Crown and the Importance of Management
I’m hoping for everyone else currently enjoying lockdown that you are staying safe and healthy. Ultimately, as we will know, lockdowns are not pleasant for anyone although we all experience different degrees of difficultly. For those who are able to work remotely these might be a small annoyance or even an added benefit, however for those who are unable to work due to these measures it is certainly a tough time. Times like these is when it is most important to support small businesses where possible (and safe to do so).
These lockdowns, restrictions and uncertainty have made me think further about the value that a management team can either create or destroy within a business. For example, I have a good friend who owns a furniture retailer and over the past 18 months business has had a ripper of time following the decision to go full steam ahead into online sales. In fact, last time we caught up for coffee he said that even when there are no restrictions in place the majority of his sales are now online.
However, not all management teams are of a high quality. When researching a potential investment there is a mixture of both qualitative and quantitative elements that come into play. Things like the strength of the balance sheet, returns on invested capital, earnings and profitability are easily seen in the financial statements of a company (although full disclosure, often to get the most accurate picture of a businesses financial health adjustments do need to made). The barebones truth is that CEO’s almost always will paint a rosy outlook for the future prospects of a company and even when things are going terribly optimistic language will be used. Phrases such as turn around, unexpected delays, a stronger second half, the pipeline is strong etc are often used when the financials and the businesses performance are less than ideal. All in all, this part of building a model on an investment is relatively simple, particularly when the business has strong long term tailwinds behind it. The question becomes does the current stock price offer me an appropriate risk to reward ratio at the current price?
However, as we all know, companies are run by people and not all people are the same. There is a famous Warren Buffett quote regarding assessing how complicated a business is to run and I’ll slightly paraphrase it here “ Can the business be run by an idiot? Because one day it will be run by one”. Finding a high quality business that possesses the attributes that I look for is not common. Often what I find is businesses that have the potential to be high quality firms and compounders of your capital but due to management are not able to do so. Occasionally, the opposite occurs where a business that really should not be anything special is able to operate in a fantastic manner due to the exceptional nature of the management team.
One business that fits the mould of looking like it should be exceptional on paper but management significantly lets down the shareholders and investors is Crown Resorts Ltd (CWN). For those unfamiliar, Crown is the holder of exclusive casino operating licenses across Melbourne and Perth, with the recent addition of a license to operate in the Sydney market alongside the Star. These exclusive licenses in Melbourne and Perth are extremely long dated with expiries not until 2050 and 2060 respectively. While gambling would not seem like a great market to invest in, it is important to remember that every game in a casino is designed with a negative player expected value. Meaning in a nutshell, that the house has an edge and over a long enough time period will be expected to perform in line with the house edge. Pokies are the perfect example of this, where depending on the state the machines are designed to only return roughly 92 cents for every $1 entered into the machine meaning that the longer a player is using the machine the higher the likelihood that player will walk away a loser. Other games such as blackjack do not offer such a significant margin but as anyone who has been to casino knows they use tactics such as 6 decks, regularly randomised reshuffling and tweaking of standard games (such as blackjack challenge vs blackjack) to ensure that over the long term the house will win. Throw in the property holdings within the group and the ability to earn reasonable returns on capital (even after all the promotions, give a ways, gambling specific taxes etc) however the issues at Crown come from management not the effective core of the business.
Casino’s are notorious for both being heavily regulated and the public perception that they are a reminder of previously more lawless times. At the moment the failings of management to comply with the law are giving the journalists at the AFR plenty to cover and some of the findings so far are alarming to be polite. Findings have included; failure to meet regulatory/compliance standards as per its gaming license, excess influence of former chairman and 37% chairholder James Packer, a $61 million fine for mislabelling perks for punters as being losses (and therefore tax deductible to the group), senior management knowing about the previous issue in 2018 and taking until days before an inquiry into Crown in 2021 to start an internal investigation, enabling Chinese high rollers to move more than $160m out of China via credit card payments, allowing problem gamblers to punt for days straight, failure to comply with responsible gambling legislation, the relatively standard issues that casino’s face in trying to prevent money laundering and of course the well known junket operator issues in the past that lead to staff being imprisoned in China.
The extent of these issues indicate that senior management of this business have not been doing an appropriate job of operating the business, understanding their legal obligations or showing the level of competence that is reasonable to expect from a company with a market capitalisation of $6,000,000,000. During the various inquiries into Crown, the potential loss of Crown’s Gaming License in Victoria and potential not to be approved in NSW due to not meeting the oversight requirements has come up several times. Whilst, I do not believe that this outcome will occur, I do believe that the company will be forced into making significant further changes at a director/senior management level and have increased ongoing supervision or compliance requirements across state gambling control offices.
Ineffective and poor management has been at the crux of the myriad of issues highlighted above. As you would expect this has resulted in less than optimal returns for shareholders in fact, since 2007 the stock price is down over 32% despite the underlying business having attributes that are very appealing to me as an investor namely being the exclusive licenses providing a relatively strong moat, a service that has benefited from rise of the Chinese millionaire, strong brand recognition and a core product that is addictive (although I will not comment on the ethics of investing in a business such as a casino or tobacco company). At this point in time, I will continue to avoid owning the stock primarily due to what I perceive to be a low quality nature of the management team. It appears that I am not the only one feeling this way with the legal counsel assisting the Victorian inquiry into Crown deeming executive chairman Helen Coonan unfit to run the company. Maybe in the future with significant management, culture and operating improvements (or a significant falling in the share price) Crown might become investible but at this current moment I am going to for better opportunities in high quality businesses run by thoroughly impressive individuals to invest your capital into.