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Sky City Entertainment Group

By Jenny Ruth

Friday 29th May 2009

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 Jenny Ruth

Sky City Entertainment has raised $228.3 million in new equity from a mixture of an institutional placement, a share purchase plan for other shareholders and a top-up offer. The new capital lowers the company's net debt-to-operating earnings ratio from 3.1 times at December 31 to about 2.5 times and net debt-to-enterprise value from 39.1% to below 31.5%. Sky City has $124 million of capital notes maturing next year and $177 million of Australian ACES, a perpetual reset exchangeable security, resetting in 2011. It also has $485 million of US private placement debt maturing in 2012.

The company provided a trading update with the equity raising documents showing group revenue was up 4.3% in the March quarter compared with the same period a year earlier while normalised operating profit was in line with the previous period. Australian revenues were up 7% for the nine months ended March. In mid-March, Sky City said revenues from the Australian casino operations were up more than 14% in Australian dollar terms in January and February and 20% in New Zealand dollar terms.

Sharechat: What changed after the March update to make you decide you needed to raise capital? You said then debt wasn't a problem.

Sky City chief executive Nigel Morrison: It wasn't a problem and it's still not a problem. The thing about companies and capital structures today is it's prudent to raise capital when you can, not when you need it. Certainly, we have plenty of cashflow and we're very pleased with how our business is trading. At the same time, there was a view globally that gearing ratios of about three times were too high in this market. We wanted to get down to about 2.5 times. By doing that, we thought we would open up our register to more overseas investors. Our peer companies, Crown, Tatts Group, Tabcorp, all of those have gearing ratios less than our's, even after we did our placement. We still have the highest gearing. Before we did this we were significantly higher. Now we're just modestly higher.

SC: Why did you increase the top-up offer?

NM: It's probably worked out quite well. There was $35 million available through the top-up offer and the share purchase plan. The top-up component was only available if the purchase plan wasn't fully taken up. It became apparent when we were looking at demand that the share purchase plan was going to be fully taken up and therefore there wouldn't be any available for the top-up offer, so we took the opportunity to extend it. We think we did it by the right amount to satisfy the bulk of demand for the top-up offer. That was not too dissimilar to what Fletchers did.

SC: What are you doing with the funds raised?

NM: By having cash on deposit, it does reduce our net debt which is a really important factor.

SC: You surely don't want to leave the money sitting in low-interest deposits: do you have any opportunities to retire debt early?

NM: You're quite right, there are opportunities. We will opportunistically look to do that. We have quite a significant amount of debt maturing in 2012.

SC: Since that's the US private placement debt, given what's happening in the US, wouldn't at least some of those holders welcome getting their cash back early?

NM: You would think so, wouldn't you. We think the same. We will have to wait and see.

SC: So why didn't you use your $500 million of unused banking facilities to buy back the US debt ahead of the capital raising?

NM: We would've changed one sum of debt for another sum of debt. You've still got the same debt.

SC: But you could have retired some of that US debt and then gone to shareholders who probably would have thought that was a good idea?

NM: It's a question of timing and a question of what you do first. What if we had retired debt and then we couldn't get the placement away? Then you might need the placement and you might be in a very different situation. (This way) we have a very strong balance sheet and we're in control of our destiny.

SC: You're hoping Sky City will get an upgraded credit rating: when does its rating get reviewed?

NM: I'm not sure we will get a credit rating upgrade. People like Standard & Poor's and Moody's don't just change things overnight on these sorts of things. They like to look at trends. I would be surprised if our credit rating moves ... we have our cinema business and the way Standard & Poor's calculates our debt is they look at all the leases we have. That actually drops things on our gearing ratio. I'm sure Standard & Poor's will do an update relatively soon as a result of the placement. I'm sure we will have that shortly. We will keep our investment-grade rating. It will be "BBB" or "BBB-." Over time, as we move forward, we will enhance our credit rating, but I don't expect it to be in the next few months.

SC: Did you have to improve you debt position in order to attract offshore institutions?

NM: There are a lot of institutions around the world now in New York, London and Sydney, and I'm sure out of New Zealand, who won't invest in companies which have a gearing ratio of over three times. They have a blanket policy of not investing if gearing's over three times and our's was. Now (that gearing has been reduced) a number of institutions have come in.

SC: How much of the placement went to offshore investors?

NM: It was about 44% New Zealand and 56% overseas, of which 53% was Australian. We looked after our New Zealand institutions very well and made sure those that applied certainly got their full entitlement. Everybody ended up being scaled down but they did get their full entitlement. It was 3.5 times over-subscribed.

