\nMembers of the Board of Directors\n<\/p>\n<\/td>\n
\nDecember 8, 2020\n<\/p>\n<\/td>\n<\/tr>\n
\nGreat Canadian Gaming Corporation\n<\/p>\n<\/td>\n
\n\u00a0\n<\/p>\n<\/td>\n<\/tr>\n
\n39 Wynford Drive\n<\/p>\n<\/td>\n
\n\u00a0\n<\/p>\n<\/td>\n<\/tr>\n
\nNorth York, ON M3C 3K5\n<\/p>\n<\/td>\n
\n\u00a0\n<\/p>\n<\/td>\n<\/tr>\n<\/table>\n
\nDear Members of the Board:\n<\/p>\n
\nBreach Inlet Capital, LP (\u201cBIC\u201d) is a long-time shareholder in Great Canadian Gaming Corporation (the \u201cCompany\u201d or \u201cGC\u201d). We own more shares than all of the independent members of GC\u2019s Board of Directors (the \u201cBoard\u201d) combined. We also have a history of helping public companies enhance their leadership teams. As a recent example, we were part of a shareholder group that called a Special Meeting at Aimia Inc. that led to replacing 7 of 8 directors as well as the CEO1<\/sup>. For the reasons set forth below, we will vote \u201cAGAINST\u201d Apollo\u2019s proposed acquisition of GC for only $39 per share<\/span>2<\/sup>.<\/span><\/b><\/p>\n 1. We believe $39 per share vastly undervalues GC.<\/b><\/p>\n \nGC effectively has a monopoly of the casino market in the Greater Toronto Area (\u201cGTA\u201d), which is the third largest and fastest growing city in the US and Canada3<\/sup>. Furthermore, the GTA gaming market appears very underpenetrated implying immense untapped potential. For reference, we estimate the Greater Vancouver Area (\u201cGVA\u201d) generated > $500 of Gross Gaming Revenue (\u201cGGR\u201d) per capita in 20194<\/sup>, while we estimate the GTA garnered only ~$200 of GGR per capita5<\/sup>. GC recently completed its new Durham Live casino and is substantially expanding its Woodbine casino. These world-class casino resorts should arguably attract higher GGR per capita than any casino in the GVA.\n<\/p>\n \nIn addition, GC has dominant market share in British Columbia (\u201cBC\u201d). Gateway Casinos is GC\u2019s key competitor in both BC and Ontario. Gateway recently received a $200mm loan from the Canadian government6<\/sup>. While this loan may help Gateway bridge any potential liquidity issues, it also adds to Gateway\u2019s already-large debt burden. Therefore, GC could have the opportunity to: 1) capture market share from Gateway in both BC and Ontario and 2) purchase Gateway\u2019s assets at distressed prices if those come for sale.\n<\/p>\n \nLastly from a qualitative perspective, GC should benefit from the potential legalization of single-game sports betting and iGaming next year7<\/sup> given GC\u2019s significant market share and long-term government relationships. Score Media and Gaming estimates these markets could generate up to an additional $5.4b of GGR8<\/sup>.\n<\/p>\n \nFrom a quantitative perspective, Apollo\u2019s offer values GC for only ~8x 2019 EBITDA9<\/sup>. Importantly, GC\u2019s 2019 EBITDA includes little of the benefit that GC will derive from the ~$650mm of CapEx spent from 1Q19 to 3Q20. This CapEx was primarily spent on building the new Durham Live casino (which has not yet opened) and expanding existing Toronto-area casinos. From 2011 to 2017 (which was prior to GC being awarded the GTA and West GTA (\u201cWGTA\u201d) bundles), we estimate GC generated a pre-tax return on invested capital of ~25%10<\/sup>. Assuming GC produces a 25% pre-tax return on ~$650mm of CapEx and retains ~60% of profits11<\/sup>, this implies incremental EBITDA of ~$100mm. If accurate, Apollo\u2019s offer values GC for < 6.5x our estimated pro forma 2019 EBITDA<\/span>12<\/sup><\/b>. Meanwhile, US regional casino companies trade for an average of ~12.5x 2019 EBITDA13<\/sup>. We believe GC should trade at a premium to US regionals because of its monopoly in and growth potential from Toronto. Nonetheless, 12.5x our estimated pro forma 2019 EBITDA implies GC is worth > $85 per share<\/span><\/b>, significantly more than the $39 per share Apollo is offering.