We Like The Odds - QUIC

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January8, 2018RESEARCHREPORTLike the OddsJanuaryWe8, 2018Stock RatingPrice TargetGreat Canadian Gaming Corp.We Like the OddsAmidst a Canadian consumers sector with limited names that fit all thecharacteristics of QUIC’s investment strategy, Great Canadian GamingCorporation appears to be a diamond in the rough. With recent majorbundle acquisitions and plans to modernize existing casinos, thecompany is poised for future growth and success. Our three-prongedinvestment thesis includes the following factors:(1) New Opportunities in OLG ModernizationGreat Canadian has recently begun expanding into the lucrativeOntario gaming industry. With bundle acquisitions and modernizationplans, the company should experience immense growth movingforward.(2) Checking off all the Boxes for QUIC’s Investment StrategyGreat Canadian benefits from an industry-regulated environment toachieve a strong and sustainable competitive advantage. Thecompany is led by an “Outsider” CEO and surrounding managementteam who are masters of capital allocation. Despite recent growth, webelieve the company still possesses enormous upside potential.(3) Superior Financial FundamentalsGreat Canadian’s management team has been able create acompounding machine out of its business. On all analyses, thecompany has consistently compounded capital at high rates of return,while maintaining a best-in-class balance sheet.When considering investing in Great Canadian, we analyzedmanagement’s ability to redeploy incremental capital along withcomparing trading multiples to industry competitors. Doing soprovided further confidence in this investment.The information in this document is for EDUCATIONAL and NON-COMMERCIAL use only and is not intended toconstitute specific legal, accounting, financial or tax advice for any individual. In no event will QUIC, its members ordirectors, or Queen’s University be liable to you or anyone else for any loss or damages whatsoever (includingdirect, indirect, special, incidental, consequential, exemplary or punitive damages) resulting from the use of thisdocument, or reliance on the information or content found within this document. The information may not bereproduced or republished in any part without the prior written consent of QUIC and Queen’s University.QUIC is not in the business of advising or holding themselves out as being in the business of advising. Manyfactors may affect the applicability of any statement or comment that appear in our documents to an individual'sparticular circumstances. Queen’s University 2018BUY 42.00BearCasePriceTargetBullCase 36.00 42.00 44.00TickerTSX:GCMarket Cap ( MM)2,061.0P/E NTM19.2xEV/EBITDA NTM9.7x52 Week v-17IndexConsumers & HealthcareJon Allionjallion@quiconline.comAndrei Florescuaflorescu@quiconline.comIoulia Malamoudimalamoud@quiconline.comConnor Stecklycsteckly@quiconline.comBronwyn Ferrisbferris@quiconline.com

January 8, 2018We Like the OddsTable of ContentsCompany Overview2Industry Overview3Investment Thesis I: Opportunity in OLG Modernization4Investment Thesis II: Checking Off all the Boxes5Investment Thesis III: Strong Compounder & Healthy Balance Sheet6Valuation8Risks and Catalysts9References10Appendix111

January 8, 2018We Like the OddsCompany OverviewThe Great Canadian Gaming Corporation (TSX:GC)offers gambling, entertainment and hospitality servicesin British Columbia, Ontario, Nova Scotia, NewBrunswick and Washington State. GC operates 21gaming facilities, within which exist, 15 casinos, 4racetracks, 3 show theatres and over 45 food andbeverage outlets. GC’s gaming facilities are operatedunder long term contracts with regional regulatorybodies, including the Ontario Lottery and GamingCorporation (OLG) and the British Columbia LotteryCorporation (BCLC). The company is sizeable, with acurrent market capitalization of 2.1Bn and totalrevenues equalling 566.4MM in 2016. GC earns aportion of its total gaming revenue (some is collectedby governmental bodies) and, with the exception ofNova Scotia, who collects revenue from non-gamingrevenue as well, all revenue earned through nongaming business operations (e.g. revenue attributed tohotels). Regionally, the vast majority of revenue isgenerated from GC’s operations in British Columbia,EXHIBIT IGambling Industry Product and Service SegmentationElectronic GamblingMachinesCasino GambliingLotterywhere it operates recognizable and respectedproperties, such as the River Rock Casino and HastingsRacetrack. This regional concentration is despite thefact that gambling in British Columbia is onlyresponsible for 16.5% of total Canadian gamblingrevenue, whereas provinces with greater populations,Ontario and Quebec for example, are responsible for40.3% and 20.3% respectively. Nationally, the companyholds approximately 2.7% market share. Recently, GChas begun refurbishing and rebranding many of itsproperties and expanding, by developing newproperties. This can be partly attributed to OLG, as itrecently awarded GC a few long term contracts whichgive GC the right to operate several more gamingfacilities. The current CEO of GC is Rod Baker, who hasheld the position since 2011. Previous to his role asCEO of GC, Baker was President of a financial tion.EXHIBIT IIMajor Industry Players by Market ShareOntario Lotteryand GamingCorp. (OLG)Loto-QuebecCasino table gamesBingoBritish ColumbiaLottery Corp.RafflesOtherHorse RacingOtherGC2

