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Good morning, ladies and gentlemen, and welcome to the Churchill Downs Incorporated 2021 Fourth Quarter and Year-End Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Nick Zangari, Vice President of Treasury, Investor Relationships and Risk Management.
Thank you, Franzy. Good morning, and welcome to our fourth quarter and year-end 2021 earnings conference call. After the company's prepared remarks, we will open the call for your questions. The company's 2021 fourth quarter and year-end business results were released yesterday afternoon. A copy of this release announcing results and other financial and statistical information about the period to be presented in this conference call, including information required by Regulation G, is available at the section of the company's website titled News, located at churchilldownsincorporated.com as well as in the website's Investors section. Before we get started, I would like to remind you that some of the statements that we make today may include forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC, specifically the most recent report on Form 10-K. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and Form 10-K are available on our website at churchilldownsincorporated.com. And now I'll turn the call over to our Chief Executive Officer, Mr. Bill Carstanjen.
Thanks, Nick. Good morning, everyone. With me today are several members of our team, including Bill Mudd, our President and Chief Operating Officer; Marcia Dall, our Chief Financial Officer; and Brad Blackwell, our General Counsel. We have a lot to cover today. I will briefly share some high-level thoughts on our 2021 results and then provide updates on a number of strategic topics. Marcia will then walk through our results in more detail and provide an update on our capital management strategy, which is especially important in light of the announcement on Tuesday of our acquisition of substantially all of the assets of Peninsula Pacific Entertainment, which is also known as P2E. After she finishes, we will take your questions. So first, some high-level thoughts on our 2021 results. We delivered record net revenue of nearly $1.6 billion and record adjusted EBITDA of $627 million in 2021 despite running the 147th Kentucky Derby with significant limitations on attendance and despite continued COVID-related restrictions at our HRM and gaming properties during the year. Our net revenue increased by over $0.5 billion and adjusted EBITDA increased by $340 million compared to 2020. This growth was driven by Derby Week, our HRM expansion in Kentucky, and our regional gaming businesses. The return of Derby Week to its normal first Saturday in May, along with limited spectators, provided a nice increase over 2020 when we conducted the event without fans. We also saw continued growth from Derby City Gaming and the benefit of the first full year of operations for our Oak Grove HRM facility in Kentucky. We expect to build on the positive momentum of our Kentucky operations in 2022, particularly with respect to the Derby, which will return to full force as I will discuss in more detail in a few minutes. Adjusted EBITDA from our TwinSpires Horse Racing business was down slightly compared to the prior year as people return to racetracks and other brick-and-mortar facilities to wager in person. It is important to note that nearly 54% of all wagers on U.S. Thoroughbred racing in 2021 were placed online, which is still up significantly from 2019 when approximately 40% of all wagers were online. We expect to see online wagering on horse racing level out and stabilize at around 50% in 2022 based on the trends that we saw in the second half of 2021. Still a nice growth story compared to 2019, and this business continues to show organic growth after adjusting for the disruption caused by the COVID pandemic. We believe we will continue to pick up share in 2022 in the online segment in an industry that flat to modestly up. Our Sports and Casino business performed largely in line with what we expected in 2021 and the very challenging market conditions as we developed and launched online in retail sports books and online casino operations in various states. I will share more regarding our go-forward strategy in this space in a few minutes. We are going to make some changes and drive bottom line improvements across the segment in 2022. All of our regional gaming properties grew adjusted EBITDA in 2021 compared to 2020 and compared to 2019 with our wholly owned casino margins up nearly 11 points compared to 2020 and up nearly 8 points compared to 2019. As we look to 2022, we do see modest pressure on margins from inflation with respect to labor and other direct costs. We will work to offset these where we can. Again, it appears to be a modest impact right now, and we believe there is quite a bit of growth in this segment in 2022. Overall, we are very pleased with the results that our team has delivered in 2021, and we believe we are very well positioned to continue to grow