Trump Bull's Rebuttal
by Dale Wettlaufer ([email protected])

Paul and I should get together to draft a resolution, stipulating our agreement on a number of issues:

Whereas we agree that the debt load of Trump Hotels & Casino Resorts is terrific in relation to its market capitalization and owners' equity, and

Whereas we agree that Trump's interest expense is huge in relation to its earnings before interest, taxes, depreciation, and amortization, and

Whereas we agree that depreciation is an economic expense that reflects to a considerable degree the necessity of cash outlays to maintain the corporation's ability to generate revenues, and is therefore mistakenly seen by some as a "return on capital" rather than the correct "return of capital," and

Whereas Trump Hotels & Casino Resorts faces increasing regional and local competitive pressures; now, therefore, be it

Resolved that it is hard to find a case to invest in this company.

I fully stipulate the above, Paul. What I won't agree to is being a bear on this company, which I hope I have demonstrated in my opening argument can be dangerous to one's financial health. There's just way too much leverage in the price of this company's equity in case Donald Trump does strike a deal to recapitalize, sell, or merge it with another company. As I said earlier, Donald Trump has ended up on top of too many sticky situations to believe that he'll just cave in to the difficulty of this situation.

I think one flaw in your argument is that you treat too much of the capital expenditures as maintenance capital expenditures, when in fact the 10-K shows that much of the company's cap ex programs have gone toward expansion and discretionary refurbishment and not just maintenance. I agree that there's little headroom above the company's debt service needs to spend aggressively on capital expenditures, but recent programs have put the company on a good footing as far as bricks and mortar go.

I also agree that there's lots of leverage in the operating model of a casino. Above a certain level, incremental revenues bring a good deal of cash to the operating income line. One good way to take advantage of this leverage is to reign in some of the company's general & administrative expenses. We're not talking about sales and promotional expenses here, we're talking about corporate overhead that isn't going to cannibalize the company's sales base. A 10% reduction in G&A expenses is equal to 11% of 1997 EBITDA, which would certainly not hurt the company's valuation.

In early February, the company announced that it had retained Donaldson, Lufkin & Jenrette to look into strategic alternatives. This doesn't sound like a company that is overjoyed at its current market valuation. Mario Gabelli, no dummy when it comes to business, either owns or directs funds that own nearly 10% of the company. I don't think that Gabelli, Conseco Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CNC)") else Response.Write("(NYSE: CNC)") end if %>, Oppenheimer, Dimensional Fund Advisors, and Donald Trump himself, all of which together own a controlling interest in the company, are going to sit around twiddling their thumbs while the company heads down the road toward bankruptcy.

A short position here gives you pretty paltry upside if the company does a deal below the industry-average EBITDA multiple around 8. Between 8 and 9 times EBITDA, you start to lose money on a short. At 9 times enterprise value-to-EBITDA, you're gone, and between 9 and 10 times, you're toast:

                   Results in Per-Share 
 EBITDA Multiple         Equity Value of 
    8                         $4.59 
    9                         11.10 
   10                         17.61 
   11                         24.12 
 

One could make the case that the principals here could take it under, but there's not too much upside for the shorts on that one either. I'm not sure that I would put myself in the position of losing $6.50 per share for every point of change in the EBITDA multiple that a motivated seller could wring out of this issue. In addition, there's room for other financial engineering moves such as making Trump into a management company and doing away with the physical elements of the casino business. Assuming that the balance sheet values of the company's plant, property, and equipment accurately reflect economic reality, a REIT could assume the company's real estate and improvements, clearing away most, if not all, of the company's net debt, and leave Trump in a position to generate earnings by managing the operations.

In sum, you're dealing with a master salesman, along with a master financial guy in Mario Gabelli, who can get a deal done at a multiple that could blow away the shorts in trump. Sorry if I don't pose the bull case in a classic bull/bear paradigm. I'm easy pickings for a person who knows so much about casinos, so I am altering the terms of engagement on this one. My personal reading on this, as a generalist, is that the risk/reward for the shorts here is terrible. While that doesn't make me a bull on this company's stock, I firmly resist the arguments of the bear camp on this one.

Next: The Bear Responds