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High stakes

By Andrea Fox

Tuesday 1st June 2004

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Is sharemarket darling SkyCity playing fast and lose with the punters' cash? Andrea Fox looks at the odds


It's not just the punters getting their adrenalin-rush jollies at SkyCity these days. Judging by the entertainment juggernaut's hot shopping pace since February, the company's directors are getting their thrills too.

SkyCity's masters may be forbidden from gambling in the company's casinos, but with four acquisition announcements in three months - including a second casino buy in Australia - there's clearly no law against them playing the market. On top of this, they've appointed a Sydney-based Aussie, Rod McGeoch, as their new chairman. And picked a fight with Christchurch Casinos chairman Barry Thomas with their proposal to buy 40.5 % of the casino company he heads. (He was so riled he publicly intimated they should take a jump off their 328 metre-high Auckland tower.)

So what's going on at the Auckland headquarters of one of the New Zealand's leading wealth generators? And, more importantly for investors in the Kiwi sharemarket darling, is SkyCity about to do as The Warehouse has done by rolling too many dice in Australia?

Money machine
To understand the market's doubts and questions about SkyCity's newest playgrounds, it helps to know some basics about the business. The company listed in 1996. Its flagship Auckland operation has been nothing less than a money making factory since it opened that same year. It cost nearly $500 million to build and reaped nearly $200 million in earnings before interest, tax, depreciation and amortisation (ebitda) in 2003. Auckland has doubled its profits in the past five years, representing about 15% compound growth from a constant asset base, resulting in massive free cash flows, says independent financial analyst Roger Armstrong.

Over all its operations, the group has recorded six consecutive years of profit and dividend growth, reporting a return to shareholders of 455% in the seven and a half years since listing. Its share price has swelled by more than 250% since its market debut. Dividends have lifted from 14.5c in 1997 to 67c last year (it has a 90% dividend payout policy). Earnings per share have risen from 18 cents in 1997 to 51 cents last year. The group's operating revenues last year were $556 million (including $336 million from its New Zealand casinos), up $46 million on the previous year.

And, even better for SkyCity, government regulation has ensured its dominance in New Zealand - no more new casino licences will be issued.

So what were the announcements that got everyone talking? In February SkyCity said it was buying the Darwin casino in Australia's Northern Territory for NZ$220 million. The share price immediately took a hit as investors remembered that the company's first Australian purchase, the Adelaide casino, was still performing disappointingly after SkyCity purchased it four years ago. (The share price shortly after took a second knock when the half year profit of $55.1 million disappointed the market).

The second announcement came in early April. SkyCity said it was buying Aspinall's 40.5% stake in Christchurch Casinos for $93.7 million. This company, of which Thomas's Skyline Enterprises also owns 40.5%, also has a 33% stake in Dunedin Casinos. The deal would give SkyCity an interest in five of New Zealand's six licensed casinos. The Commerce Commission was still considering SkyCity's application for clearance as Unlimited went to press.

Number three announcement, two weeks later, that SkyCity was making a $14 million takeover offer for its listed cinema company subsidiary SkyCity Leisure, was simply seen as a "mopping up" of the 26% it doesn't already own. Still, there was surprise that the move had come so soon. SkyCity bought 74% of the company, then called Force Corporation, in 2001 and 2002, saving it from certain disaster. But Armstrong says it still has poor underlying profitability and SkyCity's involvement would have to be considered a failure.

In between announcements, SkyCity opened a $150 million convention centre in Auckland, to be complemented by a new hotel to open in August.

On top of all this, in late April SkyCity announced plans to increase its shareholding in the Hamilton casino, agreeing to buy a 15% stake from Tainui Group Holdings for $10.5 million, taking its stake from 55% to 70%.

So, on the casino front, we now have SkyCity owning, or prospectively owning, 100% of SkyCity Auckland, 70% of SkyCity Hamilton, 60% of Sky Alpine Queenstown, 40.5% of Christchurch Casinos, 100% of SkyCity Adelaide (its second biggest business after Auckland), and 100% of Darwin casino.

Thomas, a Queenstown accountant and chair of Skyline Enterprises, growls that the company is positioning itself for a national industry takeover. Some institutional investors and analysts simply think its directors need to put away the chequebook and have a good hard think. Suddenly our sharemarket sweetheart is attracting some sour press.

