Investor Interview with SkyCity's Evan Davies

Casino operator Sky City, which in February reported a 4% rise to $55.1 million in first-half net profit, has been acquisitive of late. Following the February announcement of its A$195 million ($220 million) purchase of the Darwin casino with the announcement earlier this month that it intends paying $93.75 million for a 40.5% stake in the Christchurch casino.

ShareChat: Why are you buying into the Christchurch casino, despite the obvious animosity from chairman Barry Thomas? What are your expectations of getting a board seat/seats, given his opposition? Will you be content without board representation?

Sky City managing director Evan Davies: Certainly there had been public comments of opposition from Barry Thomas prior to our purchase, but really the basis for those, apart from his own interest in purchasing the stake, continues to elude me. The benefit that he thinks might accrue to Christchurch shareholders as a consequence of that opposition also continues to elude me. Whether that opposition continues, I guess only time will tell. Owners of this level of shareholding generally think it's appropriate that their interests are represented at the board table. Certainly owners such as ourselves who are experienced, competent operators in the sector could add value. We think it would be in the interests of the other shareholders as well as ourselves for us to be represented. But we have purchased Aspinall New Zealand and Aspinall New Zealand is represented. Mr Thomas has stated categorically that we won't have representation, but we do already.

SC: What will you do if you don't get Commerce Commission approval?

ED: This is a circumstance in which they have previously found that casinos operate in regional markets which certainly seems to me to be correct.

SC: What about the market for high rollers, isn't that a national market?

ED: Not really. Christchurch don't operate in the same way or with the same programs that Auckland does, or for that matter our business in Queenstown. Customers at that end of the market can go to other places. They can go to Melbourne or our property in Adelaide or to our property in Darwin. Mr Thomas has categorically said we will have no influence of any kind. He can't have it both ways. Irrespective, I can't imagine why we would make either Christchurch or Auckland less attractive to those kinds of customers. I think it's a desperate argument. If it was an issue, I would imagine it would be an issue for (Thomas' company) Skyline which has substantial stakes in Christchurch, Queenstown and Dunedin. It doesn't seem to be a concern for them.

SC: Do you want to increase your stake? Are you talking to the minority shareholders?

ED: We've got no expectations. We're happy with the position that we've contracted on. I do take issue with constant references to a disrespect or lack of proper communication on our part in terms of keeping Skyline and Mr Thomas informed as to our interest. We had suggested we approach Aspinall jointly.

SC: Isn't it an accepted rule-of-thumb that you shouldn't buy anything that Kerry Packer is selling?

ED: That probably isn't a bad rule-of-thumb. The situation here is slightly different. You have to understand the history. Consolidated Press (a Packer controlled company) has a stake in the Christchurch business but it's as a consequence of their relationship with the Aspinall family, which is not to say it was accidental. This was an Aspinall vehicle that Consolidated Press has a minority stake in.

SC: Shouldn't you be concentrating on getting Adelaide sorted first before making other acquisitions?

ED: It's gone somewhat slower than we would have liked, but it hasn't been that long. We've been working of the business effectively for around three years. Certainly, it's challenging. I think that one shouldn't over-state the issues in Adelaide. This is a business that is making money and is trading successfully. It's not making as much money as we would like it to or that we expect it will, but it is moving in the right direction. We think we have a plan in place that will see the rate of progress increase. There aren't a great number of these kinds of assets available in Australasia. When circumstances arise that allow you to acquire all or part of businesses in your sector and when you think the price is appropriate and you think you can add value, you can't wait. We were in a resource position to be confident we could add value to Darwin. We think the price is certainly reasonable. In Christchurch, if the other shareholders are prepared to let us add value, we think there's an opportunity to add value there too.

SC: How likely is it that you will proceed with stages two and three of the Adelaide development?

ED: The way we've talked about it is not so much that we're doing stage one and we may do stage two and we may do stage three. We've talked about it in the sense of a complete package with points in time that allow us to check that customer reaction is as we thought it would be. Our expectation is that we will go ahead with all three stages.

SC: You blame lack of parking for some of Adelaide's under-performance - does Adelaide really have a parking problem?

ED: Adelaide doesn't have a parking problem, that's absolutely correct. For its size, the city works very effectively in terms of traffic movement and the availability of parking. Auckland can look at the situation there with envy. But there's not a dedicated parking facility as part of the complex. We want to give our customers the opportunity to feel that they can go out, particularly in the evenings or later on at night, and have an entertainment experience that they feel is safe, reliable and secure. For all customers, but particularly for women customers, it provides them with the choice to go out either alone or in a group and feel comfortable in all circumstances. It's not that they can't park in reasonable proximity - there are a number of car parks within 200 to 400 metres.

SC: Isn't Sky City protected against any adverse regulatory changes in Adelaide? Could it even benefit from such changes?

ED: Yes, to an extent, but not entirely. The agreement with the government to buy the casino protected us in most respects from any adverse changes in the taxation structure. It doesn't prevent the tax structure being changed but if it were, we would be compensated. It provides protection against excessive competition outside the casino. If pubs and clubs were allowed more machines, we would be allowed more machines, but we can't go backwards. There are proposals to ban smoking in the casino in Adelaide. There's no protection against those kinds of adverse changes.