January 8, 2018We Like the OddsIndustry OverviewGambling in Canada is a 15.5Bn industry. Over thepast five years, industry has declined by 0.8%, asconsumers decreased overall discretionary spendingand in a disproportionately high amount, spending ongambling. This decline can also be attributed to: slowper capita income growth, rising prices of someessential products and competition from US casinos. Inaddition, the overall volatility of the Canadian dollarhas discouraged US citizens from traveling to Canadato gamble. Another factor, which has affected thegrowth of the traditional gambling industry, is therising competition resulting from alternative forms ofentertainment (e.g. smartphone games).The industry is concentrated, with the largest fouroperators controlling an estimated 69% of industryrevenue. This consolidation is primarily due to heavyregulation, which has also resulted in nearly half of allrevenues being paid out to governments and charities.Crown Corporations hold a large share of the marketand regulation of the gambling industry is within thejurisdiction of the provinces. While each provinceregulates the industry in a unique manner, federal lawrequires that gambling is “conducted and managed”directly by provinces. To comply with this law,provinces enter into long term contracts with privatesector operators that give the responsibility of specificservices or the entirety of day-to-day operations forgambling facilities to these companies. Theresponsibility to ensure that the facility adheres toregulations, among other, smaller, responsibilities, isleft to the governmental regulatory body. In this way,provinces comply with the Criminal Code of Canadabut avoid the responsibility of having to operate allgambling facilities directly. One of the main Canadiangambling regulatory bodies is the Ontario Lottery andGaming Corporation (OLG). To drive privateinvestment in gaming infrastructure, create jobs andincrease provincial government revenue, OLG hasbegun a bidding process for the right to operate“bundles” of potential or existing gaming facilities.These bundles are grouped according to thegeographic regions in which they are located. Thisprocess is a part of the OLG’s Modernizing Lottery andGaming in Ontario program.It is expected that the gambling industry will growslowly over the next five years (approximately 0.5%)despite further US competition, as new casinoscontinue to be built in states like New York andMassachusetts. The following trends, which promoteindustry growth, are anticipated for key industryeconomic drivers in 2017: consumer spending willincrease, the Canadian dollar will weaken, relative tothe US dollar and leisure time will increase. Thesetrends are expected to offset the detracting force ofincreasing US competition and drive growth in thegambling industry. However, if the threat of consumerdebt affects economic growth, it is probable thatdiscretionary spending will be further reduced, leadingto stagnation or decline in the gambling industry.While insignificant to current revenues, the emergingonline gaming segment could provide the Canadiangambling industry with much needed stimulus.Traditionally, Canadians have used unregulatedoffshore websites, called the “grey market”, to gameonline. These offshore companies offer online gamingopportunities to citizens globally, but are based out ofcountries with little gambling regulation. Therefore,these companies circumvent North Americanregulations and taxes, yet still have access to the NorthAmerican customer base. To capture this lost revenuestream, provinces have begun to offer online gamingthrough their various crown corporations (e.g. OLG).However, these websites have yet to significantlycontribute to provincial gaming revenue due to greymarket competition.EXHIBIT IIICanadian Gaming Industry Revenue Growth (%)3