Analytical angst
Armstrong, and another independent analyst Brian Gaynor, say SkyCity's investment track record is poor outside its money-spinning Auckland operation. Gaynor reckons the company's done a good job in Auckland, but its other acquisitions are a "mishmash" that add nothing to the group's performance. Armstrong calls its adventure in internet gambling company Canbet (32.6% shareholding) a flop, notes that the Queenstown investment is in loss, and says Adelaide's approximately $17 million annual operating profit represents only a 7% return on a $250 million investment. Only the new Hamilton casino looks like paying its way (on a $50 million investment).

Goldman Sachs JBWere portfolio manager Paul Harrison is reported as saying SkyCity's investment in Australia is only slightly less than in New Zealand - $450 million against $500 million. But while New Zealand operations have returned a gross $200 million, Australia has earned just $55 million. Goldman sold half its SkyCity stake last year, fearing the company would invest again in Australia before achieving satisfactory returns from its first foray. Tower Asset Management, understood to own just under 5% of SkyCity, has told the company it's concerned. Its New Zealand equities analyst Paul Robertshawe says SkyCity has two very successful investments - Auckland and Hamilton. Both are regulated monopolies. There is only one casino licence in those cities.

The remainder of its interests have embedded varying degrees of value destruction, he says. In competitive environments SkyCity has not shown it has acquired well, run the businesses particularly well, or even turned them around well, he says.

Like other SkyCity watchers, Robertshawe notes that in Australia, the company has much tougher competition for the gambler's dollar than here at home. But he concedes SkyCity's capacity for growth is limited within New Zealand.

Not all institutional investors are anxious. AMP Henderson, which owns under 5% of SkyCity, says it's comfortable with the acquisitions. Portfolio manager Nat Vallabh says if it wasn't it would have sold its stake by now. "The company is focused on managing its capital and has rewarded its shareholders adequately in the past. We feel there may be some bumps along the road but we feel their positions will continue to provide maximum returns to shareholders going forward. There may be some hurdles though."

Vallabh is surprised at the pace of acquisition but says to some extent it reflects what buys were on offer. But he doesn't want to see any more ­purchases in the near future.

"We don't mind if they acquire assets provided it meets their cost of capital. The Australian expansion is marginal in this regard. At this stage we are watching from the sidelines and seeing how they go on that."

AMP Henderson will give SkyCity another two or three years to get Adelaide performing, Vallabh says. That's how long the company says it will take a new $NZ79 million revamp project to pay off.

Aussie ambitions
SkyCity managing director Evan Davies is unmoved by the fuss. He says the doubters are taking a short-term and narrow view of the company's investment strategy. The former town planner has post-graduate credentials in science and tourism management, urban and regional planning and was paid $1 million last year. He says the Adelaide casino was always going to be a five to seven year programme. The rundown casino cost $A185 million, with another $A12 million required immediately for essential work. But Davies says this early cash injection was never intended to be the ultimate solution.

The casino's revenues have grown, but have tapered off in the past 12 months, he says. The planned redevelopment would reposition the casino as a high quality, multi attraction entertainment venue - the same approach that has made the Auckland operation a goldmine.

The value of the Adelaide business today is well above the original purchase price, Davies says. But Armstrong doubts that. If the casino was sold today it would probably book a loss, notwithstanding the casino's assets being more popular today than when SkyCity bought it, he says.

New chairman Rod McGeoch, a lawyer and Telecom director who masterminded Sydney's bid for the 2000 Olympics, says Adelaide is still operating on the multiples it was purchased on, and was a "good buy".

Darwin, however, is no turnaround challenge. It's a well appointed and well-oiled operation, Davies says. McGeoch is also enthusiastic about the site - Darwin has the highest disposable incomes in Australia, an increasing military presence, and a raft of new infrastructure projects, he points out.

On SkyCity's other investments Davies takes criticism on the chin. Queenstown, which has two casinos, has been a "real struggle", he says. "We certainly haven't made money in Queenstown yet. The other operation [Wharf Casino, owned by local Michael Stone and US interests] is not public, so we don't know how he's done."

He concedes Canbet hasn't delivered and the jury is out on the investment. But on SkyCity Leisure Davies digs his toes in. SkyCity's core business is entertainment, and cinemas are integral, he says.

