In the final week of December, 2008, a newspaper headline was ominous: “Retail experts predict more store closings, bankruptcies, layoffs in 2009.”
Will pari-mutuel retailer Magna Entertainment Corporation (MEC) be among the casualties?
The Toronto-based Magna Entertainment was launched in 1999 and its stock is traded on the Toronto Stock Exchange and on Nasdaq. MEC states in its U. S. Securities and Exchange Commission (SEC) filings: “Based on revenues, MEC is North America’s number one owner and operator of horse racetracks, and is a leading supplier, via simulcasting, of live racing content to the growing inter-track, off-track, and account wagering markets.”
While this statement is factually true, Magna Entertainment is certainly not a leader when it comes to profitability. The company has a consistent record of losses and the red ink is burgeoning, so much so that the “Going Concern” section in its SEC filings is unequivocal: “…the Company’s ability to continue… is in substantial doubt and is dependent on the Company generating cash flows that are adequate to sustain the operations of the business, renewing or extending current financing arrangements, and meeting its obligations with respect to secured and unsecured creditors, none of which is assured.”
Unfortunately, Magna Entertainment cannot survive on its present course. Its current ratio, which measures the company’s capacity to meet its maturing obligations, is dangerously below 1, the bottom-line losses are mounting, the company has a negative cash flow, the debt load is growing, MEC is unprofitable on an EBIDTA (earnings before interest, depreciation, taxes, and amortization) basis, and the faltering economy is not conducive to MEC boosting racetrack handle and selling off properties to reduce the debt burden. In short, the reality is grim and deteriorating rapidly. Compounding the difficulties, the company has repeatedly had destructive turnover in its top management ranks. To be sure, a bright spot for MEC is the likely prospect of getting slot machines for the company’s Laurel Park racetrack in Maryland, but that would not be nearly enough or soon enough to rectify the situation.
Moreover, although MEC did a 1:20 reverse stock split, effective July 22, 2008, in order to get its stock price over $1 per share and comply with Nasdaq requirements, the share price has again fallen below $1. Consequently, MEC is in danger of being delisted by Nasdaq, in which case the stock would trade on the Over the Counter Bulletin Board or on the Pink Sheets.
Magna Entertainment has closed down some facilities and has a number of its smaller racetracks up for sale. If MEC could sell one or more of these, it would provide cash to at least mitigate the debt load, but this is a big if in the current economic downturn. Even were MEC to sell all of the properties it has for sale, in the near future, it still might not be viable because it has a negative EBITDA in all of its geographic operations, including California and Florida where its two best-known racetracks are located.
MEC’s dilemma is the result of too fast of growth fueled by too much debt to digest and perhaps of overpaying for acquisitions. The company is de facto bankrupt with no good options left and has destroyed a lot of shareholder wealth.
The judgment here is that most of the MEC racetracks would have a better chance at profitability if they were sold off piecemeal, provided that the new owners bought at a reasonable price (i.e., a price justified by the cash-flow potential) and substituted an equity infusion for debt. Recapitalization would free management of the onerous task of meeting the interest payments on the debt and thereby allow them to make capital improvements, enhance customer service, and devote more resources to sales and marketing.
On their own, the racetracks would also be free of the corporate overhead now allocated to them by MEC. Finally, privately-owned racetracks would not incur the significant costs that come with being a publicly-traded company and all of the associated government-mandated reporting. And owners would not be as vulnerable to shareholder litigation.
Magna Entertainment’s founder, Frank Stronach, has a personal story that is both remarkable and inspirational. It is the journey of a young Austrian immigrant to Canada, who rose from being dirt poor to become one of his adopted country’s wealthiest and most prominent citizens. Magna International, the auto parts company he started, was the centerpiece of Stronach’s rags to riches saga.
Stronach also became one of the luminaries of Thoroughbred horse racing. His farms have bred the winners of most of the sport’s premier events, including Breeders’ Cup races and the Preakness and the Belmont. What he has tried to do for racing with Magna Entertainment is commendable and entailed a risk that he did not need to take on. But it has not worked as planned.
Like Stronach and all serial entrepreneurs, they inevitably experience their share of failures. For Stronach, the Achilles’ heel has been Magna Entertainment, which is not surprising: an entrepreneur’s sparkling success in one industry does not mean that the person has gained the acumen to be successful in another industry with vastly different characteristics. The skills and knowledge needed to start, build, and operate an auto-parts industrial company are not the same kinds of competencies required in a retail horse-racing franchise.
The racing industry and its many constituencies have an enormous stake in Magna Entertainment’s outcome. The shock waves of an outright MEC failure would reverberate throughout the racing world, particularly if the company’s Santa Anita and Gulfstream Park properties were to go the way of commercial and/or residential development in a bankruptcy. A bloodstock business with a shrinking base of racetracks from which to retail and showcase the product is on a precarious trajectory.
Major stakeholders in the horse racing industry need to consider purchasing individual MEC racetracks and retaining the best sports/retail executives they can find to operate them, probably via equity-sharing incentive compensation. Attempts have already been made to buy some of the MEC racetracks, but now that the company’s situation is so desperate, negotiations could be more productive.
(Full Disclosure: Bill Shanklin is not a shareholder in Magna Entertainment Corporation and does not have the company’s stock shorted.)
Copyright © 2009, Horse Racing Business
January 17, 2009: While Kentucky Slept
January 31, 2009: When Kentucky Awoke
Racetrack companies whose stocks are publicly traded will be assessed in the coming months.