Donaco shareholders best markNovember 29th in their calendars. A...

Donaco shareholders best markNovember 29th in their calendars. A group of shareholders, led by former chiefoperating officer Gerald Nicholas Tan Eng Hoe, have requisitioned anextraordinary general meeting to roll the board on that day. It's an importantevent with serious consequences.

Here's why we think Donacoshareholders should vote AGAINST resolutions 9 through 20.

Star Vegas sours

Key Points

• Star Vegas profitability plunges

• Previous management trying to take over

• High-risk/high-return with small position size

  Donaco International is a SouthEast Asian gaming business founded by Tan Sri Lim Goh Tong, the late founderof Singapore's esteemed Genting Group. Tan Sri Lim Goh Tongconstructed theAristo International in Northern Vietnam in 2002, a five-star resort with 400rooms. His grandson Joey Lim then became CEO, spearheading Donaco's ASX listingin 2012 and the $527m acquisition of Star Vegas Casino in Cambodia in 2015, a385-room resort with 170 gaming tables and over 1,000 gaming machines.

  As part of the deal, Donacoacquired Star Vegas's buildings and entered a 55-year lease with Thaibusinessman Somboon Sukjaroenkraisri for the land. Somboon received 18% ofDonaco's shares as part of the purchase as well as a seat on Donaco'sboard.

  At its peak in 2017, Donacodelivered an operating profit (before depreciation and amortisation) of $65m.But then everything unravelled and Donaco languishes with a $74m marketcapitalisation today.

  Donaco alleges that Somboonbreached his non-compete clause when he began competing in a neighbouringproperty in 2017. The competition hurt Donaco's earnings - Star Vegas's EBITDA fellfrom $67m to $27m today - and the casino's carrying value suffered a $344mimpairment. This sparked the fiery legal battle that's still burning today.

  Donaco is seeking $350m ofdamages in the Singapore Arbitration court; however, a Cambodian court hasruled that Somboon is within his right to cancel Donaco's lease of Star Vegas.Everything hinges on the Singaporean arbitration, which is set to hand adecision later this year. Donaco could lose its biggest casino or receive anenormous legal settlement.

  The important vote

  Donaco maintains that its legalcase in Singapore is strong. A $500m acquisition normally receives extensivelegal attention to protect against any and every eventuality, and Singaporealso has a good reputation for upholding the law. But Donaco shareholders havelearned to not be surprised by anything.

Table 1: Bear case
	EBITDA	Multiple	Value
Star Vegas	0	6	0
Aristo	18	6	108
Corporate costs	-8	6	-48
Enterprise value			60
less net debt			-8.6
less outstanding vendor payment			-19
Equity value			32.4
Shares			823.6
Per share value			$0.04
All millions except per share value
Source: Company reports, analyst estimates

Perhaps the best indicationthat Donaco's legal claim has merit is Somboon's response - he's gone toconsiderable lengths to absolve himself of any liability. On the surface, theupcoming AGM looks to be a case of a disgruntled ex-employee out for revenge andvindication. But as described in the Notice ofMeeting for AGM: 'There is evidence that Mr Tan is abusiness associate of Somboon Sukjaroenkraisri, the Thai vendor of the StarVegas business'.

Mr Tan has proposed the removalof Donaco's five existing directors and that they be replaced by himself andfour other directors of the requisitioner's choosing. It's possible that Mr Tanis acting on behalf of Somboon, with the intention of cancelling theSingaporean arbitration to remove Somboon's potential legal liability. Ifthat's the case, Donaco shareholders would be significantly worse off by votingin Mr Tan and his mates. Given the risk, the best course of action is to vote AGAINSTresolutions 9 through 20 at the upcoming AGM.

There's always the chance thatMr Tan isn't acting on behalf of Somboon, of course. But it still seems sillyto vote him in anyway. The last thing Donaco needs right now is more boardinstability, and given the chaos and wealth destruction he presided over aschief operating officer between 2017 - 2019, I struggle to see how he's abetter fit.

The art of portfolio management

You may be wondering why we'rewasting our time with a risky tiddler like Donaco? The answer is because itoffers a highly asymmetric payoff.

Table 2: Bull case
	EBITDA	Multiple	Value
Star Vegas	50	8	400
Aristo	18	8	144
Corp costs	-8	8	-64
Enterprise value			480
less net debt			-8.6
less outstanding vendor payment			0
Equity value			471.4
Shares			675.4
Per share value			$0.70
All millions except per share value
Source: Company reports, analyst estimates

Starting with the bear case, ifwe assume Donaco loses the Singapore arbitration and its Cambodian casino, allthat will remain is the Aristo International in Northern Vietnam. It's likelythat this casino is worth north of $100m, with FY2020 EBITDA on track for $18mor so. The Aristo has decent prospects as the Vietnamese Government is aminority owner and the casino is an important employer in the region.

We arrive at a bear casevaluation of four cents a share after netting off Donaco's net debt and theStar Vegas lease payment it has withheld from the vendor whilst legal action ispending.

It doesn't take J.K Rowling'simagination to outline Donaco's bull case, which hinges on Donaco winning itsSingaporean arbitration and retaining Star Vegas. Collecting an arbitrationaward from Somboon will be difficult, so we're only assuming Donaco cancels his18% holding of Donaco shares and foregoes the outstanding lease payment, but weacknowledge Donaco could receive more than that. The bull case assumes thatStar Vegas' profitability improves but remains well below prior levels.

This presents a payoffstructure of around -70% to 700% at current prices. Most investors shy awayfrom situations like this due to the prospect of a large loss, but astuteinvestors know this can be managed by limiting the position's size. Forinstance, a 1% position in Donaco has the same portfolio impact as a 10%position in a business that offers a -7% to 70% return.

Donaco isn't for the faint ofheart and if previous management gets enough votes, the consequences could beserious. If you're already a Donaco shareholder, it's time to speak up. Westrongly recommend you vote AGAINST resolutions 9 through 20 atthe upcoming AGM.