\n<\/p>\n \nStated differently, we estimate Apollo\u2019s offer values GC for only ~10x 2019 cash EPS14<\/sup>. Again assuming incremental EBITDA of $100mm as outlined above, this equates to an estimated pro forma 2019 cash EPS of ~$5.0015<\/sup>. This also implies Apollo\u2019s offer values GC for < 8x our estimated pro forma 2019 cash EPS<\/span><\/b>.\n<\/p>\n \nMore importantly, we forecast 2019 cash EPS will rise ~85% to ~$7.00 by 2022<\/span>16<\/sup><\/b>. As articulated above, we think GC can earn a 25% pre-tax return on its GTA\/WGTA CapEx. We estimate that GC plans to spend ~$1.7b from 2019 to 202217<\/sup>. If GC earns 25% on this CapEx, GC will have earned < 40% pre-tax return on its entire GTA\/WGTA investment18<\/sup>. For reference, we estimate GC earned > 40% pre-tax return on the East bundle19<\/sup>. Applying 20x to our estimated 2022 cash EPS of ~$7.00 implies GC could be worth ~$140 per share by 2022<\/span><\/b>. Our 2022 estimate could prove conservative because we do not include any benefit from share repurchases, iGaming legalization, sports betting legalization, or growth from 2019 in GC\u2019s remaining casinos.\n<\/p>\n \nSimplistically, we believe Apollo\u2019s offer undervalues GC because $39 per share is below the price where GC repurchased substantial stock. In 2018 and 2019, GC bought back ~$350mm of stock and paid up to $51 per share. Then in February 2020, GC announced a $500mm tender at up to $46 per share<\/span><\/b>. We think it is highly unlikely that COVID or any other factors have materially impacted GC\u2019s long-term earnings power. Supporting this notion, several US regional casinos grew 3Q20 EBITDA between 5% and 19% year-over-year20<\/sup>.\n<\/p>\n \nGC\u2019s \u201cShareholder Update\u201d presentation21<\/sup> appears to be an attempt to scare shareholders into accepting Apollo\u2019s lowball offer by conveniently now<\/i> claiming that costs in Toronto will rise faster than revenue and specifically pointing to the escalating revenue thresholds. We do not know the thresholds, but we know that: 1) GC\u2019s Board wanted GC to repurchase ~20% of its shares at up to $46 per share just this February indicating they thought GC was materially undervalued, 2) US casinos are quickly recovering from COVID implying the same will happen to GC\u2019s casinos, and 3) GC\u2019s GTA\/WGTA agreements were amended \u201cto compensate the Company for its services over the duration of the Pandemic and a period of subsequent ramp up of operations as the business returns to historical levels\u201d by providing \u201can additional variable component fee\u201d<\/span><\/b>22<\/sup>. In fact, GC receives this \u201cadditional\u201d compensation during the 50-guest maximum restriction plus<\/i> an additional three years.