in 2022. Now updates on 5 areas of strategic focus for our team. First, our major organic investments; second, our go forward to inspire sports and online casino strategy. Third, our Calder and Arlington land sales. Fourth, our recent announcement related to the P2E acquisition. And fifth and last, our plans for the 148th running of the Kentucky Derby this May. First, an update on our major organic growth projects. Starting with the multiyear projects at Churchill Downs Racetrack. As a reminder, the first project is the Homestretch Club, which is on schedule to be operational for the Kentucky Derby. The Homestretch Club includes 3,250 premium seats that will provide a variety of high-end experiences. As of today, all of the lounges and dining tables have been sold as has 2/3 of the stadium seats. We anticipate that the Homestretch Club will be completely sold out by early April, which is a great accomplishment by our team. We have also begun the work on the Turn 1 project, which will add a significant amount of premium covered seating overlooking the first turn as well as an indoor dining space. This new area will replace a lower-end large temporary seating area. Work on this project will accelerate after Derby Week and will be ready for Derby next year in 2023. The designs for the Paddock project are also well underway. And this project will be completed for the 150th Derby in 2024. We will provide a more fulsome update on our July earnings call and expect that this project will be a spectacular addition to our facility. Switching to our historical racing operations in Kentucky. Over the past 3 years, we have made significant progress in building out our venues across the Commonwealth. Let's begin with Derby City Gaming. As we previously announced, we are expanding the facility to hold up to 450 additional HRMs and to add a 123-room hotel. We are also adding some additional dining and entertainment options for our guests. We anticipate opening the gaming floor expansion by the end of 2022 and the hotel in the second quarter of 2023, most likely not quite in time for the Kentucky Derby. Regarding our prior announcement to build a new HRM facility in downtown Louisville, we have executed an agreement to buy a great building on the corner of West Market Street and South Fort Street in the heart of Downtown that is an ideal location for this facility given its proximity to the convention center and other downtown Louisville attractions. We have designed a new facility to build upon our Derby theme and to attract locals as well as tourists. We anticipate opening in the second quarter of 2023. Turning to Turfway Park. We continue to make great progress building a new HRM facility. As a reminder, we plan to open with 850 HRMs and the ability to expand within the existing footprint to 1,200 as soon as demand ramps up. We are building a sports bar, a VIP gaming area, a lounge, simulcast room and a club house that will double as an event center that can accommodate large events. We've had some supply chain delays related to roofing insulation and electrical materials and are now targeting a September 1 grand opening for the facility. The team has managed inflation and supply chain issues very well, but we had to accept some plays with respect to the materials I just mentioned. We are close to the finish line on this one, on budget, and we are thrilled to offer this exciting entertainment venue for Northern Kentucky and the Tri-State area around Cincinnati. Let's spend a minute on our HRMs and our OTBs in Louisiana. Our team has been aggressively working to expand our OTBs in order to offer HRMs. We will be adding a total of approximately 600 machines across 14 of our OTBs. We plan to have approximately 220 HRMs operational in 6 OTBs by the end of second quarter, 200 HRMs operational and 4 additional OTBs by the end of third quarter and the final 180 HRMs operational and the remaining 4 OTBs by the end of the fourth quarter. We will have a mix of game titles from all of our HRM manufacturers, including Aristocrat and Konami as well as the popular IGT Wheel of Fortune game. Next, regarding our Terra Haute project in Indiana. We were successful in winning the casino license for Vigo County and plan to build a destination casino resort called the Queen of Terra Haute. Our team competed in a head-to-head public competition against 3 other bidders in an all-day event in November. We were officially awarded the license on January 6 of this year. We have purchased a 50-acre parcel of land off Interstate 70 at the State Road 46 exit on the far east side of Terra Haute to get us as close to the western portion of the Indianapolis metropolitan area as possible. We are in the process of obtaining all of the permits and approvals required and finalizing the designs for the property. We are planning to start construction in late May with the target grand opening in late 2023. This will be a $240 million to $260 million project. Regarding Rivers Des Plaines Casino. As a reminder, Rivers is expanding its facility between the