Gamehost Inc. (TSX:GH) – Gambling the old-fashioned way

An overview of Alberta's only public casino operator

Disclosure: We own this.

Some say the stock market seems more like a casino these days and we are here to join the party. But we are not here to talk about gambling antics like NVIDIA short-dated call options or the next memecoin. Instead, we want to talk about gambling the old-fashioned way in Alberta.

What do you get when you combine a conservative management team and a few casino licenses in a growing jurisdiction that limits them? It turns out you get pretty good returns on capital and trading today for ~10x FCF. Why gamble when you can bet on the house?

Gamehost Inc. has been quietly operating a few well-run casinos in Alberta and has used their free cash flow to repay debt, pay a dividend, and repurchase shares. Now that they are almost completely de-levered, what’s next? But first, how does legalized gambling work in Alberta?

Disclaimer - The content contained in this blog represents the opinions of contributors. You should assume contributors have positions in the securities discussed, whether long, short, or somewhere in between, and that this creates an obvious conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance whatsoever and are subject to certain risks, uncertain risks, and other factors. Information might also be completely out of date and may or may not be updated. No one guarantees the accuracy of any information provided and none of the information should be construed as investment advice under any circumstance, and the blog is a blog and not a registered investment advisor or broker in any jurisdiction. Frankly, no information here should be used for any purpose except for entertainment (and we hope you enjoy).

Gambling in Canada / Alberta 101

To understand Gamehost, you must understand how gambling works in Canada. Gambling, in general, is prohibited under the Federal Criminal Code of Canada except for certain exceptions, with the relevant one being:

207 (1) Notwithstanding any of the provisions of this Part relating to gaming and betting, it is lawful

(a) for the government of a province, either alone or in conjunction with the government of another province, to conduct and manage a lottery scheme in that province, or in that and the other province, in accordance with any law enacted by the legislature of that province;

…

(4) In this section, lottery scheme means a game or any proposal, scheme, plan, means, device, contrivance or operation described in any of paragraphs 206(1)(a) to (g), whether or not it involves betting, pool selling or a pool system of betting other than

· (a) three-card monte, punch board or coin table;

· (b) bookmaking, pool selling or the making or recording of bets, including bets made through the agency of a pool or pari-mutuel system, on any horse-race; or

· (c) for the purposes of paragraphs (1)(b) to (f), a game or proposal, scheme, plan, means, device, contrivance or operation described in any of paragraphs 206(1)(a) to (g) that is operated on or through a computer, video device, slot machine or a dice game.

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(4.01) In paragraph 4(c), slot machine means any automatic machine or slot machine, other than any automatic machine or slot machine that dispenses as prizes only one or more free games on that machine, that

· (a) is used or intended to be used for any purpose other than selling merchandise or services; or

· (b) is used or intended to be used for the purpose of selling merchandise or services if

o (i) the result of one of any number of operations of the machine is a matter of chance or uncertainty to the operator,

o (ii) as a result of a given number of successive operations by the operator, the machine produces different results, or

o (iii) on any operation of the machine, it discharges or emits a slug or token.

https://laws-lois.justice.gc.ca/eng/acts/C-46/section-207.html

As a result, gambling in Canada is under provincial jurisdiction. Alberta, like every other province, is effectively its own country with its own rules and so you must look at it as a separate standalone market from other provinces, particularly since the main population centers are not close to the B.C./Saskatchewan borders making interprovincial competition limited. As Gamehost only operates in Alberta, this only covers the Alberta market dynamics.

The Alberta Model

Legalized gambling in Alberta is regulated and overseen by the Alberta Gaming, Liquor and Cannabis Commission (AGLC). Here's a breakdown of how it works:

• Regulatory Framework - AGLC Oversight: The AGLC regulates all forms of gambling in Alberta. Activities are governed under the Gaming, Liquor and Cannabis Act.

• Besides casinos and machines, charitable gaming, lottery (Western Canada Lottery Corporation) and sports betting (playalberta.ca) are legal.

• Casinos are privately run but heavily regulated and using a charitable gaming model (see next).