Wheeler dealers
Okay. That's SkyCity today, warts and all. But what about tomorrow? What are these directors going to come up with next to expand SkyCity's empire?

Is it, as has been suggested, a board of deal makers, folk who get an adrenalin buzz from acquiring things and sealing deals? Davies is definitely a deal maker. He's been chief of development company Rainbow Properties and general manager of Brierley Properties, which developed SkyCity. He morphed from the Auckland SkyCity building project boss into the entertainment group's chief along the way. He's also made his mark in tourism, chairing the Tourism Industry Association until 2001.

Chairman McGeoch is notable for having got his home city the Olympics. Deputy chair Patsy Reddy is another Brierley alumnus, now an executive director of investment company Active Equities. (She's also a Telecom director and invited McGeoch into SkyCity). Bill Trotter is chairman of a deal makers' advisor, investment bank and sharebroker First NZ Capital Group. Elmar Toime, former chief executive of NZ Post and now based in London trying to improve the fortunes of the UK's Royal Mail, has also sealed a few deals in his time though his background is more rooted in company operations.

Independent analyst Gaynor thinks there is a groundswell of antagonism among institutions and major shareholders towards SkyCity's expansionist moves. But Davies is quick to say it's not analysts who are griping - just "fund managers from one or two institutions". The analysts he talks regularly to "have not been critical." Nor have Australian shareholders, he says. For his part, McGeogh says he's not aware of shareholder unrest about SkyCity's direction.

So it seems a safe bet that SkyCity will keep marching on into Australia. Davies says the Darwin acquisition is "consistent with the company's previously stated intention of growth". "We have been saying for some time that SkyCity is well-positioned for expansion and Australia presents a logical opportunity."

McGeoch says there are "fascinating strategic issues" unfolding across the Tasman - such as the $2 billion battle for control of NSW gaming group TAB - and SkyCity wants to be an ongoing player in the market, he says.

And it's possible SkyCity's expansion may not stop at Australia. McGeoch: "There's the rest of the world ticking along which at least we have to be cognisant of." He is watching the UK government's proposals for that country's gaming industry, and also notes that Chinese gambling mecca Macau is to grant more casino licences.

Underpinning the SkyCity board's confidence in its growth strategy appears to be Davies' confidence. He believes the company has a winning formula, honed and polished in Auckland and transportable overseas. That formula is about providing diverse entertainment rather than gaming, he says. "Every component of the business has a role to play and needs to be considered as a profit centre, an attraction in its own right."

Davies says SkyCity's business model is high volume, low ticket. It wants the average visitor to spend $50-60 dollars and stay 2.5-3.5 hours. "We are all about people who once a month want to go out for an evening or an afternoon and spend $50 for a couple of hours of fun."

The feisty Thomas won't be drawn on whether SkyCity is good at what it does. All he knows is that it's a conglomerate which operates entirely differently to Christchurch Casinos, has "different standards" and simply isn't a compatible partner.

So, if the Commerce Commission gives the go-ahead to the deal, could he work with them? "With great difficulty, and I've warned them of that." But the two companies work together in SkyCity Queenstown, so what's all the huffing and puffing about? "We are in a different situation there, we are in the minority. They will be in a minority in Christchurch, so lookout!"

Davies says Thomas's talk is "all posturing, nonsense". SkyCity would be happy to have just an interest in Christchurch, but it would also be happy to own it - but he can't quite meet the reporter's eye over the Christchurch agenda. Thomas, meanwhile, swears there are no negotiations going on for SkyCity to buy Skyline's stake. And he's adamant SkyCity wouldn't get Aspinall's two board seats at Christchurch.

Welcome to the high-rollers club, where the adrenalin's pumping.

What would you wager?
Total turnover of gambling industry - $13.3 billion
Total prize money returned to customers - $11.5 billion
Total expenditure on all forms of gambling in NZ - $1.87 billion
Total expenditure in all NZ casinos (as proportion of the $1.8 billion) - $457 million

SkyCity - fast facts
Annual revenue - $556 million (year ended June 2003)
Earnings before interest and tax - $201 million (year ended June 2003)
Total assets - $1.014 billion (at December 2003)
Market capitalisation - $1.8 billion

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