existing casino building and the parking garage on the north side of the property. The expansion will accommodate approximately 725 additional gaming positions based on a combination of new slot games and table games, resulting in the facility utilizing its full 2,000 positions permitted under current law. The first phase of our gaming expansion opened on January 24 of this year. We added approximately 200 slot machines and 24 table games. The second phase of the expansion is on track to open on April 7. It will add approximately 300 slot machines, a new 22-table poker room and a new casino bar. We expect the third and final phase will open in early May. It will include a new 10,000 square foot ballroom and an additional new space for private events and live entertainment. This is an exciting project for Rivers, and we believe a very efficient deployment of growth capital that is solely funded from cash flow and additional debt financing at the Rivers entity level. Now let's talk about our sports and online casino business. We are always committed to building long-term value for our shareholders and consistent with this commitment when we see that an investment is not progressing as we had planned, we will redeploy the resources and capital to other growth projects or return the capital to our shareholders. We have proven with our past decisions that we are willing to walk away from businesses where we do not see a secure enough path to consistent profitable growth with an acceptable return for our shareholders. When the U.S. Supreme Court overturned the federal ban on sports betting in May of 2018, we had high hopes for the potential to build a profitable business in this space. Our initial strategy was to leverage a variable cost technology model and be disciplined in our marketing spend with a focus on bottom line profitability as states legalized online sports wagering and iGaming. We have profitable retail sports books in 4 of our casinos. However, the online sports betting and online casino space is highly competitive with an ever-increasing number of participants that the states have licensed. Many are pursuing maximum market share in every state with limited regard for short-term or potentially even long-term profitability. Because we do not see for us a path in which this business model delivers predictable and acceptable margins for at least several years, if ever, we have decided to exit the B2C online sports betting and iGaming space over the next 6 months. We will focus on our retail sports betting operations where we are profitable, and we will seek to monetize where appropriate our market access rights to other participants. We consistently receive interest from other industry parties with respect to market access in states where we conduct operations or have the rights to do so. We do expect to still have a slight drag in the high single-digit range for the year on our adjusted EBITDA from the combined retail and online sports and casino businesses as we wind down the online business. We will work to minimize as much of this drag as we can. This isn't the result we wanted when we started this business back in late 2018, but it is the prudent next step forward for our company. We remain absolutely committed and excited about TwinSpires Horse Racing as its top line, bottom line and margins continue to demonstrate that this is a special online business with a sustainable, scalable and unique business model that delivers profitable growth today just as it has since we started the business well over a decade ago. Next, I'll discuss our process to sell the excess land at Calder and our Arlington Park property. We previously announced our agreement to sell 116 acres next to our Calder Casino for $291 million to Link Logistics. We are progressing through all of the closing conditions and obtaining rezoning requirements needed by the purchaser of the property. We anticipate closing the sale in the second quarter of this year. We intend to minimize the tax consequences related to the gain on the sale through the use of a 1031 exchange. We have retained approximately 38 acres of land that the Calder Casino utilizes for its facility and parking for its guests. We have also retained an additional 17 acres of land that is along Northwest 27th Avenue that is not necessary for the Calder Casino long term and that may be redeveloped or sold in the future. We also previously announced we had entered into an agreement to sell the Arlington Park property to the Chicago Bears for $197 million. The Arlington Park facility is a 326-acre property in Arlington Heights, Illinois. Pending receipt of remaining approvals, the transaction is anticipated to close in the first half of 2023. Similar to the Calder land sale process, we intend to minimize the tax consequences related to the gain on the sale to the use of a 1031 exchange. Now I'd like to discuss the announcement that we made Tuesday regarding our agreement to acquire substantially all of the assets of P2E. As you saw in the press release, we have agreed