SC: Why did the company chose Goldman Sachs JB Were to manage the capital raising rather than its usual adviser, First NZ Capital?

NM: I can't really comment too much about the past. I've been chief executive for probably 14 or 15 months and have worked closely with a number of different firms over the period. There are very good firms. We wanted firms with very good connections in New Zealand. I had had some experience with Goldman Sachs in the US and had used them in the past. They're very strong in gaming globally and in Australia. We've been working with them doing a whole range of things. We've built up a very good relationship with them over time. We were approached by about four firms, all very, very competitive, Goldmans, First NZ and two other major firms, all very keen for the business. We chose Goldmans. We knew the people and we had been working with them for some time.

SC: What sort of growth opportunities do you expect to emerge?

NM: There are a number of opportunities. It's a challenging economic environment. There's been some talk and speculation about a casino in Wellington. We're in the casino business and we think that would be an attractive proposition. We have 50% of Christchurch. In reality, I don't think 50% of anything really works for us. We would like to increase that to a controlling position or get out of it. There are interesting opportunities in Australia. Tabcorp is a very interesting company. I think there will be some rationalisation of the casino and gaming industry over the next two or three years. Tabcorp and Tatts Group have lost their gaming licences to operate in Victoria. That really de-stabilises both of their organisations to some extent. They will be needing to work out what they are in the future. If we could acquire some smaller casinos from Tabcorp in Queensland at some point, I think that would be an interesting opportunity. I think things will unfold over the next two or three years. We've got our businesses very much under control. We're very pleased with the growth we're getting in our businesses, particularly in Australia.

SC: Your Australian revenue growth does look very strong: what are the management initiatives which have contributed to this?

NM: Fundamentally, we've changed the way we run the Adelaide casino. We were running it as a night club. We were attracting young people coming in late at night. They had probably been to another bar before they come to the casino. The environment wasn't conducive to mature gaming for people who want to do it in a safe, secure but entertaining environment. We had more of a 19 year-old, doup, doup, doup-band type environment. We've had very strong growth in Adelaide. Consistently now for the last three or four months our revenues have been up 20%-plus in Adelaide. We're significantly up in table business and gaming machine business. We've lifted the presentation of the property and service standards. We've cleaned up the property and that's been very successful. Having said that, it was off a low base. It's still not a top-performing casino. Darwin's a great place to be. It's a casino growing 7% or 8% per annum. We've spent a lot of money on Darwin over the last year or so and we think we're poised for further growth.

SC: How much of the growth has been due to the Australian government's stimulus measures?

NM: There's no doubt casinos and pubs and clubs, I guess, primarily pubs and clubs with machines, do receive some of that money, as do retailers of plasma screens. My personal view is it wasn't a very prudent move by the Australian government and I wouldn't encourage the New Zealand government to do it. In terms of our growth, it might be 1% or something. It wouldn't be overly significant. We've been getting sustained growth throughout the period that's been due to other factors than the (Australian prime minister Kevin) Rudd handout.

SC: Do you expect Australian revenue to continue to grow as strongly? From what you've just said, I'd guess the answer is yes.

NM: We've been getting 20% growth in Adelaide. I think we won't sustain that growth in Adelaide because we're really comparing two different businesses. Once we've got a full year of that (new business), we will go back to more modest growth in the high single digits going forward. Adelaide and South Australia benefit quite a lot from the recent Australian government budget - infrastructure projects, desalination plants - and there's still a lot of resources development by BHP and Roxborough Downs. Adelaide's future is looking pretty good for the next few years. It has a pretty stable political environment. I think Adelaide will be a good place to be for the next few years.

SC: What still needs to be done to improve the cinemas business? Can it be made to deliver adequate returns?

NM: We're working very hard. Our management team there, the general manager Jane Hastings, is doing a very good job. We've grown revenues reasonably well. We've got a pleasing EBITDA (earnings before interest, tax, depreciation and amortisation) result for that business this year. It's a challenging business. Operationally, we're doing things quite well and managing our labour costs well and marketing the business well. It's holding up in this economic market place. You are very dependent on the cinema product put out by Hollywood - that's probably been a bit better in recent times. It's a changing business. We do have a lot of leases and very expensive rents. We need to look at that and see if we can restructure the rental side of that business. That really does make it very challenging. It's not a core part of our business. We clearly are a casino business. In the long term, it would make sense for us to separate ourselves from the cinema business. In the meantime, I think we're doing the best we could possibly do with the business growing revenue and growing EBITDA.

