Investors hope Sky City's buying gamble pays off

Friday 12th October 2001

Casino operators hate the word gambling. They tend to prefer terms such as gaming or wagering instead.

Sky City goes a step further by using the word "entertainment." It emphasises the message that a trip to its casinos is not simply an exercise in greed but one that comes with music, accommodation, food or drink.

"One of Sky City's key philosophies involves offering customers a variety of entertainment experiences rather than simply a gaming experience," managing director Evan Davies says in the company's latest annual report.

The company is so keen on this concept it has changed its name, from Sky City to Sky City Entertainment Group, although it is hard to see how anyone is going to use the longer name over the shorter and more familiar.

Both chairman Jon Hartley and Mr Davies devote space in the report to discussing how the name change fits into the company's growth strategy. This is exactly what investors want to know but is sadly missing from many reports.

The company wants to extend its successful management of the Auckland casino and related facilities to other gambling venues. In the past year it has bought into a casino in Adelaide, opened its Queenstown casino, taken a stake in internet gambling service Canbet and bought half of cinema company Force Corporation.

The company's statements about the last investment have been vague in the past but fortunately the report is more forthcoming. Put simply, Sky City lusts after the foot traffic going through Force's flagship multiplex just a few blocks away from its Auckland casino. By taking control of the cinema complex, it hopes to be able to steer some of those customers into its gambling and entertainment facilities.

All these new assets, some of which have not performed as well as hoped, are keeping the company busy and Mr Davies warns the current financial year "is one of consolidation."

A financial and operating report within the document gives a very good picture of the performance of each of the group's assets. Most of these have shown single-digit growth rates in revenues, and some have even shrunk slightly, which explains Sky City's desire to expand by acquisition.

While sparingly used, graphs showing income and gross earnings (ebitda) usefully display the contribution made by its Auckland, Adelaide and other assets.

Even more useful is an asset-by-asset wish list of achievements to be attained in the coming 12 months.

Where the financials are concerned, Sky City demonstrates the quandary many businesses find themselves in when they try to expand. To add value, a new asset needs to have the same profitability or better as existing ones.

This is hard to achieve as generally it is poorly performing assets that are put up for sale. Therefore, a company has to depress its short-term profitability when buying assets in the expectation that it can generate better results in the future.

This has been the case with Sky City as it has had to pump lots of money into the Adelaide casino for refurbishment and promotion to bring it up to its standards. Meanwhile, Force Corporation, in Sky City's own words, "is overgeared and its debt facilities have been poorly structured."

These new assets helped Sky City improve revenue by 50% to $442.4 million in the year to June. However, its expenses jumped 63%, leaving an operating profit up a more modest 19% to $107 million. That is a gross profit margin of 24% against last year's 30.5%.

It also appears to have paid over the odds for its new assets. Notes to the accounts show a $31.8 million write-off on goodwill "arising on acquisition of subsidiaries and associates." Another note shows that $19 million of this alone came from the Force Corporation purchase.

Fortunately, Sky City's casino in Auckland is a hugely efficient moneymaker. Investors will be hoping the company is not taking a gamble on expanding beyond this.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Web: www.mcewen.co.nz; email: davidm@mcewen.co.nz

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