to pay close to $2.5 billion for Colonial Downs Racetrack and its existing 6 historical racing entertainment venues in Virginia, the del Lago Resort & Casino in Waterloo, New York and the operations of the Hard Rock Hotel and Casino in Sioux City, Iowa. With our acquisition of Colonial Downs comes to development rights to build up to 5 additional historical racing entertainment venues in Virginia with collectively up to approximately 2,300 additional HRMs. In total, this transaction includes up to 11 HRM venues and up to 5,000 HRM machines. We are acquiring the rights to several active development projects, including the construction of a large gaming resort with up to 1,800 HRMs in Northern Virginia, which we call the Dumfries Project as well as a new HRM venue in Emporia, Virginia near the North Carolina border. In addition to an entirely separate from these HRM projects, we are also very excited to acquire the rights to P2E's ongoing efforts in partnership with Urban One to win the right to develop 1 casino and resort a proposed Class III casino in Richmond, Virginia. We believe in the potential of this project and look forward to jumping in. We included the details for each of these properties in our press release earlier this week, so I won't repeat it all today. We are particularly excited about the opportunity to significantly expand the HRM footprint in Virginia. P2E has a unique set of HRM assets that they have developed and managed that is tied to the ownership and operation of Colonial Downs Racetrack all very much in our wheelhouse. We plan to strategically grow and expand their existing properties and also complete the development of the Dumfries Project and the gaming venue in Emporia as well as other projects yet to be far enough along to warrant discussion today. We will work to build upon and improve the strong HRM foundation that the P2E team has built using lessons learned from our successful HRM development in Kentucky, including opportunities to improve the quality of HRM titles and features available to patrons. We are also very excited about Hard Rock, Sioux City and del Lago Resort & Casino. We believe the Iowa and New York properties are excellent facilities with strong teams and states we really wanted to be in. We think we can show stable incremental improvements in operating performance and look forward to being a good partner in these communities. Both of these are outstanding properties and opportunities for our company. Overall, we believe this is a very unique set of assets that expands our geographic footprint and provide significant additional scale to our company in the coming years at a very attractive multiple. We are also thrilled to have the operating teams in all 3 jurisdictions join the Churchill team. We expect to close the transaction by the end of 2022, subject to necessary approvals. And it is our reasonable expectation that we will be able to defer the tax on the game from the sale of the Calder land in connection with the closing of the P2E transaction. Our final topic is the preparations for the 148th Kentucky Derby which will be run on May 7. We are returning to full capacity and will deliver an amazing experience for everyone. Our traditional Derby Week events will be back for the first time since 2019, including our opening night celebration. In addition, most, if not all, the various celebrations and parties that raise money for numerous charities and community organizations in the month-long lead up to the Kentucky Derby will return this year. If you haven't bought your tickets yet, you better do so soon, the demand is incredibly strong with very few options remaining for tickets. This year's Derby Week is shaping up to be truly special with all the magic and the steek that may have been missing a bit in the last couple of years. In summary, 2021 was a tremendous year for our company with record financial results, both for net revenue as well as for adjusted EBITDA. We are positioned for ongoing growth in the coming years from the organic investments that we are making in our iconic asset, the Kentucky Derby, our HRM assets in Kentucky, our HRM expansion in Louisiana and our Terra Haute project in Indiana. And now we will look forward to adding the assets of P2E to our growing portfolio of entertainment and gaming facilities. We are grateful to all of our leaders and team members who have helped to deliver our results to date are helping to build our business to create the best possible total shareholder return for our investors over the long term. And finally, I would like to recognize the passing of Richard Duchossois, who we affectionally called Mr. D, on January 28 of this year, Mr. D was a long-term shareholder and prior long-time Board member, who was also a tireless champion of our company and Thoroughbred racing. He had an extraordinary life and it was a mentor and a friend to so many of us at Churchill Downs. We will miss his grace, wisdom and humor. With that, I'll turn the call over to Marcia, and then we will take your questions. Marcia?