\n<\/p>\n \nDigging further into the thresholds, CEO Rod Baker stated on the 3Q18 earnings call: \u201cI am pleased to report that our current GGR run rate already exceeds our peak threshold level that will occur in 4 years from now\u201d<\/span><\/b>. We estimate GTA run-rate GGR was ~$1.3b in 3Q18 implying the 2022 GTA threshold is < $1.3b. As outlined above, we estimate GTA GGR would need to grow > 150% to be equivalent to GVA GGR on a per capita basis. If so, then this implies GTA GGR would need to rise to ~$3.3b. GC\/Brookfield receive a fixed fee of ~$75mm plus 70% of GGR above the threshold. Coupled with non-gaming revenue growing from 1% of GGR to our estimate of 20% and assuming 40% EBITDA margin, then this would lead to the GTA producing > $800mm of gross EBITDA23<\/sup>. That would equate to an even larger pre-tax return on capital than the 25% we had assumed above. Either way, we believe the thresholds will not be an issue and GC will rapidly increase profits in the GTA (and WGTA).\n<\/p>\n 2. We think GC\u2019s undisturbed share price could have been above Apollo\u2019s offer already.<\/b><\/p>\n \nGC\u2019s share price closed at $30.25 on August 12, 2020. Later that evening, GC reported +$32mm of Adjusted EBITDA and +$5mm of operating cash flow for 2Q20. These results were remarkably impressive given that all of GC\u2019s casinos were closed in 2Q20. GC\u2019s 2Q20 EBITDA easily beat consensus\u2019 expectations of NEGATIVE<\/b> $12mm and likely pleasantly surprised most shareholders. Yet, GC\u2019s CEO Rod Baker seemed to intentionally express a dire tone during the 2Q20 earnings call. In fact, he used the word \u201cchallenging\u201d on seven different occasions. In turn, GC\u2019s share price declined and never returned to its August 12th<\/sup> price until after announcing Apollo\u2019s offer. Meanwhile, share prices of US regional peers have increased by ~50% on average since August 12th<\/sup>. If GC\u2019s share price had risen 50% like the US regional casinos, then GC could currently be trading for ~$45 per share<\/span><\/b>.\n<\/p>\n 3. We are concerned by the troubling process that appears to have led to GC\u2019s Board agreeing to Apollo\u2019s offer<\/b>.\n<\/p>\n \nFirst, GC would effectively be selling \u201cat the bottom\u201d given depressed earnings this year yet recently renewed optimism about an earnings recovery in 2021+. Second, GC\u2019s Board seemed to rush the process with Apollo, as it took less than 11 weeks from Apollo\u2019s initial offer of $38-41 per share to signing a definitive merger agreement. Third and inexcusably, GC\u2019s Board did not conduct a sales process or seem to contact any other potential bidders after receiving Apollo\u2019s initial offer. Most specifically and during the 3Q20 earnings call, CEO Baker indicated that Brookfield was not contacted about submitting a bid. Given that Brookfield is GC\u2019s 50\/50 partner in the GTA, we would be surprised if Brookfield did not have an interest in acquiring GC. Instead of seeking to maximize shareholder value, GC\u2019s Board appears to have rushed to take the first offer on the table<\/span><\/b>.