Churchill Downs, Inc. (CDI) is a key player in retail horse racing, especially because of its ownership of the American sport’s crown jewel, the Kentucky Derby.  Howard Klein, a perceptive and respected gaming/leisure analyst and publisher of the casino investment site The House Edge evaluated CDI for Seeking Alpha on June 27, 2018.  In that report, he compared CDI to Las Vegas Sands as an investment opportunity.  He said about CDI:  “To properly value the stock, you need to see it not as a gaming operator but as something of an iconic racetrack event linked to an internal hedge fund.”

Klein is candid:

“Readers…have long known that I have never been a fan of the stock of Churchill Downs, Inc.  To be precise I am not fan of the stock, but generally like the company.  CDI is a solid, decently run, diverse entrant in the gaming sector.  Better than some, less so than others… My concern in past posts as well as in this one is my continuing puzzlement that given the asset base, performance, and forward potential, the stock trades at around $300 a share.”

Klein cites familiar metrics and trends to explain his reasoning for stating that CDI stock is overvalued:

CDI’s racetrack “segment produced $276m in revenue, or approximately 31% of total 2017 revenue. The iconic Kentucky Derby is a superb event with a great history, but it alone cannot reverse the negative demographic trend of live racing attendance and handle declines going on for decades now.  Firstly, the average age of a racetrack bettor is 51 years.  And according to a Jockey Club study, the industry is losing 2% of its fans a year to the glum actuarial realities.”

Klein’s most intriguing and thought-provoking narrative concerns CDI’s sale of its Big Fish subsidiary for $990 million in December 2017, ostensibly so CDI could focus on core assets in racing and casinos.  He referred to the sale as “sudden” and “shocking” to some followers of CDI.  According to Klein’s unnamed sources, the main motive for the sale was to raise cash to buy back stock, reportedly because “CDI had caught wind of an activist investor who had acquired somewhat less than 5% of its stock with the strategy of instituting a battle for control and, upon a win, unload the crown jewel asset, Churchill Downs and the Kentucky Derby event, for an estimated $2b.”

CDI is not the kind of situation an activist would typically target in that the company has produced outstanding returns for its shareholders, with its stock price soaring by nearly 65% in the past year.  Only if the stock price faltered badly would activists be enticed to buy more stock and demand one or more seats on the board of directors, and perhaps even control (about 75% of CDI stock is owned by institutions).

In closing, the view here is that because CDI’s businesses are confined to gambling-centric entertainment, the company does not at all resemble how a hedge fund operates.  Klein makes a persuasive case that CDI stock is overvalued, but so is the entire stock market if the Shiller historical P/E ratio is the benchmark.

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