Q09 consensus for revenues and cash EPS of $159.6 million and $0.17, respectively.  We currently forecast revenues of $164.0 million and cash EPS of $0.17.  Here are our key assumptions for the quarter:

• A YOY decline in same store sales of 7%
• A 20% YOY decline in cash advance revenues to $65.7 million.  GCA continues to suffer from a reduction in both transaction size for credit card cash advances and a reluctance on the part of the consumer to take on additional credit card debt.
• 6.7% YOY growth in ATM transactions. We have assumed GCA’s ATM transactions will benefit from the mix shift away from credit cards.
• Gross profit margin of 25.0% for 4Q09, up from 24.5% for 3Q09

We think the “set-up” for GCA shareholders in 2010 remains very favorable even though many key executives within gaming companies have offered a cautiously optimistic outlook on 2010, at best and an outright cautious outlook, at worst.  Current consensus revenue estimates for 2010 contemplate a 1% decline for GCA in 2010, which we would characterize as overly conservative given the momentum building in some of GCA’s key markets such as Las Vegas and Connecticut.  We currently forecast revenues and cash EPS of $693.7 million and $0.80 compared to consensus of $670.4 million and $0.78.  Our key assumptions for FY10 are as follows:

• A decline in same store sales of 5% in 1Q10, after which we expect comps to gradually improve over the course of the year.  We estimate GCA will exit 2010 generating 5% comps.
• An 11.7% YOY decline in credit card cash advance revenues in 1Q10.  We expect GCA to witness 5-7% revenue growth from credit card cash advance in the second half of 2010.
• 2.6% YOY growth in ATM transaction revenue for all of 2010.
• Gross profit margin for the full year of 25.9%, which would represent a 110 bps increase YOY.  GCA’s gross margins are highly levered to credit card cash advance volumes. In the past, when credit card cash advance revenues have exceeded 50% of the company’s total, GCA has generated gross margins in excess of 30%.
• Interest expense of $17.6 million for the full year.  Even though we expect GCA to continue to pursue debt repayment options, the company remains highly exposed to movements in 1-month LIBOR through its $410 cash facility (for its ATM’s and other cash advance terminals) through Bank of America.  We expect one-month LIBOR to increase to 75 bps from 40 bps currently.
• We forecast $85 million of FCF generation for GCA in 2010

Key Questions Heading into Earnings

Here is a list of questions and issues we would like GCA to address in its earnings release and subsequent conference call:

• How did the company’s same store sales trends progress over the course of the quarter? Was there a meaningful shift in credit card cash advance volume?
• How did revenue performance differ between the company’s larger markets and destination casinos (Las Vegas, Atlantic City, and Connecticut) and for that in local markets?
• What is the timing of closing for the Western Money Systems acquisition? How will this impact 2010 financial results?
• Will GCA pursue other acquisitions of equipment OEM’s? Is vertical integration a primary strategy for the company going forward?
• What new cashless gaming products does the company plan to introduce and deploy in 2010? Has the company obtained any new regulatory approvals for cashless gaming products?
• How is the rollout of QCP express progressing (credit card cash advance cashless product)? How many customers does the company currently have for the product?
• How will gaming expansion in Kansas, Maryland, Pennsylvania, and Ohio impact the company’s growth over the next 2-3 years?
• The tender premium (102%) for the company’s 8.75% senior subordinated notes expires March 2010.  Does the company plan to tender, repurchase, or otherwise refinance the senior subordinated notes?
• What is management’s orientation towards capital allocation between acquisitions, debt pay down, and share repurchase?

Valuation Remains Compelling

Historically, GCA has traded off a non-GAAP measure called “cash EPS” which is effectively GAAP EPS plus the benefit of the company’s $150 million deferred tax asset.  Remember, the company’s deferred tax asset will reduce cash taxes paid by $18 million annually through 2019.  On cash EPS, GCA shares now trade at 11.4x 2009 cash earnings.  We recognize that the secular growth story in the US gaming market and the notion that gaming revenues were “recession proof” has been more or less demolished by this downturn.  We now view the gaming industry as cyclical with the potential for cycle-to-cycle growth.  GCA’s revenues are far less cyclical and the company has the opportunity to expand into cashless gaming products, ancillary service lines, and introduce new products.  We find GCA’s current valuation of 11.4x and 9.9x our cash EPS estimates for FY09 and FY10 as excessively cheap.  We think a 14-16x multiple on cash EPS for GCA shares is more than reasonable given the stability of the company’s free cash flow, its strong market position, high ROE and improving returns on capital. At 14-16x our FY10 cash EPS estimate GCA shares would trade at $11.20-12.48/share or 40-60% above current levels.

Source: PAA Research

As always, please act accordingly…