Description

Summary

In my first VIC write-up on Great Canadian Gaming (GC), I went over the background as to why I think the company may be facing a potential existential risk with regards to allegations of illegal money laundering taking place at its BC casinos. I am providing this update to VIC members on a number of highly relevant recent developments on this issue. Surprisingly, my conversations with market participants indicated that not all investors are aware of what has transpired over the last few months as it relates to these allegations.

I am again a contrarian and may in fact be alone in holding this position, but I do not believe that the money laundering issue has gone away, and that the release of the Peter German report does not exonerate GC from potential wrong-doing. There has been so much controversy over the alleged money laundering, as well as the process to-date run by the local NDP government, that I believe the likely outcome is that there will either be an additional provincial government investigation, or a full blown independent public inquiry into the events that transpired here. Neither will be positive for GC’s stock price, and it could end up weighing on the shares for years.

Overview of Recent Events

I have included a brief timeline of major developments relating to alleged money laundering taking place in B.C. casinos. Much of the coverage has been provided by local and regional news outlets, thus making it more difficult for investors, particularly international investors, to stay on top of.

September 22, 2017 – MNP report is released, highlighting that $13.5 million worth of $20 dollar bills was accepted by the River Rock Casino in July 2015. Law enforcement intelligence have indicated that these funds may be direct proceeds of crime. See Appendix for further details.
September 27, 2017 – FINTRAC states that it is reviewing the MNP report, to determine whether any action on its part is appropriate. FINTRAC states that its examination team found 80 percent of staff at the River Rock “demonstrated limited knowledge of money laundering” in 2016.
October 16, 2017 – Vancouver Sun article alleges that the River Rock Casino knowingly accepted millions in suspicious cash that was provided to VIP gamblers by lenders who were banned from B.C. casinos. See Appendix for further details.
June 5, 2018 – Great Canadian Gaming signs new operational services agreements with the British Columbia Lottery Corporation for terms of 22 years covering all of its B.C. facilities. Operating commissions for regular limit table games are increased to 42.5% from 40%, and 77.5% from 75% for poker.
June 27, 2018 – Attorney General’s office releases “Dirty Money” report. The document contains numerous references to the River Rock Casino as the epicentre of money laundering in British Columbia. While the entire 247-page report is worth a read, I have highlighted a number of items that may affect Great Canadian Gaming in the Appendix.
July 10, 2018 – Global News interviews Fred Pinnock, former commander of BC’s Integrated Illegal Gambling Enforcement Team who stated on the record that “organized criminal activity was running amok” in casinos, and that the B.C. Liberals and RCMP were aware of the issues and deliberately turned a blind eye. Although he did not name names, he stated in the video interview that he was “very much look forward to receiving a subpoena to give evidence.”
July 15, 2018 – David Eby is reported to be reaching out to Fred Pinnock, after the July 10th Global News interview. The article states that “B.C’s Attorney General is not ruling out the idea of prosecutors approving criminal charges as more shocking accusations are made about dirty money being laundered in casinos.”
July 24, 2018 - Global News article alleging ties between Great Canadian Gaming and Cheng Yu Tung, a Hong Kong tycoon suspected of links to organized crime, prompting the Attorney General to suggest that this new information could lead to an investigation by B.C.’s gaming enforcement branch.

The Global News article also references oral depositions given by two former surveillance employees of Great Canadian, who both resigned due to issues relating to disagreements about how Great Canadian Gaming treated alleged loan sharking activity. I have included the source documents to these depositions in the Appendix below. They are a worthwhile read.
August 14, 2018 – It is reported that David Eby has provided a lawyer to Fred Pinnock, former commander of BC’s Integrated Illegal Gambling Enforcement Team, and a chance to tell his story. Eby stated: “This is a whistleblower opportunity for Mr. Pinnock to disclose everything that he has in order to assist government in deciding whether a public inquiry is warranted”. Eby said that Pinnock’s information will decide whether the government moves ahead with a full-blown public inquiry into money laundering.

It is reported that Pinnock will be meeting with outside counsel hired by the BC government in September 2018. A quote from this article: “It was the Wild West in those large casinos where organized criminal activity was running amok,” Pinnock said at the time. “They all knew what was going on.”
August 29, 2018 – It is reported that documents and source interviews reveal that the BCLC had warned Great Canadian Gaming executives about River Rock Casino staff shredding paper records of large cash transactions, potentially avoiding scrutiny from FINTRAC.
September 24, 2018 – GC issues a press release announcing that executive officers of the company are intending to adopt an automatic securities disposition and/or purchase plan. These automatic plans allow insiders to sell, purchase or transfer shares (including upon exercise of stock options) regardless of any subsequent material non-public information they receive. Once a plan is established, the executive is not permitted to exercise any further discretion over the trading activity.