January 8, 2018We Like the OddsInvestment Thesis I: Opportunity in OLG ModernizationThe OLG modernization process presents anopportunity for GC to expand. Already, GC has beenawarded the Greater Toronto Area (GTA) Bundle, theWest Greater Toronto Area (West GTA) Bundle and theEast Bundle. In regard to the GTA Bundle, GC is a 49%equity partner, working in partnership with Brookfield,an alternative asset manager. Concerning the WestGTA Bundle, GC in a 55% equity partner working inpartnership with Clairvest, a private equity firm.Regarding the East Gaming Bundle, GC will operatethrough a subsidiary in which GC holds 90.5% equityinterest. Together, these bundles represent ten gamingzones and include established gaming sites such as theWoodbine Racetrack, Brantford Casino and GrandRiver Raceway. As of fiscal 2015, the East, the WestGTA and the GTA bundles represent 124.2MM, 339.7MM, 879MM of revenue, respectively. Of thethree gaming bundles awarded to GC, only the EastGaming Bundle involves the development of a newgaming facility, which is the responsibility of GC, theGTA and West GTA bundle involve solely the oversightof operations of existing facilities.OLG began awarding gaming bundles in 2015 andthere are two outstanding gaming bundles still to beawarded, the Central and Niagara bundles. Combined,these groups represent five gaming zones and 1Bnof revenue. GC has been short-listed for both of thesebundles. OLG has cited three main criteria whenevaluating potential operators: gaming experience,financial strength and property developmentexperience. As a corporation with 36 years of gamingexperience, stable financials (as will be discussed later),and a successful development history, GC can be seenas a viable candidate for both of these bundles. Aswell, GC’s viability as a candidate is proven by its beingpreviously awarded bundles by OLG.The GTA, West GTA and East gaming bundles, as wellas the possibility of being awarded an outstandingbundle, provide GC with a runway for growth in aprovince which is responsible for over 40% of nationalgaming revenues. This is a low risk expansionopportunity as almost all casinos, with the exception ofthose yet to be developed, involved in these bundleshave already been proven as profitable.EXHIBIT IVOLG Gaming Bundles and their Corresponding Revenues1600Revenue ( MM)In 2012, OLG announced a modernization initiativewhich was intended to drive private investment in thegaming industry and increase governmental revenuesfrom it. Now, in 2018, the modernization process is in astage which involves OLG awarding bundles of longterm contracts (called gaming bundles) for potential orexisting gaming facilities to private operators. Thesegaming bundles consist of several gaming zones,grouped together on a geographical basis. In total,this initiative concern 27 gaming zones that span theprovince of Ontario. The size of facility developed ineach zone is regulated by the OLG’s prescribedmaximum number of slots allowed and maximumnumber of live tables allowed for that zone. For eachgaming zone, there is a separate bidding processwhich follows the same three general steps. Firstly, theprivate operators must pass a prequalification process,this creates a “short list” of potential operators. Next,the operators on the short list are allowed to apply forthe contract. Finally, the contract is awarded to thewinning bidder.12008004000Bundles Awarded Bundles Awardedto GCto OtherCompaniesOutstandingWest GTAEastGTANorthSouthwestOttawaNiagaraCentral4

January 8, 2018We Like the OddsInvestment Thesis II: Checking Off all the BoxesAt the beginning of the 2017-18 year, the QUIC teamestablished an investment strategy to follow for allstock making selections. The strategy entailed thefollowing four-step process:EXHIBIT V: QUIC’s Investment Strategy123Discover Companies with a SustainableCompetitive AdvantageWith Management that are Capital AllocationMastersEnsure a Runway for Growth Exists4Pay a Fair Price(1) Sustainable Competitive AdvantageThe Canadian gaming environment provides anextremely favourable industry to operate in, which GChas taken advantage of. Great Canadian hascommitted to long-term agreements with provincialcrown corporations. Furthermore, GC operates inseveral segments (New Brunswick, Nova Scotia, andmost notably the GTA as of 2018), where the companypossesses a monopoly as the only regionaloperator. These characteristics provide GreatCanadian Gaming with a sustainable competitiveadvantage (or in business terms, a moat), which GCshould continue to capitalize on to outperform itscompetitors.(2) “Outsider” CEO and Stellar Management TeamGC is led by CEO Rod Baker, who we believe fits thecharacteristics of an Outsider CEO. Baker rarely meetswith the research analysts, nor does he appear on thecover of business magazines. His sole focus is oncapital allocation, with the intention of growing thebusiness on a per-share basis as much as possible.Baker also owns a significant ownership stake in thebusiness, holding 5% of all outstanding shares.Furthermore, GC’s management team has alsoorchestrated several successful major acquisitions inprior years, exhibiting traits of patience and thinkingfor the long-term. Evidence of the company’ssuccessful track record is detailed more in investmentthesis III, outlining management’s successful ability togrow the business, while maintaining a healthy balancesheet. We have confidence in GC’s management andtheir ability to deliver strong results moving forward.(3) Runway for GrowthWhen investing in any company, it’s vital to lookahead and not get caught staring in the rear-viewmirror. Despite GC’s tremendous success which hasbeen reflected in significant share price appreciationrecently, we are confident the company can still be amulti-bagger over the upcoming decade. GC is puttingsignificant capital to work, modernizing locationsacross Canada, while capturing bundles in the GTA andseveral other prime locations. With the company’sstellar track record of capital allocation and highROIC, we are confident management will continue todeliver and create value for shareholders.(4) Paying a Fair PriceGreat Canadian trades at a discount to several of itscompetitors despite possessing stronger margins,revenue growth, and a cleaner balance sheet. Whenconsidering growth opportunities moving forwardthrough modernization of existing facilities and recentbundle acquisitions, we believe the company has theability to achieve 15% returns per annum over thenext 5-10 years.5

