When it comes to Kerzner International ( KZL), the Bahamas-based luxury resort and casino operator, hedge funds are game. A look at the stock's top 20 holders reveals the presence of four hedge funds, among them activist manager Pirate Capital, with 2% of the shares, according to Thomson One Analytics. Collectively, the four funds owned 7% of the shares as of Dec. 31. When hedge funds show an appetite for a particular stock, there's often a story. In the case of Kerzner, the catalyst is a belief the company is poised to win two Singapore casino licenses. "They're seen as the front-runner," says Lawrence Klatzkin, an analyst at Jefferies & Co. who has a buy rating on the stock with an $81 price target. The stock closed Wednesday at $69.35. Last year, the Singapore government decided to legalize gambling and invited interested parties to submit proposals for two licenses, one for the Marina Waterfront and the other on Sentosa Island. "This project would be extremely lucrative for Kerzner, considering the size of the market and the limited supply. We believe the company has a very strong chance at obtaining one of the licenses," worte Klatzkin in a research report. Apparently, hedge funds believe that too. "These are very big contracts. Hedge funds are speculating that Ketzner could get one of these," says Steven Kroll Jr., an analyst at Monness, Crespi, Hardt & Co. Kertzner is not alone in the race for the Singapore contracts. Two big competitors, MGM Mirage ( MGM) and Harrah's ( HET), are also involved, along with Las Vegas Sands ( LVS) and Genting from Malaysia. But Kroll says that Kerzner should benefit from its family-oriented business model. The company's major source of revenue is its flagship Atlantis, an upscale casino resort on Paradise Island in the Bahamas. It's very "focused on family," he says. Besides the casino, the Atlantis complex offers kids activities with 11 pools and a Marine Habitat filled with sharks and fish. This type of resort could be a good fit for Singapore. "Singapore does not want to be cheesy. They don't want a huge casino. They want activities for adults and children and, by the way, good gaming as well," says Kroll.
Ricky Sandler, managing member of hedge fund Eminence Capital, which owns a little bit more than 2% of the shares, also sees Kerzner as a front-runner in Singapore, saying it's one of the few companies to develop destination resorts combined with gambling. In addition, Kerzner, with its successful island resorts, would be a good match with the waterfront locations in Singapore, says Klatzkin. Finally, the company benefits from its partnership with CapitaLand, one of the largest listed property companies in Asia. Klatzkin says that CapitaLand has good relationships with the Singapore government, which should help. The plot thickens here, as MGM also has a partner with CapitaLand. But Klatzkin says that it's possible to envision that both companies may win since there are two contracts. The Singapore government is not expected to make a decision before September. Even without any new businesses in Singapore, Kerzner attracts hedge funds because of its healthy balance sheet and solid pipeline of projects. The company should be a strong earnings grower: it's currently expected to earn $2.59 a share this year, $3.32 a share next year and $4.05 in 2008, according to averages compiled by Thomson First Call. The relatively rich price-to-earnings ratio of 26.8 based on this year's estimate falls to 17.2 looking out two years. Bulls believe the potential for growth isn't reflected in the company's stock price, a situation hedge funds like to exploit. In 2005, the company held $116 million in cash and cash equivalents. "Cash has always been good. They generate a lot of cash out of their Paradise Island facility," says Kroll. In addition, "there is a lot of visible growth for a relatively small company," says Sandler. Kerzner has a $2.5 billion market capitalization and 36.5 million outstanding shares. The company has undertaken several projects worldwide that could raise earnings. In Dubai for instance, Kerzner began building a $1.5 billion resort expected to open late 2008. In Morocco, the company has entered a joint venture with two local partners for the operation and development of a resort casino. And by 2007, Kerzner will complete a $700 million expansion plan for its Paradise Island, adding a 600-room, all-suite hotel.
This pursuit of new international projects may be particularly timely with gaming gaining ground globally. "Gaming is becoming more socially acceptable. It is also a way for governments to raise money," says Sandler. There are no super casinos for now in the U.K., for instance, and there are talks of developing large gaming resorts in Thailand. In general, "hedge funds invest in a number of gaming names," says Bill Schmitt, an analyst a CIBC World Markets, because the sector is filled with headlines. Laws that introduce, ban, limit or reintroduce gambling create catalysts for hedge fund trades. The uncertainty around the inclusion of casinos in the New Jersey Smoke-Free Air Act -- which bans smoking in indoor places -- is a perfect example. The bill finally passed in January with a provision that exempts casinos, a plus for investors making bullish bets in Atlantic City-based casino companies. Executives at Pirate Capital, Glenhill Overseas Management and Hayground Cove Asset Management, all funds that invest in Kerzner, did not return calls. A spokeswoman at Kerzner declined to comment.