Notably, the CEO, Rod Baker has set-up an automatic plan to exercise 500,000 options and subsequently sell up to 500,000 common shares. These shares have a market value of over $23 million. Terrance Doyle, the COO, is setting up an automatic plan to exercise 50,000 options and subsequently sell up to 50,000 common shares.

It is concerning to me that at a time when his company is in the media spotlight for controversial issues, the CEO is opting to potentially sell shares, rather than buying stock in the open market. Bloomberg shows that Rod Baker holds just 74,914 shares of GC.

Valuation and Conclusion

My belief after reviewing all the information below is that there is a lot of anger among the populace in British Columbia over this issue, as it has received widespread local attention. This coverage is much less impactful at the national level. A recent survey indicated that there was increasing support for a public inquiry, similar to the 2011 Charbonneau commission on the awarding and management of public contracts which resulted in criminal charges for many individuals including the mayors of Montreal and Laval. It is possible that a similar inquiry will be launched by the B.C. provincial NDP government, which would likely be a negative for Great Canadian’s B.C. operations and its stock price.

As a gauge of local sentiment, take a look at Attorney General David Eby’s Twitter account. He posted this two weeks ago regarding the casino money laundering file. Pretty impressive engagement for a politician:

Citizens have even created faux movie posters with the cast of characters:

Furthermore although hard to predict, a public inquiry in B.C. may have knock-on effects in other provinces given the highly regulated nature of gaming in Canada. It was reported in the July 2018 Global News article that Great Canadian’s “continues to be reviewed for management integrity by Ontario’s regulator, due to allegations made public last year by Eby’s ministry.” The new Ontario Premier, Doug Ford, has shown that he will not hesitate to become involved with private corporations, causing the resignation of the entire board of Hydro One and its CEO by utilizing a “nuclear option”, threatening to shred contracts. Based on my research, it does not appear that investors have factored in any of the potential existential risk here.

Contrary to popular opinion, a review of GC’s Core Business (I define it as their operations excluding Ontario, which I address in the Appendix), indicates that it is facing significant headwinds, with EBITDA declining -6.6% yoy in the first six months of 2018.

(Company Reports and my estimates)

Regional gaming comps trade at a median multiple of 8.0x 2018E and 7.6x 2018E EBITDA. I have applied an 8.5x multiple for GC’s Core Business. One could argue this is generous, given that GC’s Core Business has experienced EBITDA declines and faces significant future existential risk. I would expect any announcement of a public internal or internal investigation by the BC government to weigh heavily on sentiment going forward.

(Bloomberg and my estimates)

I have valued the Ontario assets based on multiples of book. I have reviewed the Seeking Alpha write-up and find the arguments to be compelling. In my view, given the high financial leverage (over $1.0 bn of JV level project debt) and the escalating (and unknown) Annual Thresholds, these bundles should be regarded more as option value than huge home runs.

For a cautionary case study of a Canadian +$1 billion dollar casino development project which also had significant financial leverage, and ended up being completely written off last quarter, please see the Appendix.

(Company Reports and my estimates)

Appendix

I recommend that all current and potential investors in Great Canadian Gaming review this Appendix and all of the source documents listed to come to their own informed conclusions.

Global News Article Alleges Ties to Gambling Tycoon

Global News reports that Great Canadian Gaming was allegedly partnered with a Hong Kong tycoon with suspected links to organized crime in a Macau based casino ship venture in the South China Sea, dating back to 2001.