• VLTs and Slot Machines: Found both in casinos and bars. Operators share revenues with the government.

• Charitable gaming Includes bingo, raffles, and pull tickets. Proceeds benefit charities and non-profit organizations.

• The Western Canada Lottery Corporation operates games like Lotto Max and Scratch & Win on behalf of Alberta.

• And for sports betting, both retail and online betting are permitted via platforms like PlayAlberta.ca.

Casino gaming revenue is split between the province, the operator (i.e. Gamehost), and charities depending on the game. Operators used to get 15% but are currently getting 17% under a temporary pilot program (background detailed later below). Casinos have casino nights, where registered charities come in and help run the casino. These nights can be very significant for the charity and an essential part of their organization’s fundraising.

https://aglc.ca/sites/aglc.ca/files/2023-11/Casino_REC_Proceeds-20231121.pdf

The provincial licensing philosophy

The biggest risk a casino has is that another one is opened just across the street. What makes Alberta a good jurisdiction to operate in is that the regulator realizes that healthy casinos and well-placed machines are more profitable for both the province and the operators. In turn, the province limits casinos based on population growth and also has a methodical process for VLTs.

One interesting nuance in Alberta is that operators do not actually own the VLT machines. They are actually owned by the province and are placed in the operator’s facility. The province caps the number of VLT machines and tracks their relative performance. It then continually removes the worst performing VLT’s and moves them to other locations. To see what we mean, here are the early days of the AGLC tweaking their operations.

Payout rates are ~92% over the entire network over all spins, with the remaining split between the operator/charity/province as outlined above. The province currently has about 6,000 machines.

Here is the process if you wanted to install a new VLT in Alberta.

10.2.9 AGLC may consider an application to install VLTs on licensed premises. To be eligible for installation, an applicant must have a valid Class A Minors Prohibited liquor licence for a premises that is not located in a community that prohibits VLT installations (see Subsections 10.2.14 to 10.2.16). (Amended Nov 2024)

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10.2.13 New VLT retailers will initially be part of AGLC's trial network in order to determine whether or not the level of consumer demand, as determined by AGLC, can be achieved at that location. As a part of the trial network:

a) the new VLT retailer will be provided with a 26 week sales target, established using AGLC's most current VLT consumer demand assessment model; and

b) upon completion of the initial 26 week period, if the VLT retailer:

i) achieved or exceeded AGLC's sales target it will no longer be included in the trial network; future assessments will be done in accordance with Section 10.6; or

ii) does not meet AGLC's sales target, it will receive a written notice from AGLC indicating that an additional 13 week assessment period is required. Upon completion of the additional 13 week assessment period, if the VLT retailer:

-achieved or exceeded AGLC's original 26 week sales target it will no longer be included in the trial network; future assessments will be done in accordance with Section 10.6; or

-continues to be below AGLC's original 26 week sales target, the VLTs will be removed and the Video Lottery Retailer Agreement will be terminated.

…

Fun note for Albertans: The following communities prohibit VLTs - County of Lethbridge, Municipal District of Opportunity. Wood Buffalo, Canmore, Cardston and Sylvan Lake.

See the full handbook here - https://aglc.ca/sites/aglc.ca/files/2024-11/24-11-29%20LH%20Handbook.pdf

As a side note, the province has been run a pilot program of the take rate. We will have to wait to see if this becomes permanent. The annual impact to Gamehost is $2-3MM.

In exchange for providing gaming services, Gamehost receives a commission from the AGLC based on 15% of the net revenue after payout to customers generated from the slot machines. Effective April 1, 2023, AGLC has implemented a pilot project to evaluate the effects of operator initiated promotions designed to increase cash play on slot machines. Operators will absorb the cost of any promotions offered and receive 17% of the net revenue after payout to customers for a two-year period. Operators are required to submit regular reporting to AGLC detailing specifics of promotions offered. AGLC will evaluate the effects of this promotional spending on slot cash play over the two-year period. Management is hopeful the additional 2% of net win to operators could be extended or become permanent.