SC: What can you do to improve revenues from Sky City's international business?

NM: The international business is a bit like tossing a coin. You can toss it more times - that's what we're trying to do - or you can get lucky and get more heads than tails. We were lucky last year and we weren't lucky this year. The reality is we don't have enough volume, we don't toss the coin enough times. We need to reduce the volatility of that business. We've employed a couple of new people. One started this week in Melbourne. We've got three people based in Melbourne and people in China and Singapore and some other offices in South East Asia. We're really trying to build our turnover in that business, driving business into Darwin, Adelaide and Auckland. We are seeing some pleasing growth in turnover. Last year was a freak period - it (profit) was three times usual. I think you will see some improvement going forward in our turnover in that business.

SC: What's happening to address Adelaide's lack of parking facilities?

NM: They're not ideal but we don't think they're an impediment to us enhancing the performance of Adelaide at this point in time. I think we've demonstrated that through the growth we've achieved. Having said that, they are a problem but to fix them on that site is very expensive. We've had some discussions with the government and there does seem to be some support for relocating into another facility with established parking. Adelaide has huge potential. The spend per capita on casinos in Adelaide is probably the lowest of any casino in Australia. To that extent, it's got the highest upside potential. It is significantly limited by the facilities we operate from. We've had discussions with the government and they're certainly warming to that. We're working through what the available options might be.

SC: It is a beautiful old building.

NM: It would be good as a library, I think. There are probably two casinos in Australia which don't work, Adelaide and Brisbane, and they're both in beautifully restored old buildings. It's like in a shopping centre, ground floor works best. The Adelaide building, once you get off the small ground floor, is very much a rabbit warren and a very, very difficult property to manage and to build the business from.

SC: Is the improvement seen in the Auckland casino sustainable?

NM: It depends on the economy in New Zealand. I think Auckland has still got a lot of potential as an entertainment destination. I think there's a lot we can do with our Auckland business. We're upgrading the quality of our hotel rooms in the Sky City Hotel which is probably Auckland's best four or five star hotel. We're spending money on our bars and restaurants. We want to make Auckland a more diversified entertainment destination rather than just somewhere people might go to play table games or machines.

SC: What are you doing to ensure management doesn't focus on the other assets at the expense of the Auckland casino?

NM: It's a question of managing all of your assets, having the right management and having strong management. We are certainly focused on Auckland, I can tell you that. We have some of the best gaming operators in Australasia running our business. (Morrison named a number of people including table games manager Ejaaz Dean, who had previously worked at three different Australian casino companies, gaming machines manager Matthew Hardman, who also had 20 years experience in the casino business, Sky City hotels group manager Simon Jamieson, who had opened five luxury hotels in New Zealand and Asia and who has more than 25 years experience in large-scale hospitality businesses.) I think we've got a very, very strong management team. This business is all about people and all about quality management. We've changed 80% of the top 12 people in the last year and got a very good team. We're continuing to invest in Auckland. We would love to extend our convention facilities and be Auckland's premier convention facility. There's a lot of debate about new convention facilities. We would be very pleased to extend our facilities so we could accommodate 3,000 delegates. We want to develop Federal St and turn it into more of a pedestrian access route. We're working very closely with (Auckland mayor) John Banks and his team. They're very supportive of bringing entertainment back into the city. We continually get behind major events in Auckland. If you're going to have a major event in Auckland for 600 or 700 people, the venue of choice is Sky City.

SC: What impact do you expect from the introduction of player information display (PID)?

NM: Quite frankly, I think it's a ridiculous development. It's a move that was introduced in Canada in Nova Scotia. For some reason, New Zealand thought it fitting to copy it. They're walking away from it in Canada. Our larger players find it a real invasion of privacy. People can stand behind you and see how much you've spent. To mandatorily take over the machine and make it put up a screen and tell you how much you've spent every 20 or 30 minutes so that the world can see, we don't think is very useful. We think it's an undesirable process. We don't think it will make any difference to player behaviour. It's only in two places in the world, Nova Scotia and New Zealand, and it's already being dropped in Nova Scotia. You just upset the 98% of people who enjoy their entertainment rather than helping the 1.5% of people who have an issue. It really is an undesirable measure. It won't affect us, other than it cost us $20 million to comply with the requirement to put it in.

Written by Jenny Ruth, 27th May 2009

Bond Offer: Infratil Ltd, 7.2 year & 10.2 year unsecured unsubordinated bond


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