The casino cruise was allegedly “plagued by problems with Chinese gangsters and armed junket operators, according to documents and witness interviews. It ended in a number of law suits.” (Note, I have included the source documents to these lawsuits and oral depositions further on in this Appendix)

Concerningly, Attorney General David Eby stated to Global News that the allegations of unregistered individuals participating in companies that deliver gaming services in B.C. are serious, and that credible information should be forwarded to the Gaming Policy Enforcement Branch so that appropriate investigations can be initiated. Sandy Garossino, a former Crown prosecutor has stated that this is a bombshell that “blows upon the necessity of a public inquiry into what happened in B.C.:

(“Alleged partnership of Canadian casino company with gambling tycoon could trigger new investigation”)

Gaming is a Highly Regulated Industry… Including Regulatory Requirements on Shareholders

While allegations about potentially unregistered individuals being involved in business dealings with Great Canadian Gaming back in 2001 may be dated, it is important to note that gaming is a high regulated industry which requires registration of gaming service providers and workers. It is my understanding that there is no statute of limitations on this requirement. The registration requires background investigations of registered individuals including interviews, as well as the reporting of civil litigation, criminal or regulatory investigations or other legal proceedings:

(Gaming Control Act)

In fact, gaming regulation can extend to passive investors in gaming companies. In the BCLC operational services agreement with casino operators, one of the clauses is that the Service Provider (i.e. casino) is required to restrict ownership interests above five percent (5%) unless the shareholder first obtains written consent of the Gaming Policy and Enforcement Branch, as well as written consent of the company. These greater than 5% shareholders are deemed to be “Significant Interest” holders. There are also further restrictions on Significant Interest holders increasing, or decreasing, their ownership:

(BCLC Operational Services Agreement)

Great Canadian Gaming also discloses a 5% and 10% threshold in their Management Information Circular, which cites their Articles of Incorporation, noting that the company may enforce the share constraints by placing stop transfers on common shares or seeking injunctive relief. Common shares of Great Canadian Gaming include a legend on these regulatory constraints:

(Great Canadian Gaming 2017 Management Information Circular)

The consequences for a shareholder not receiving regulatory consent while owning a >10% interest may be severe. The shares may be placed into escrow, and the company may then liquidate the shares on the TSX, or repurchase for cancellation the shares at a 10-day VWAP. Until such time a shareholder complies with the advance notice requirement, the shareholder will not be entitled to exercise voting rights nor receive dividends or other distributions:

(Articles of Great Canadian Gaming Corporation accessed via SEDAR)

The regulatory approval to become a >5% is not simply a one-time requirement. There is an ongoing requirement to be monitored by the Service Provider for any material breaches or allegations of a material breach of Applicable Law:

2003 Civil Action Claiming Misconduct Against Great Canadian Gaming

In 2003, Allegiance Capital Corporation filed suit against Great Canadian gaming Corporation alleging fraud and violations of the Racketeering Influenced and Corrupt Organization Act (amongst other allegations). I have downloaded a copy of the complaint, it is a worthwhile read.

(Allegiance Capital Corp. First Amended Complaint and Jury Demand)

Allegiance Capital Suit: Sworn Testimonies of Former Employees in Security and Surveillance

Two former high-ranking employees in the security and surveillance departments of Great Canadian Gaming both gave sworn court testimonies that loan sharking was taking place in casinos, and that management was aware of these activities, and only wanted to give the appearance of deterring them.

These allegations have not been proven in court, as Great Canadian Gaming settled with Allegiance Capital with a payment by GC to Allegiance for in the amount of CAD$2.275 million in December 2004.

Employee #1 - Proka Avramovic, Manager of Security and Surveillance

Proka Avramovic, Manager of Security and Surveillance, who was also contacted by Global News in their July 2018 article, testified in court that he was advised by his superior to get his people to “turn their heads the other way when they see those big loan shark around because that’s good for business.”

He testified that he resigned from Great Canadian Gaming as a result of illegal activities taking place.

(Complete source document: Oral Deposition of Proka Avramovic, April 9, 2004 111 pages)

Employee #2 –Nebojsa Sikimic, Director of Surveillance

Nebojsa Sikimic was appointed Director of Surveillance, reporting directly to Executive Vice-President Brian Egli. Sikimic testified in court that he resigned from Great Canadian Gaming due to a number of problems including missing chips, missing tapes, over-recorded tapes, and loan sharks.

(Complete source document: Oral Deposition of Nebojsa Sikimic, April 9, 2004 127 pages)

Allegation that River Rock Casino Knowingly Accepted ‘Banned’ Cash

The Vancouver Sun in October 2017 reviewed a 2016 audit by the B.C. gaming policy and enforcement branch, suggesting that River Rock staff in 2015 allowed high-rollers to buy chips with funds from private lenders who were under BCLC anti-money laundering restrictions, and who were subject of a major RCMP investigation:

(“B.C. casinos knowingly accepted 'banned' cash: Confidential report”)

The article further quotes the auditors stating that while the River Rock has criteria to prevent refining (a money laundering technique), they had concluded that the controls in place may not be functioning as intended:

(B.C. casinos knowingly accepted 'banned' cash: Confidential report”)

Charles Ming, Late Director of Great Canadian Gaming Had Personal Criminal History Statement

I recently came across this document, which is a Personal/Criminal History Statement for the late Charles Ka Fook Ming, who was a director of Great Canadian Gaming Corporation. Based on this document, it appears that he was charged twice with bribery, which was later overturned.