Thanks, Bill, and good morning, everyone. It has been an exciting and very busy week for everyone. I'll start with a few thoughts on our 2021 results and provide an update on our capital management. Then I'll provide some additional insights regarding the P2E acquisition. As Bill shared, we just finished a record 7 year with record revenue and record adjusted EBITDA. As I reflected on 2021, there are a few takeaways that I want to share with you. First, it was great to return to running the Kentucky Derby at its normal time on the first Saturday in May and with spectators, albeit more limited than we typically would have. Our team at Churchill Downs Racetrack used this past year to test a new all-inclusive concept that was ultimately very well received by our guests and significantly enhanced the experience for everyone who attended the events. We're all looking forward to having everyone back to celebrate this year's running of the 148th Kentucky Derby in early May. We intend to sell all of our reserve seating with the all-inclusive concept and expect sponsorships and wagering to return to historical levels. We expect to see significant growth in adjusted EBITDA from the Derby compared to 2021 when we had more limited attendance. Second, organic growth from our HRM facilities in Kentucky contributed $83 million of adjusted EBITDA growth in 2021 compared to the prior year. Our HRM properties, our unique assets that our team has been able to efficiently build and design to collectively generate margins that are more than 10 points higher than margins for regional casinos. As important, the success of these HRM facilities generated more than $31 million of purse money in 2021 for our Kentucky racetracks and provided nearly 700 new permanent jobs for our state. In aggregate, our adjusted EBITDA from HRM facilities accelerated every quarter in 2021 as we continue to build our customer databases and expand market awareness. Third, although our 2021 adjusted EBITDA was down slightly for our TwinSpires Horse Racing business compared to the prior year, it was still the second highest level adjusted EBITDA ever for this business. COVID cost had technology paradigm shift in 2020 as the closure of brick-and-mortar betting facilities shifted wagering on horse racing to online. Although there has been some erosion as brick-and-mortar facilities reopened, there has been a fundamental material increase in the percent of wagering on horse racing that occurs online compared to a few years ago. This will continue to benefit our TwinSpires Horse Racing business going forward. And last, we generated a significant amount of free cash flow in 2021, nearly $420 million which was up $300 million over 2020 and $176 million over 2019. As our new properties opened in 2022 and beyond, we expect to continue to see a very significant growth and free cash flow from all of our businesses. Turning to capital management. In 2021, we spent approximately $40 million on maintenance capital for capitalized labor-related improvements to our TwinSpires Horse Racing technology platform, the new turf course at Churchill Downs Racetrack and maintenance at our gaming properties. For 2022, we expect to spend $60 million to $70 million on maintenance capital. We plan to allocate more maintenance capital towards refreshing our slot capital and hotel facilities at our regional casino properties. We also have some hurricane Ida related projects planned in Louisiana that we expect to eventually recover through insurance. Regarding project Capital, in 2021, we spent $52 million on project Capital of which the majority was spent at Turfway Park and Churchill Downs Racetrack as well as on completing the Oak Grove facility. For 2022, we anticipate spending $300 million to $350 million on project Capital. We will be completing Turfway Park as well as the Homestretch Club at Churchill Downs Racetrack. We will also begin to make significant investments in the other projects that Bill discussed. As you know, we believe in returning capital to our shareholders in the form of dividends and share repurchases. We announced our 11th consecutive year of dividend increases with a 7% increase in our annual dividend that we paid in January of this year. In aggregate, we also repurchased 1,471,000 shares in 2021 at an average share price of $202 per share. At the end of December 2021, our bank net leverage was 3.2x and our external net leverage was 2.7x. Our leverage has continued to decline because of our strong operating results across all of our segments in 2021. Regarding the P2E acquisition, there are a couple of items that I would like to clarify further. First, regarding the purchase price multiple, we will be acquiring substantially all of the assets of P2E as well as certain development rights for multiple of less than 9x adjusted EBITDA. As we thought about how to best communicate the multiple for this transaction, we started with the 2021 adjusted EBITDA of the existing assets that we were acquiring. We increased our 2021 adjusted EBITDA for the reduction in corporate overhead that upon closing will no longer be needed. And we also made run rate adjustments to the adjusted EBITDA for 2 of the Rosie's properties in Virginia, the [indiscernible] expansion, and the Dumfries facility that opened in 2021 that are both still ramping to full operating capacity. The effective purchase price multiple would be 10.2x based on these adjustments. We then reflected $600 million to $800 million of additional investment and the related projected EBITDA for the other development rights that we acquired to determine the ultimate transaction multiple of less than 9x. These development rights include the rights to expand the Dumfries facility into a large gaming resort with an incremental 1,650 HRMs in Northern Virginia. These rights also include the development of Rosie's Gaming Emporium in Emporia with an additional 150 HRMs as well as the rights to add a little over 500 HRMs in other locations in Virginia. It is important to note that the economics of the transaction will