\n<\/p>\n 4. We believe GC\u2019s Board and senior management\u2019s interests are not aligned with shareholders. <\/b><\/p>\n \nEven when including DSUs gifted to them, GC\u2019s Board (excluding CEO Baker) have only a 0.3% economic interest in the Company. Far more troubling, GC\u2019s Board recently issued \u201clong-term\u201d cash incentive awards to CEO Baker and President Terrance Doyle of $6mm and $3mm<\/span><\/b>, respectively24<\/sup>. As if Baker and Doyle were not earning enough with their combined $26mm+ in change of control payments, they will now receive an additional $9mm combined. Given this, we could understand why GC\u2019s Board and senior management support Apollo\u2019s offer and the prospect of immediate payouts on what were supposed to be long-term incentives. Unfortunately, their personal gains appear to come at the expense of shareholders\u2019 best interest.\n<\/p>\n 5. We think the Management Information Circular lacked critical details to support Apollo\u2019s offer. <\/b><\/p>\n \nThis is the first merger proxy that we have seen that fails to include a forecast, trading comps, or transaction comps. We believe these details may have been intentionally omitted because their inclusion would highlight that Apollo\u2019s offer significantly undervalues GC. Further, a multiple of EBITDA is the casino industry\u2019s standard method of valuation. Yet bizarrely, even the word \u201cEBITDA\u201d was only referenced in the definitions section and to describe the decline in GC\u2019s EBITDA in 2020.\n<\/p>\n \nIn summary, we plan to vote \u201cAGAINST\u201d Apollo\u2019s offer of $39 per share and would likely vote against any offer that is not materially higher<\/span><\/b>for the reasons outlined above. We do not appear alone in opposing Apollo\u2019s offer. A ~14% shareholder said \u201cthis is a terrible and ridiculous deal\u201d during the 3Q20 earnings call. Another ~4% shareholder followed that comment by saying \u201cI think this transaction materially undervalues the Company, and we have no intention of voting for it\u201d. Several weeks later, news outlets reported that a ~10% shareholder submitted a private letter to GC\u2019s Board outlining its reasons to vote \u201cAGAINST\u201d Apollo\u2019s offer25<\/sup>. Lastly, an ~18% shareholder also reportedly plans to vote against Apollo\u2019s offer26<\/sup>. Based on our analysis above, we agree with the conclusions independently reached by these large shareholders.\n<\/p>\n \nWith sound execution and an improved macroeconomic backdrop, we believe GC could be worth ~$140 per share within two years. We are unlikely to vote \u201cFOR\u201d a transaction until GC\u2019s long-term intrinsic value is more accurately reflected in the price offered by Apollo or another potential suitor.\n<\/p>\n \nBest Regards, \n____________________________________________________\n<\/p>\n 1<\/sup> Sources: Aimia Reconstitutes Board<\/a>; Aimia Announces Transformation<\/a><\/p>\n 2<\/sup> All $ amounts displayed in CAD\n<\/p>\n 3<\/sup> Sources: Toronto Fastest Growing<\/a>; Toronto 3rd Largest<\/a><\/p>\n 4<\/sup> Source: BCLC 2019\/20 Report<\/a><\/p>\n \n~$1.9b 2019 Adjusted BC GGR = ~$1.8b Reported + $75mm impact of COVID (pg. 10 of BCLC report)\n<\/p>\n \n~$1.3b 2019 GVA Revenue = ~$1.9b 2019 Adjusted BC GGR x 70% (BIC estimate)\n<\/p>\n \n~$515 GGR per Capita = ~$1.3b 2019 GVA Revenue \/ ~2.6mm GVA population\n<\/p>\n 5<\/sup> ~$200 of GGR per Capita = ~$1.3b GTA GGR (BIC estimate) \/ ~6.2mm GTA population\n<\/p>\n 6<\/sup> Source: Gateway Loan<\/a><\/p>\n 7<\/sup> Source: Sports Betting & iGaming Legalization<\/a><\/p>\n 8<\/sup> Source: theScore Estimate<\/a><\/p>\n 9<\/sup> ~$350mm 2019 EBITDA = Reported Adjusted EBITDA \u2013 Lease Payments \u2013 Minority Interest EBITDA + estimated Minority Interest Lease Payments\n<\/p>\n \n~$2.8b Enterprise Value = $39 per share x 56.4mm shares + ~$640mm net debt (excludes an estimated 30% of Ontario Cash and 50% of GTA Debt because controlled by Brookfield)\n<\/p>\n 10<\/sup> ~25% PT Return 2011-2017 = ~$80mm growth in EBITDA \/ ~$310mm capital deployed (CapEx + acquisitions)\n<\/p>\n 11<\/sup> Brookfield Business Partners (\u201cBrookfield\u201d) retains 50% of GTA profits, so we estimate this implies Brookfield receives ~40% of GTA + WGTA profits.