Alberta is one of the lowest operator paid gaming jurisdictions in North America. For example, next door in B.C. it is 25% and operators also get a facility development fund (where capital spent on facility upgrades can be earned back). Details here -https://corporate.bclc.com/content/dam/bclccorporate/reports/expenses-and-compensation/2023/gambling-service-provider-commissions-report-2022-23.pdf

Alberta also has regulated First Nations casinos - https://aglc.ca/gaming/charitablegaming/host-first-nation-casinos

Brief History – The Gamehost story

To simplify a long story, Gamehost is the combination of several joint ventures and properties from key founders who combined casino licenses, hotels, and land to ultimately create what Gamehost is today.

On June 1, 2003, specific hotel and gaming assets owned by Service Plus, then a Canadian public company, Will Inns and Boomtown were purchased, through a series of reorganization transactions, by the Fund, operating through the Limited Partnership. Also, Service Plus transferred its 40% interest in the Deerfoot Inn and Casino Joint Venture to the Fund. These transactions were completed through a plan of arrangement under the ABCA pursuant to which Service Plus Shareholders (excluding certain insiders of Service Plus and the Fund) indirectly exchanged their Service Plus Shares for Fund Units on a 0.328 of a Fund Unit for each Service Plus Share. The insiders, directors and officers of ServicePlus, Will Inns and Boomtown exchanged specific assets, being the Boomtown Casino in Fort McMurray, Alberta, the Great Northern Casino in Grande Prairie, Alberta, the Grande Prairie Real Estate, in Grande Prairie, Alberta, and the 40% interest in the Deerfoot Inn and Casino Joint Venture in Calgary, Alberta, a joint venture for the then proposed new casino and hotel facility in Calgary, Alberta in return for Class B Units of the Limited Partnership

On June 4, 2003, the Fund Units began trading on the TSXV under the Symbol “GH.UN”.

In July 2003, an 11,000 square foot expansion of the Great Northern Casino was completed. The expansion included the addition of 59 new slot machines bringing the total slot machines at the casino to 299, the maximum allowable for a minor casino in Alberta at that time.

In June 2004, construction was commenced on the Deerfoot Inn and Casino project in Calgary and was completed in November 2005.

The ownership structure of individual assets was a bit complicated before. For example, Deerfoot Inn’s structure at the beginning below. Ownership of their various properties is now simplified after various transactions over the years.

The Deerfoot Inn JV was formed pursuant to a joint venture agreement dated April 26, 2001 among Service Plus, Will Inns, Winners Gaming Inc. (“Winners Gaming”) and JM Wood Investments Ltd. (“JM Wood”). Will Inns, a corporation controlled by David Will, then a director of Service Plus, currently a Trustee of the Fund, and the President and CEO of GMI has a 31% interest in the joint venture. Winners Gaming, a corporation controlled by Darcy Will, then a director of Service Plus and currently a Trustee of the Fund has a 20% interest in the joint venture. JM Wood Ltd., a corporation controlled by Jed Wood, then a director of Service Plus and a former Trustee of the Fund, has a 9% interest in the joint venture. The remaining 40% interest of the joint venture originally held by Service Plus was transferred to the Limited Partnership under the Plan of Arrangement. The Deerfoot Inn JV owns and operates the Deerfoot Inn and Casino.

The last acquisition - 2018

The “acquisition” in 2018 was the final step to simplifying the ownership of Gamehost and its various assets. The acquisition being the Encore Suites Hotel next door to Gamehost’s Great Northern Casino in Grande Prairie. This was the final step, and we consider the ownership structure of their properties now simple and complete, albeit with a gross overriding royalty built in for a key owner.

On December 14, 2018, Gamehost acquired the Encore Suites Hotel (defined below) from Peace Country Hospitality Inc. for a price of $12.5 million.

On December 14, 2018, Gamehost acquired the Encore Suites Hotel from Peace Country Hospitality Inc. for a price of $12.5 million. Peace Country Hospitality Inc. is a company controlled by David Will, Darcy Will and Elston Noren, each of whom are officers and significant shareholders of Gamehost. This was a related party transaction under applicable securities laws, but the transaction was exempt from the formal valuation and minority shareholder approval requirements under applicable securities law for related party transactions as both the fair market value of the property, and the business being acquired, and the fair valuation for the consideration paid were substantially less than 25% of Gamehost’s market capitalization. The transaction was approved by the independent directors of Gamehost.

