DBRS Assigns Provisional Rating of B (high) to Gateway, Stable Trend

DBRS has today assigned an Issuer Rating of B (high) to Gateway Casinos & Entertainment Limited (Gateway or the Company) and a provisional rating of B (high) to the Company’s proposed new Senior Secured 2nd-Lien Notes, both with Stable trends. The Senior Secured 2nd-Lien Notes have a recovery rating of RR4. The ratings reflect Gateway’s concentration in the Greater Vancouver Regional District (GVRD), competition for discretionary income and the high degree of financial leverage. The ratings are also based on the Company’s strong market positions in the fastest growing and most prosperous regions of Canada and the symbiotic relationship with government that is beneficial to incumbent casino operators.

Gateway is one of the largest casino operators in Canada, with 12 gaming facilities located in British Columbia and Alberta. Based on revenue, the Company has a leading market share in the GVRD, is the dominant operator in the Thompson-Okanagan region and is the third-largest player in Edmonton, a more competitive market. In 2010, under previous ownership, Gateway entered into a series of forbearance agreements in order to restructure its debt obligations. DBRS notes that Gateway’s assets consistently generated economic profit throughout this period and the restructuring was the result of extremely aggressive leverage. As part of the restructuring, Catalyst Capital Group Inc. obtained a majority equity stake in the Company with the intention of taking it public.

Since the restructuring in 2010, Gateway’s earnings profile has weakened. Although the Company has maintained leading market positions, revenue has remained relatively stable despite the purchase of three smaller community gaming centres. The western Canadian gaming market has grown steadily over this period, indicating that Gateway has lost market share. Furthermore, while Gateway’s operating margins remain high relative to peers, they have contracted over this time period due to increased labour costs in British Columbia, as well as aggressive marketing spend that did not translate into growth in operating income.

Gateway’s financial profile benefits from its cash generating capacity and low maintenance capex but is constrained by high leverage and low coverage ratios. While cash flow from operations has declined in line with operating income in recent years, Gateway has generated positive free cash flow before dividends since 2011, in the $25 million to $50 million range. Although the Company maintains a discretionary dividend policy that has varied, DBRS notes that current shareholders have injected capital if and when necessary. Subsequent to the recapitalization, Gateway’s balance sheet debt is expected to increase by approximately $50 million to $510 million. As a result, lease-adjusted debt-to-EBITDAR and lease-adjusted EBITDAR coverage ratios should weaken to 6.1 times (x) and 2.7x, respectively.

DBRS believes Gateway’s earnings profile will strengthen over the near-to-medium term as the new management team’s investments and initiatives should increase customer traffic and reverse recent market share losses and margin erosion. DBRS believes gaming revenue will grow in the mid-single digits, driven by three casino expansions where utilization is currently high and an improved food and beverage offering to attract casual gamers. DBRS forecasts margins will improve slightly, resulting from the benefits of operating leverage, the new management team’s focus on cost cutting and the additional government-serviced slot machines. As a result, DBRS expects EBITDA to grow approximately 10% by 2015.

DBRS expects Gateway’s financial profile to improve over the medium term as the Company increases its cash generating capacity and uses the majority of its free cash flow to fund its scheduled debt repayments. Cash flow from operations is expected to grow in line with operating income, increasing by approximately 20%, to more than $60 million in 2015. DBRS expects Gateway to invest $40 million to $50 million per year over the next three years to fund property relocation and expansion. DBRS believes free cash flow will be used for deleveraging, rather than returns to shareholders, as the Company prepares for an initial public offering within the next two years.

DBRS anticipates approximately $35 million of debt reduction (including $21 million of scheduled amortization payments) through 2015. This deleveraging, combined with growth in operating income, could result in a material improvement to key credit metrics (i.e., lease-adjusted debt-to-EBITDAR near 5.0x by 2015), which may warrant a positive rating action. That said, should lease-adjusted debt-to-EBITDAR increase to more than 6.5x, either resulting from weakening operating performance or debt-financed returns to shareholders, ratings could be pressured.

Notes:
All figures are in Canadian dollars unless otherwise noted.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Gaming Industry, which can be found on our website under Methodologies.