be further enhanced as a result of the acquisition being treated as an asset purchase for tax purposes. This is what allows us to step up the asset value and deduct the goodwill for tax purposes, thereby enabling us to realize incremental tax benefits over the next 15 years which will provide additional cash flow to the company and enhance the overall economics of the transaction. We are also structuring aspects of the acquisition to qualify as a 1031 transaction,so that we can defer the tax on the gain on sale of a land near Calder Casino. This will further enhance the overall economics of the transaction. This acquisition is immediately accretive to free cash flow and diluted earnings per share. Second, we are often asked how we will find strategic assets that we want to acquire and how we will win those assets given the competitive environment. This transaction is a true testament to the benefits of long-term relationships that exist at many levels between our team and leaders in the industry to get this deal done. Our willingness to be flexible to accommodate the seller's desire to do an OpCo PropCo transaction related to the Iowa asset as well as to accommodate facilitating the solid redemption of their debt resulting in financial savings that will ultimately accrue to the seller, truly differentiated our company as we work through the negotiation of this transaction. Third, would you plan on using cash on hand, cash from the sale of the land near Calder Casino and issuing new debt to finance this transaction. We are projecting that our pro forma bank covenant leverage will be less than 4.2x upon completion of this transaction. Our bank covenant leverages were projected to quickly decline below 4x in the quarters following the closing of the transaction. And last, 2022 is shaping up to be a great year prior to the addition of the P2E assets. We are expecting double-digit adjusted EBITDA growth and double-digit free cash flow growth in 2022. The growth in 2022 is expected to be driven by the Derby, as I discussed a few minutes ago, the continued expansion of our HRM assets, including the opening of Turfway Park, the exiting of the online Sports and Casino business, which will eliminate more than a $30 million loss from a run rate adjusted EBITDA and the growth in our regional casino assets. The addition of the P2E assets significantly expands our geographic footprint for HRMs and increases the scale of our business substantially. We believe the P2E assets and the development rights that we will acquire as part of the acquisition, coupled with the balance of the organic growth projects that Bill discussed will continue to accelerate the growth trajectory of our company for many years to come. Upon completion of this acquisition and the development projects that we've announced, we will own or manage one of the most desired collections of entertainment assets in the market. These assets will include the iconic Churchill Downs Racetrack along with 12 HRM properties and 13 regional gaming properties as well as one of the industry-leading horse racing wagering platforms in TwinSpires. These assets will generate significant free cash flow with one of the strongest balance sheets in the industry. Our diversification across our 3 segments will enable us to create long-term shareholder value in the years to come. With that, I'll turn the call back over to Bill, so that he can open the call for questions. Bill?
Thank you, Marcia. If anybody has any questions out there, we're happy to take them at this point.
[Operator Instructions]. We have a question coming from the line of David Katz from Jefferies.
Bill, I wanted to ask about the digital commentary. We've obviously all debated this with you and discussed it with you over the past couple of years. And given Marcia's laying out just of the scale and scope of what you have as a land-based operator, I just wonder how you see the value in that to the digital marketplace? It is happening. It is granted expensive, but is there some value in there to capture? Is it just selling off market access rights? Or is there something larger in there for you to capture value from over time?
Sure. Thanks David. It's good to chat with you again. So when it comes to the digital space, I think it's hard to write the future at this time. We'll have to watch what states do, what tax rates are, what competition is. But ultimately, we're here to make money. That's the task that we're assigned to by our shareholders. So right now, it doesn't look good. In the future, we'll have to see how it develops. But where we see the opportunity for our company right now is TwinSpires Horse Racing. I'm not a person that likes to stay theoretical for very long. Ultimately, you put your team on the field, and you see what your results are and you adjust to that. And what we have found over time, and it's been well over a decade, is that our TwinSpires Horse Racing business, our online business for horse racing is an excellent business. And even in this current environment is holding up extremely well. And it's just as promising as it's been over the -- more than a decade since we first started it. So we'll focus on what we see as working. We'll watch everything else. We'll monetize our market access, and we'll keep our eyes open and our ears appealed. So I feel really good about this decision, although I wish it could have been different, but gambling ultimately is a margin-driven business, and you have to set up your teams and you have to set up your processes to guarantee that you can drive margins. We can do that with TwinSpires Horse Racing, but we just don't see that for us in the broader online segment. So we'll keep watching that business over time. We'll watch the others that are in it. And we'll see where the future takes that space.
Okay. I appreciate that. And if I may follow up quickly. Just Marcia, on the details that you've laid out, irrespective of how the bank will calculate it, where is actual leverage? Where do you actually expect that to peak, is that somewhere in the mid-4s?