(Source Document)

Allegations of Potential Misconduct In Attorney General Commissioned Money Laundering Report

In September 2017, British Columbia’s Attorney General David Eby appointed an independent expert to conduct a review of B.C.’s anti-money-laundering policies and practices in the gambling industry. He appointed Peter German, a former deputy commissioner of the RCMP and Correctional Service Canada, and the author of Canada’s leading anti-money-laundering law textbook to conduct an independent review and make recommendations if necessary for reform.

On June 27, 2018, Peter German’s final report was released to the public. Although much of it focuses on structural issues and political inaction which were contributing factors to the money laundering issue taking place in B.C. casinos, he does point out a number of deficiencies taking place at Great Canadian Gaming properties, which investors should be aware of:

BCLC investigator noted that the River Rock VIP room was “full of facilitators”, and stopped filing Suspicious Transaction Reports in amounts below $50,000:

Source: Dirty Money: An Independent Review of Money Laundering in Lower Mainland Casinos conducted for the Attorney General of British Columbia
The River Rock Casino’s cessation of the filing of Unusual Financial Transaction reports for buy-ins under $50,000, would be a violation of the Canadian Federal Proceeds of Crime (Money Laundering) and Terrorist Financing Act:

(Dirty Money: An Independent Review of Money Laundering in Lower Mainland Casinos conducted for the Attorney General of British Columbia)
River Rock accepts $100,000 in twenty-dollar bills two days in a row by a patron who engaged in minimal gaming, whilst a BCLC investigator was on-site. When questioned by the BCLC investigator, casino officials told him to not interfere or direct his staff:( Dirty Money: An Independent Review of Money Laundering in Lower Mainland Casinos conducted for the Attorney General of British Columbia)
Peter German suggests that the River Rock VIP area has a cultural issue which places anti-money laundering compliance second place to revenue generation:

(Dirty Money: An Independent Review of Money Laundering in Lower Mainland Casinos conducted for the Attorney General of British Columbia)

2016 MNP Report

The MNP report states that GPEB has identified $13.5 million in $20 bills being accepted at the River Rock Casino Resort during one month in July 2015, and that law enforcement intelligence has indicated that this currency may be the direct proceeds of crime.

(MNP report for the British Columbia Gaming Policy Enforcement Branch)

The MNP report also suggests that the River Rock staffs have fostered a culture of accepting large bulk cash transactions:

(MNP report for the British Columbia Gaming Policy Enforcement Branch)

What About the Ontario Upside?

Bullish investors make the argument that Great Canadian Gaming’s newly acquired Ontario assets offer significant unrealized upside potential.

I have thoroughly reviewed the Ontario assets and have a few points to make:

First, the stock is up 38% YTD, and is up 83% since they announced that they won the GTA bundle. Meanwhile, GC’s Core Business has deteriorated and has suffered from EBITDA declines. It is not as if the market is unaware of these bundles.
This Seeking Alpha write-up lays out in tremendous detail how analysts have improperly calculated the value of the OLG bundles due to the unique concept of Annual Thresholds in the bidding mechanism. Thus far, I am not aware of any compelling arguments that suggest that the Annual Thresholds do not materially increase in the years to come. The higher the thresholds increase, the greater the execution risk for Great Canadian. As a reminder, the GC partnership that owns the GTA bundle only keeps 70% of the gross gaming revenue above a certain undisclosed threshold (which varies by year). However, they are responsible for 100% of the operating costs. Therefore, significant growth in gross gaming revenue does not necessarily translate 1:1 to growth in revenue to the partnership – it all depends on what the Annual Threshold is. If the Annual Threshold grows faster than the growth in gross gaming revenue, and if operating costs are growing quickly as well, the partnership could actually see EBITDA declines.

