NEW YORK (CNN/Money) -
The grandeur and tradition of horse racing will be celebrated Saturday with the 128th running of the Kentucky Derby, but the company that hosts the sports' most popular event no longer can afford to peg its future to one race on the first Saturday of May.
Churchill Downs Inc. (CHDN: up $0.03 to $36.98, Research, Estimates) has been on a five-year acquisition binge as it gobbles up other tracks in the consolidating and financially-challenged horse racing industry. The buying spree has added four tracks in five years, allowing it to have betting, revenue and earnings all rise by about 40 percent a year since 1997.
But the need to issue additional shares to make the deals has depressed earnings per share growth.
The company was disappointed when it posted a slight drop in EPS last year to $1.67 a share in 2001 from $1.75 in 2000 and $1.72 in 1999.
Analysts surveyed by earnings tracker First Call are looking for an increase this year, but only up to $1.81 a share.
A 44 percent run-up in its stock price since early November has raised its price-to-earnings ratio to a healthy 22.1, leaving some analysts questioning how much more upside there is left for the stock in the near-term. Churchill Downs is already at a higher multiple than most of the stocks in the Dow Jones U.S. casinos index.
The horse racing industry, which once had a virtual monopoly on legal gambling in the country, now finds state lotteries, riverboat gambling and Native American casinos popping up across the nation, siphoning off gambler's dollars and interest.
New competitive threat from slots
The competition has prompted Churchill Downs to push hard for legislation to allow it to have slots, not just beneath the famous twin spires of its old Kentucky home, but also at the other premier tracks it has purchased, Hollywood Park in Inglewood, Calif., and Arlington Park outside of Chicago.
|Churchill Downs Inc. wants to bring slot machines to its famous old Kentucky home as well as its other tracks.
"It's only a matter now of when, not if, we will get slot machines or video lottery terminals into our facilities," predicts Churchill Downs Chief Financial Officer Bob Decker.
The pressure to expand to other forms of gambling is two-fold. The race tracks face competition for gambler's dollars and interest from nearby casinos such as the riverboats that dock on the Indiana shore of the Ohio river directly across from Louisville, Ky. In addition some race tracks have already won the right to have slots that has allowed them to supplement their prize money and win the competition to have better quality horses appear at their races.
Last fall New York passed legislation in the wake of Sept. 11 to allow slots at its tracks. The threat of having the machines at Aqueduct Race Track in New York City, with its huge population base nearby, has the potential to send purses soaring, and prompted legislation to allow slots in 16 different state legislatures.
"This prospect of machines at Aqueduct sent shockwaves through industry," said Eugene Christiansen of Christiansen Capital Advisors, an expert on gaming. "You're talking about a potential for huge differences in purses - maybe doubling. I think Mr. Decker is right when he says it's a matter of when the machines will spread."
Off-track betting on the rise
Christiansen and Ryan Worst, gaming stock analyst with Dresdner Kleinwort Wasserstein, both think that Churchill Downs is well positioned for growth in the consolidating industry. Part of their reason for optimism is the growth of off-track betting and revenue from the closed-circuit broadcasts of its races to about 1,100 betting parlors around the country.
"On-track wager and attendance is down, a lot of that is made up by wagering from off track locations," said Worst. "I think there is a valid business model, exporting racing signal to other locations, with a lot of growth potential internationally. And I think eventually people will be able to wager from home."
The growth of off track wagering is a key to Churchill Downs' growth strategy. The company has a closed-circuit horse racing channel, the Churchill Downs Simulcast Network, which broadcasts races from all of its tracks live to parlors and other race tracks for a percentage of the amount wagered on those races at the parlors. That revenue comes with virtually no additional cost to the company, helping its bottom line.
The company is looking to increase its penetration in overseas off track betting markets. Decker estimates that an estimated $15 billion to $16 billion wagered on horses in the United States is dwarfed by the $83 billion wagered outside the country. Worst also sees the simulcast market and the potential for further acquisitions as enough to keep the company growing despite some difficult industry dynamics.
Still Worst downgraded his recommendations on Churchill Down and two other horse racing stocks, Penn National Gaming Inc. (PENN: Research, Estimates) and MTR Gaming Group Inc. (MNTG: Research, Estimates), he said mostly because of the recent appreciation in their stock prices. Still, he has an "add" recommendation on Churchill Downs, rather than the "hold" rating on Penn National, which already has seen the introduction of slot machines at its key tracks.
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Worst's 12-month target price for Churchill Downs' stock is $43, which is about 14 percent above current valuations.
"The company's size and standing relative to its peers, a premium brand, and significant growth opportunities warrant a premium valuation in our opinion," he wrote in a note to clients a month ago.