David, what I said is that for bank leverage, we expect it to be -- which is how we think about it is that it will be less than 4.2x. And so that's really what we're looking at as we think about how the [Technical Difficulty] and what really matters as we look at going to market to raise the debt and what we think is the metric that we should be concerned with. And then it will very quickly drop below 4x.
Your next question comes from the line of Dan Politzer from Wells Fargo.
So I wanted to follow up on the capital allocation. I think you guys have talked about target leverage in a 3 to 4x range. Here, I think you're going to be at the upper end of that. And I guess, how are you thinking about that relative to buying back stock? And along with that, certainly with the passing of Mr. D and maybe some changes in his state planning, and you've historically been a buyer of his shares. Like how should we think about all these kind of moving factors as it relates to your capital allocation?
Dan, I believe we still have tremendous capacity to be able to either acquire things that are strategic for our company or to buy back stock should those opportunities arise in the future. So clearly, we have repurchased shares throughout 2021. And we, depending on the stock price, are very strategic in our repurchasing of our shares in the marketplace and obviously have made very strategic block repurchases in the past, and we will continue to be able to do that going forward. As I just mentioned, with the answer to David's question, our leverage from a bank covenant perspective will drop very quickly below 4x. As you know, we have the Arlington land sale that will be completed in the first half of 2023 as well. So our businesses collectively generate a significant amount of free cash flows, and we can use that and when you think about free cash flow to equity, we can use that for either dividends or share repurchases. And so we have a lot of opportunity for different options.
Got it. And then just turning to TwinSpires. Bill, I know you mentioned you guys are here to make money for shareholders and certainly have been opportunistic in the past. Can you talk a little bit about the rationale maybe for exploring a sale there? Is it -- what -- was this a function of maybe some evolving changes in the competitive environment? Was it just being opportunistic? Can you just maybe touch on that topic?
Well, for us, it's really our own journey. So it wasn't a function of what other people are doing in the market or other people's stories or views of how the future would be. So it was really important to us to make sure that we maintain the skill sets that we need to maximize TwinSpires. And there's always a number of different ways you can look at any circumstance. But for us, we really wanted to make sure we kept the folks that -- and the team that has worked so well together and they've been built so carefully over time to perform because we do see TwinSpires Horse Racing as a continuing growth story for our company. So the best path for us is the path we've chosen, and we do have these assets, the market access that might be attractive, appear to be attractive to other people, and we'll see where that takes us. But ultimately, this wasn't a circumstance where we want to be out of the digital business. We needed to step away from Sports and iCasino, but there's a piece of this segment that we think we're really good at and we want to make sure that we can continue to compete in.
We have a question coming from the line of Shaun Kelley from Churchill Downs.
I'm pretty sure I work at Bank of America still. But Bill, I wanted to go back to the online piece and maybe just continue on TwinSpires for a moment. Does exiting the B2C or the D2C, however you want to call it, online piece, at least period of time here, does this open you up to any sort of broader partnerships with other brands that are continuing the journey on, let's call it, sports betting and the online casino side? And the reason I'm asking is because you seem to have like a unique customer acquisition tool, I think one that you yourself have highlighted through TwinSpires. And is this a channel that you could now open up to another partner that would probably have some value there that you could unlock some other way if it's not through direct operation of those platforms yourself?
Thanks for the question, Shaun. And for everybody, I just want to clarify, Shaun does not work for Churchill Downs. He works for Bank of America. So we're not planting questions to be asked. So that's a really forward-looking question, Shaun. And I think it's an interesting one, and I think it's a logical one and an obvious one. But I can't really explore it in any kind of detail in this forum because it's very future-focused. So certainly, there's probably some possibilities there. So I want to acknowledge that it's an interesting topic and it's an interesting thing to talk about, but it's not one that we can comfortably do so at this time given the restrictions around these sorts of phone calls. So I'm happy to take another question where I hope I can give you a more satisfying answer. But on that one, I'd probably just go with a simple answer of yes, potentially, but I couldn't go any further than that.