I think the most important thing to acknowledge is that the Annual Thresholds are unknowns. I find it difficult to underwrite an investment thesis where the crucial piece of information that the investment thesis hinges upon has not been disclosed by management. This risk is further exacerbated by the fact that CEO Rod Baker has filed an automatic disposition plan to sell up to $23 million worth of stock.
Bullish investors offer that the number of slot machines and table games in GC’s bundles are set to increase dramatically. This is true. However, it is also important to acknowledge that the number of slot machines and table positions is set to increase by a huge amount province-wide. I have compiled a schedule of all the casino/land-based gaming assets in Ontario, along with an estimate of their current electronic and table gaming positions, and the new maximums as set by the OLG.

As you can see, the number of electronic gaming positions have been approved by the OLG to increase by 73% province-wide (from approx. 22,600 games to 39,000 games). The number of table games is set to increase by 223% (from approx. 3,900 games to 12,700 games). While only a portion of the expansions have been announced thus far, it is still early days and I would expect that the bidders who won these assets will quickly make plans to redevelop existing sites and/or build new ones.

Here is a select number of redevelopments announced thus far in Ontario:

$318mm Hard Rock development: https://globalnews.ca/news/4197575/ottawa-rideau-carleton-raceway-expansion/
$60mm Sudbury redevelopment: https://www.newswire.ca/news-releases/gateway-casinos--entertainment-proposes-to-build-a-premier-casino-and-entertainment-property-in-greater-sudbury-628206413.html
$26mm Casinos Point Edward investment: https://www.newswire.ca/news-releases/gateway-casinos--entertainment-announces-plans-to-invest-26-million-in-gateway-casinos-point-edward-to-rebrand-as-starlight-casino-631559103.html
$1.3 billion Durham Live complex: https://www.canadianbusiness.com/lists-and-rankings/richest-people/apostolopoulos-family-durham-live/
$200mm Southwest region investment plans: https://lfpress.com/2017/05/09/gambling-olgs-new-operatorin-london-and-region-promises-200-million-improvement/wcm/24a267d2-25bc-318d-da23-cf255c8a960a
$140mm Western Fair redevelopment: https://lfpress.com/news/local-news/no-gateway-deal-but-rezoning-starts-at-western-fair
$36mm Dresden redevelopment: https://www.gatewaycasinos.com/gateway-unveils-plans-to-invest-36-million-create-up-to-200-new-jobs/
Hanover site expansion: https://www.gatewaycasinos.com/gateway-announces-expansion-of-hanover-site/
$2 billion Woodbine development: https://www.toronto.ca/legdocs/mmis/2018/ex/bgrd/backgroundfile-114005.pdf
$10mm Mohawk investment: https://torontosun.com/2017/06/13/mohawk-racetrack-ups-its-game/wcm/661a3ac2-bde8-406e-b998-45c0eb484ac8

The total announced capital expenditures is already in excess of $4 billion. It is almost a certainty that there will be more investment announcements to come as all operators seek to maximize their potential returns.

The take-away here is that yes, it is true that GC’s gaming bundles have upside potential via the introduction of additional slots and tables. However, this is a province-wide phenomenon and not without execution risk. The key risk for Great Canadian is if they have indeed bid aggressively to win the largest gaming bundle, the Annual Thresholds may move up quickly. This information that is not available, and I have difficulty underwriting the bull case investment thesis.

Parq Vancouver – A Case Study in Risks Inherent in Newbuild Casino Development
The Parq Vancouver is a premier entertainment complex owned by Dundee Corporation and Paragon Gaming. No expenses were spared in its development, and it featured two hotels (JW Marriott Parq and DOUGLAS, an Autograph Collection hotel), a casino, rooftop park, 8 restaurants and lounges, 60,000 sq ft of meeting and event space and Vancouver’s largest hotel ballroom. The construction cost was reported to be $957 million.

(http://paragongaming.com/developments-properties/parq/)

Parq Vancouver’s grand opening was in September 2017. By June 30, 2018, Dundee Corporation had completely written off its equity investment:

(Dundee Corp 2018 Q2 Financial Statements)

In my view Great Canadian’s Woodbine redevelopment in Ontario faces similar execution risk. It also has the added burden of having an escalating Annual Threshold to deal with.

			2018	2019
Price:	46.55	EPS	2.53	2.91
Shares Out. (in M):	61	P/E	18.4	16.0
Market Cap (in $M):	2,850	P/FCF	N/A	N/A
Net Debt (in $M):	200	EBIT	264	322
TEV (in $M):	3,050	TEV/EBIT	11.6	9.5
Borrow Cost:	General Collateral