January 8, 2018We Like the OddsInvestment Thesis III: Strong Compounder & Healthy Balance SheetWe believe that GC's management team is both greatat being productive with their capital and managingtheir balance sheet. We want to invest in companiesthat yield greater returns on their earnings than whatis available in the broader market.(1) Market Value Generated on Retained EarningsTo evaluate GC's ability to generate returns on theirearnings, we use Warren Buffett's 1 Test, which hetalks about in his 1984 shareholder letter. This highlevel analysis essentially compares how much of acompany's earnings are retained to how much marketvalue was generated over the same time period,usually three to five years. Buffett states that in orderto pass his 1 Test, "for every dollar retained by thecorporation, at least one dollar of market value will becreated for owners". In other words, it is onlyworthwhile for a company to retain their earnings if adollar in the hands of management is worth more thana dollar in the hands of shareholders.Over the past five years, GC has retained 191.2MM ofearnings and generated 825.7MM of additionalmarket value (see Appendix I & Exhibit VI). Assumingthe price appreciation GC has experienced in themarkets over the past five years accurately reflects theintrinsic value of the company, GC has generated 4.3in value for each dollar it retained. As such, GC easilypasses Buffett's test, which may suggest thatmanagement is smart with their capital. In comparison,none of GC's four regional peers pass the 1 Test, withChurchill Downs being the closest, generating only 0.7 in market value for each dollar retained. In doingthis exercise, we are evaluating the company’s abilityto earn a return on its incremental invested capital(ROIIC).(2) Impressive Return on Invested CapitalAnother way to evaluate GC’s ability to compound itsintrinsic value over time is by analyzing the company’sreturn on invested capital (ROIC). Great CanadianGaming’s management has historically allocatedcapital to projects that return much more than theircost of capital, and thus generate value forshareholders. We calculated the ROIC of the companysince 2005 and found that it has steadily increased tothe 24% it is currently (see Exhibit VII). The only waythis can happen is if the incremental capital invested inrecent years yields a return that exceeds what hasbeen returned in past years. The upward trendingROIC that GC has been able to achieve is importantbecause it shows that the company is currently able tofind attractive growth initiatives to invest upon. Thiscan be classified as a ‘reinvestment moat’, which ismore favourable than companies that rely on returnsfrom ‘old’ capital that have few compelling investmentopportunities presently, which is called a ‘legacymoat’.(3) Clean Balance SheetGreat Canadian Gaming’s management team has beenprudent with using debt, which has resulted in anindustry-leading leverage profile. When compared toboth regional and U.S. peers, GC’s Net Debt / EBITDAmultiple of 1.3x falls well below the industry average of4.0x (see Exhibit VIII).(4) Why Does This Matter?The gaming industry is mature. As such, it is necessaryto grow through development projects. GreatCanadian Gaming’s strong history of efficientlyallocating capital to lucrative projects, as discovered bylooking at their ROIIC and ROIC, leads us to believethat they are capable of managing the moneyinvestors put in their hands. The range ofopportunities to acquire existing facilities with theOLG’s modernization process and build new facilities inregions such as Victoria, BC offer exciting prospects toreinvest capital in the future at the high rates of returnthey have benefitted from in the past. Additionally, thecompany’s low levels of debt will allow them to incurmore debt in the future to pursue projects that willhelp generate value for GC.6

January 8, 2018We Like the OddsEXHIBIT VIEarnings Retained vs. Market Value Added (2012 – 2016)1,1008004.3 xRetainedEarnings500200(100)201220132014Earnings Retained2015Market Value Added2016Source(s): S&P Capital IQEXHIBI

gaming facility, which is the responsibility of GC, the GTA and West GTA bundle involve solely the oversight of operations of existing facilities. OLG began awarding gaming bundles in 2015 and there are two outstanding gaming bundles still to be awarded, the Central and Niagara bundles. Combined, these groups represent five gaming zones and 1Bn

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