SC: What's your view of the likely impact of smoking bans?

ED: I don't think it will cause long-term damage. Longer-term, it's a positive step for our business. In the short or medium term, it's possible a number of customers who do smoke will feel themselves to be inconvenienced. The experience in Australia and elsewhere where these changes have occurred suggest there could be a short-term impact on revenue.

SC: Aren't you building outside balconies for smokers in Auckland?

ED: We are certainly building a number that will allow customers who find themselves wanting or needing to smoke to go outside to do so.

SC: Can the (EDITDA) profit margins available from Adelaide (23.7% in 2003) ever approach Auckland levels (53.3% in 2003)?

ED: I think they will get closer than they are, but probably the answer is no. There are a number of reasons for that, mostly related to the scale and the nature of the facilities. Auckland is a 24 hour, 365 days facility that's driven in terms of utilisation by a whole variety of elements, parking, the tower, the hotel, theatre, restaurants, bars and, of course, the gaming areas themselves. Adelaide is a much more limited facility. That's one of the reasons for the development program, but we don't think we're going to get Adelaide to the same levels of utilisation as Auckland.

SC: How close to Auckland's are Hamilton's profit margins likely to get (44% in the latest first half)?

ED: We're certainly very pleased with the progress in Hamilton in the last half, but for similar reasons I don't think Hamilton will get to the same levels as Auckland. It's not a 24 hour business and it doesn't have the scale advantages that Auckland has

SC: What is Darwin's current EBITDA margin?

ED: I'm reluctant to answer that - we don't own it yet. It's certainly mid way between Hamilton and Adelaide. It's doing better than Adelaide but not quite as well as Hamilton.

SC: What "synergies" are available from Darwin? You've said both Darwin and Christchurch are efficient and well run, so what value can Sky City add to them?

ED:I don't think there's a conflict between suggesting that Darwin is being pretty well run and at the same time suggesting we can add value. For a variety of reasons related to decision-making out of the US, the Darwin business hasn't been able to participate in the premium gaming sector. We as a group do. We're active at a modest rather than very high level. Given the proximity to Asian markets, that's a prospectively significant value-add to Darwin. Secondly, the business has been relatively stand-alone. We think they've done quite an effective job, but we think there's the addition of a level of expertise from a larger operation which will assist them to grow their domestic market. We run a large sales group who are very active throughout New Zealand, Australia, Asia, North America and Europe in driving business into our hotels and attractions and conference and banqueting facilities. That group will add Darwin to its portfolio and will be able to do a much more effective job simply because there are many more of them. Christchurch is clearly more complicated and is somewhat dependent on the other shareholders' willingness. If they want to cut of their nose to spite their face, then it's prospectively difficult.

SC: Why shouldn't investors think you've made too many acquisitions too quickly? Have you ever calculated what Sky City would be worth if it had stuck to running the Auckland operations?

ED: I disagree with that completely. It's our view that a sole reliance and exposure to the Auckland business wouldn't have been in the company's best interests. It's an extremely short-term view. Management would be extremely irresponsible if they took the same approach. It's worth remembering that this is a business that's performed extremely well for its shareholders over an extended period of time. Queenstown looses money as a stand-alone investment, but what institutions aren't in a position to understand is the amount of premium business that comes through Auckland to go to Queenstown. They like the Queenstown experience but it's too small. Most of the money that's made from that business is made in Auckland.

SC: Are any of the company's investments, other than Hamilton, meeting their cost of capital?

ED: It's a way of thinking about the business that doesn't take correct account of the way in which the business has grown and the way in which the business will continue to grow. It's a focus that would not have us build the convention centre. The convention centre certainly doesn't meet its cost of capital. It's a focus that would have us not build the Sky Tower. It's absolutely critical to the way in which we have to grow the business. It's one of the worst performing businesses in terms of not meeting its cost of capital. Clearly, Queenstown would be the worst, but it's also a great deal smaller. Adelaide is a business that was entirely debt funded and it makes money. It doesn't make enough money, but there's no shareholders' money in that business.

SC: What do you look for in an acquisition and is any casino a target?

ED: We do have a particular criteria. Putting it at its simplist, we need to be convinced that we can either buy at a level that's so attractive that it makes sense or we need to take the view that there's the opportunity to add value. The Perth business was one that was speculated on for some years that we would be interested. We were not. We didn't think we were well placed to add value in the areas we thought value needed to be added.

SC: Is the strategy to continue to grow through acquistion or is it now time to bed in the new acquisitons and get them growing organically?

ED: It's always time to bed in acquisition. Our principal focus is on organic growth in our already owned businesses.

SC: Now that the Auck Casino has the full number of tables and slots allowed what percentage increase of punters at the slots and tables can be reasonably expected in 5 years time compared with now, given peak periods can't handle too many more?

ED: We've just gone to the maximum numbers of gaming positions permitted. We think over the next couple of years we will be growing both visitation and revenue as a consequence of that capacity expansion. It will take us a couple of years to fully utilise those facilities. We do think there's an opportunity to continue to grow visitation at peak periods as well as in slower periods. We may be approaching our capacity levels on a five year horizon, but it will certainly take us that time to achieve it.