We note the Wills continue to have a management services agreement. Assuming you are comfortable with this, you just need to take it into account.

The Company had related party transactions with David Will and Darcy Will and/or companies owned or controlled by David Will and/or Darcy Will (collectively the “Wills”). The Wills are key management personnel, directors of the Company, and significant shareholders. Together, the Wills control 34.8% (33.5% - 2022) of the outstanding common shares of the Company at end of the Year.

The Company incurred $1,733.9 thousand ($1,298.2 thousand - 2022) in management compensation with the Wills for the Year which is included in administrative expenses. Compensation is in the form of short term employee benefits, director fees, management agreements, and a general partnership agreement between Gamehost Inc, Gamehost Limited Partnership and the managing partner, Gamehost Management Inc. Management fees stipulated in management services agreements are based on a percentage of revenues and/or earnings before interest, taxes, depreciation and amortization. $3.6 thousand ($27.4 thousand - 2022) remains in accounts payable at the end of the Year.

A management services agreement between the Company and the Wills stipulates that the Wills are entitled to 1.5% of gross operating profit before interest, taxes, depreciation, amortization, and extraordinary items of the Company. These amounts are included in administrative expenses.

The management services company engaged to perform the services referred to above is also the general partner of Gamehost Limited Partnership. The partnership agreement stipulates that the general partner is entitled to 0.01% of all cash distributions of the partnership. These amounts are included in administrative expenses.

A management services agreement between Deerfoot and the Wills stipulates that the Wills are entitled to 1.5% of the gross revenues plus 2.0% of operational earnings before interest, taxes, depreciation, amortization, and extraordinary items of Deerfoot. These amounts are included in administrative expenses.

Gamehost today: The casinos

The Company has three casinos in the province:

• Deerfoot Inn & Casino facility located in Calgary, Alberta – Opened in 2005 and expanded/renovated during COVID in 2021. It is ~67,000 square feet, has 768 slot machines, 32 table games including poker, and also includes a 188 room hotel, 175 seat restaurant, convention facilities, and a full water park. It is wholly-owned. https://maps.app.goo.gl/7uoqTC5ywZenqw2RA

• Rivers Casino, Fort McMurray – Opened in 2006 and expanded/renovated in 2012 and also during COVID in 2021. It is ~34,000 square feet in central Fort McMurray next to the Peter Pond shopping mall. There are 406 slot machines, and table games/poker, as well as a 300 seat showroom. The facility is under a long-term lease until 2036, with an option to renew. https://maps.app.goo.gl/wZWZrzp9MWw8erNn6

• Great Northern Casino, Grande Prairie – Opened in 203 and expanded/renovated in 2006, 2013, 2017, and 2022. It has 400 slot machines, table games and poker. Next door is their Encore Suites Hotel constructed in 2016 and has 94 rooms and also the Service Plus Inn with 122 rooms. Reviews of the hotels are generally good at 3.9 and 4.5 stars - https://maps.app.goo.gl/BHmJudwS8ZuHiVzT9

Ever have trouble finding a casino? Thankfully, the province has a guide - https://aglc.ca/gaming/casinos/find-casino-rec

We note that:

• Their Calgary casino is well located, in that it is the farthest southeast in Calgary and city development southwards continues (see city development below).

• Their casino in Fort McMurray is the only one and located in the center of town.

• Grande Prairie has one other casino that opened in 2021.

• Fort McMurray and Grande Prairie populations have been relatively stable, though Fort McMurray never recovered to its 2010s pre-fire/pre-oil-crash highs. Calgary growth dynamics are good and casino well located with southward expansion. As a side note, U-Haul says Calgary is Canada’s #1 growth city (ranking below)! https://www.uhaul.com/Articles/About/U-Haul-Alberta-Top-Province-Calgary-Top-City-for-Growth-IN-2024-33118/

Financial performance, key operating metrics