\n<\/p>\n 12<\/sup> ~$450mm Pro Forma EBITDA = ~$350mm 2019 EBITDA + ~$100mm Incremental EBITDA to GC\n<\/p>\n \n~6.2x Pro Forma EBITDA = ~$2.8b EV \/ ~$450mm\n<\/p>\n 13<\/sup> Tickers for US Regional Casinos: CHDN, CNTY, CZR, FLL, GDEN, MCRI, PENN, RRR\n<\/p>\n 14<\/sup> ~$3.80 2019 Cash EPS = (2019 EBITDA \u2013 Stock-Based Compensation \u2013 Cash Interest Expense (excluding Minority Interest portion) \u2013 Taxes \u2013 estimated Maintenance CapEx (3.2% of Revenue & excluding Minority Interest portion)) \/ 56.4mm diluted shares\n<\/p>\n 15<\/sup> $5.00 2019 Cash EPS = (~$100mm Incremental EBITDA x (1 \u2013 27% tax rate))\/56.4mm shares + 2019 cash EPS\n<\/p>\n 16<\/sup> ~$250mm Incremental EBITDA = ~$1.7b CapEx x 25% ROI x 60% (BIC estimate of GC\u2019s portion)\n<\/p>\n \n~$600mm 2022 EBITDA = ~$350mm 2019 EBITDA + ~$250mm Incremental EBITDA\n<\/p>\n \n~$7.00 Cash EPS = (~$600mm 2022 EBITDA – ~$60mm CapEx (10% of EBITDA) – ~$30mm Int Exp (CapEx funded w\/FCF) – ~$110m taxes (27% rate & ~$160mm D&A)) \/ 56.4mm shares\n<\/p>\n 17<\/sup> GC disclosed plans to spend: 1) $360mm of CapEx in WGTA in the 3Q18 MD&A and 2) $1.48b at GTA on pg. 74 of Merger Proxy<\/a>. We estimate GC spent ~$160mm of CapEx on GTA\/WGTA in 2018 implying $1.7b to spend from 2019-2022.\n<\/p>\n 18<\/sup> ~$2b Total Invested Capital = ~$90mm GTA purchase + ~$100mm WGTA purchase + estimated ~$160mm 2018 GTA\/WGTA + estimated $1.7b 2019-2022 GTA\/WGTA CapEx\n<\/p>\n \n~$760mm Gross GTA\/WGTA 2022 EBITDA = ~$340mm 2019 Gross GTA\/WGTA EBITDA (BIC estimate) + ~$420 incremental Gross GTA\/WGTA EBITDA (~25% x ~$1.7b)\n<\/p>\n \n~38% pre-tax return = ~$760mm Gross EBITDA \/ ~$2b Invested Capital\n<\/p>\n 19<\/sup> 42% PT Return on East Bundle = (~$40mm purchase price + ~$80mm CapEx) \/ ~$50mm 2019 EBITDA\n<\/p>\n 20<\/sup> 3Q20 EBITDA grew y\/y at CZR, GDEN, MCRI, PENN by 10%, 5%, 19%, and 10%, respectively\n<\/p>\n 21<\/sup> Source: GC’s Shareholder Update<\/a><\/p>\n 22<\/sup> Source: pg. 10 of 3Q20 MD&A<\/a><\/p>\n 23<\/sup> Non-Gaming Revenue was > 15% of GGR at River Rock in the GVA and we think the GTA should be higher because of the amenities being constructed around the GTA casinos. Ontario EBITDA margin was 45% in 2019.\n<\/p>\n 24<\/sup> Source: Pg. 52 of Merger Proxy<\/a><\/p>\n 25<\/sup> Source: 10% Shareholder Opposition<\/a><\/p>\n 26<\/sup> Source: 18% Shareholder Opposition<\/a><\/p>\n View source version on businesswire.com: <\/span>https:\/\/www.businesswire.com\/news\/home\/20201208006124\/en\/<\/a><\/span><\/p>\n \nBreach Inlet Capital, LP KEYWORDS:<\/b> United States North America Canada Texas<\/p>\n INDUSTRY KEYWORDS:<\/b> Other Professional Services Professional Services Finance<\/p>\n
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Chris Colvin, CFA
\n
Founder and Portfolio Manager
\n
Breach Inlet Capital, LP\n<\/p>\n<\/p>\n
\n
Chris Colvin, CFA
\n
Founder and Portfolio Manager
\n
info@breachinletcap.com<\/a><\/p>\n
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