A Wall Street investment firm says Magna Entertainment Corp. - the company negotiating to buy Maryland's thoroughbred racetracks - has paid too much for low-quality tracks and that competitors will beat it in the race to attract bettors through computer and television wagering.
Dresdner Kleinwort Wasserstein recommended in a unusually comprehensive report to clients that they "reduce" their Magna holdings, signaling it expects the stock to fall 5 percent to 10 percent in the next year. Magna's stock was trading on Nasdaq at $7 on June 19, when the report was issued. It was trading at $6.99 last night.
The 60-page report was skeptical of Magna's aggressive strategy of buying many tracks so that it can offer their races on affiliated computer, telephone or interactive television systems the company is developing.
"We believe a lack of consistent quality and negative trends will make it difficult for the company to improve returns and capitalize on in-home wagering," the report concluded.
Dresdner's opinion appears to be a minority viewpoint on Wall Street. Over the past year, Magna has generated six "buy" recommendations and only one "sell" by brokerage houses tracked by Bloomberg, a financial information firm.
Earlier this month, Dundee Securities Corp., rated Magna a "strong buy" and Bear, Stearns & Co. issued a "buy" recommendation.
"We continue to like MEC's near-term and long-term growth prospects," Bear, Stearns said in a June 5 update, predicting Magna stock will hit $10.
The analysts said Magna, based in Aurora, Canada, has plenty of cash. They also liked its focus on the distribution of race telecasts to off-track customers and its recent acquisition of a Canadian harness track with slot machines.
"We continue to believe the company has a number of growth initiatives in the pipeline, and will remain an aggressive consolidator in the fragmented horse racing industry," the Bear, Stearns report said.
Magna has beennegotiating for months to buy a majority share of the Maryland Jockey Club, owner of Pimlico Race Course and Laurel Park, according to sources involved in the talks. Neither side will confirm the negotiations.
Citing a "propensity to overpay for assets," Dresdner predicted that Magna would remain profitable but that its return on investment would not improve substantially. It also said Magna's XpressBet wagering system, through which customers can set up accounts and bet on races over the phone and the Internet, is losing customers to systems that feature higher quality racing.
"In our opinion the quality of MEC's tracks is very mixed," the report said, concluding only Santa Anita Park outside Los Angeles and Gulfstream Park near Miami offer top racing. Magna also owns or is acquiring seven other thoroughbred tracks, a greyhound track and a harness track.
Fans are likely to prefer the systems of cable channel TVG and affiliated Youbet.com, which carry the signals of many, often better-known, tracks, the report said. Those systems do not own tracks.
Magna's strategy calls for owning most of the tracks its systems offer, and it has spent more than $500 million since 1998 in becoming the biggest track operator in the country.
Last year, betting through XpressBet fell 12 percent, something Dresdner believes may be related to quality. Tracks available through XpressBet paid winning horses an average of $104,000 a day in purses during the first quarter, compared with $318,000 for tracks carried by Youbet and TVG.
Wagering declines
Overall last year, wagering on races held at half of Magna tracks declined. By contrast, a similar drop occurred at only one of six tracks owned by Churchill Downs Inc., Magna's biggest competitor.
Dresdner has performed consulting services for Churchill in the past, according to a disclosure statement. Bear, Stearns says it has performed banking services for Magna.
In-home wagering is likely to grow, and other factors could boost Magna's performance, including the possibility of slots being legalized in Pennsylvania, the Dresdner report said. The company also will benefit from its position in the massive California market, where its three tracks account for about half of all the betting on horses. However, Dresdner added, "the mediocre quality of its assets, an unproven in-home strategy, and the competitive nature of the industry ... is likely to prevent substantial improvement."
The report's author, Ryan L. Worst, a Dresdner vice president and equity analyst, also cast doubt on Magna's strategy of transforming racetracks to "entertainment centers" by adding concerts, shopping and other attractions to attract new fans. These initiatives can actually hurt business - as they may have at the recent Gulfstream meet where attendance and on-track betting both fell sharply - if they drive away avid racing fans, according to Worst.
Magna vice president of finance Graham Orr said he disagreed strongly with the report's conclusions. "I'm thrilled with the tracks that we've acquired and I think we're on pace," he said. "We've improved our profitability."
First-quarter profit
Magna reported a profit of $18.6 million, or 22 cents per share, for the first three months of the year, compared with $22.5 million, or 28 cents per share, in the same period a year earlier.
Orr said the Gulfstream meet was hurt by the closure of a nearby track that reduced stabling space for horses, and the post-9/11 slump in southern Florida tourism. Even with those factors, the track's earnings improved.
He said Dresdner failed to account properly for excess real estate acquired by Magna at many of its tracks. That land may be sold or developed, but shouldn't be included in the cost base used to calculate the racetrack operating performance, Orr said.
"We feel that we have paid a very fair price for our tracks. There are a lot of attributes that go into what you pay for an asset," said Orr, adding he had called Worst to complain about the report and some inaccuracies in its data.
Worst, however, was resolute. "My conclusion still stands," he said. "Even if you take the land out, I still think they overpaid."
Pimlico and Laurel would add needed quality to Magna's menu of races, he said. But the tracks need an infusion of cash.