Understood. Maybe a little bit premature there. So second one then would be, you both -- I think you and Marcia both referenced a strong outlook for the Derby. I'm just hoping you could help us bridge a little bit of that outlook as we think about what levels of cash flow or EBITDA you're able to generate back in 2019? Are there any components of the Derby that you look back at that and say, we're not going to have these pieces online? Do you think that is a good baseline? Or do you think that's something we could even improve upon given both capital invested, yield management and frankly, some of the pricing environment that we've seen in other areas of leisure and entertainment?
Yes. Good question. We're looking to improve on 2019. And I would answer as simple as that. 2019 is a nice metric, a nice baseline to look at, but our team is motivated and focused on improving on that.
Your next question comes from the line of Joe Stauff from Susquehanna.
So maybe two questions, say, on the existing business and then one on P2E, if I could. So first question really is on your regional gaming margin outlook. As you referred to, Bill, in your commentary, there will be some natural margin contraction from all the inflationary factors. I'm wondering if you can maybe provide an update on kind of where the promotional environment is in your respective markets and how that might evolve here over the next year in possibly affecting margins? The second question is on TwinSpires. It's more of a category question, right. ADW had a step function improvement in terms of the percentage of total horseracing handle naturally because of COVID. It seems as though we've kind of stabilized here in the low 50s. And I'm wondering if you would expect it to continue to migrate upwards here this year as a percentage of, again, sort of total handle? And then third, on P2E. Bill, I was wondering if you could just possibly educate me and maybe others that are less familiar with the Virginia market, especially for HRMs, your capacity to add almost 3x more units than you're acquiring? And how that market sort of compares with the success that you've had in Kentucky?
Great, Joe. I'll start with the third question. Bill Mudd might jump into as we get towards the first question. So I'll go first, and I'm going to try to make sure we don't miss any of these. So first, I really like the Virginia HRM market. I think if you look at margins compared to the margins we've seen in Kentucky, I think it is similarly attractive. I think P2E has done a nice job in Virginia and have done things really well, and I have the highest respect for what they've accomplished. And I think we can match that and perhaps over time, do better with introduction of new machines or features and functionality, always with the focus on preserving and expanding those margins. So I think there are some parallels between the Kentucky market and the Virginia market, and those are attractive parallels for us, and that's part of the reason we were so interested in that collection of assets. The second question was the online question. It's been an interesting story over the couple of years because if you remember going back to 2020, brick-and-mortar really shut down. So everything had to go online. And then as we got into 2021, things started opening back up, but not immediately and completely. So there was a transition. And also, I think people were getting comfortable with the reality of being out in public with COVID. So that combination of factors led to sort of a gradual shifting back towards brick-and-mortar. But pre-COVID, the online channel for horse racing was about 40%. It jumped up to 60%, even maybe a little north of 60% over the course of 2020. And then in 2021, as restrictions started to lighten up and people started to feel more comfortable, it started drifting down. And we saw in the fourth quarter of '21 more like 50%. I think for the year, we were at 54%. We think we saw in the fourth quarter what we're going to stabilize at. So again, go back to what I started the conversation with, we were at 40% pre-COVID. We jumped up to 60%, maybe north of 60%. Then we started trending down. We think where we've landed based on all the data we have right now is we think we've landed at a steady state of around 50%. So there has been a step up since pre-COVID, and we think that is the new baseline from which we will grow market share in the online space. So if you look at this business, called TwinSpires Horse Racing and you compare it to 2019, you see a real jump up in profitability. You see a real jump up in share. And we think that's now a steady state. We have some noise in the middle because of the extent of COVID, but now we think we're looking at steady state. And this is the stair from which we start climbing in terms of market share going forward. The first question, I'm going to turn that over to Bill Mudd. Bill?
Yes. So your question related to margins within -- we'll take casinos and HRMs because I think there are 2 different things the way we think about them internally. Casinos have continued to grow. If you compare the fourth quarter of 2021 to the fourth quarter of '19, I think we were up over 3%. That -- as we continue to grow across that, obviously, you get volume leverages, you get more volume coming into the business, which helps margin rate expansion because you don't have to add slot attendance when you get volumes. But volumes have continued to do very well, although the strength of those increases has declined slightly over the last couple of quarters, they grew up 8% in the second quarter, 5% in the third quarter and then 3% in the fourth quarter. So that growth continues. What I would say is from a promotional environment perspective, we've been very disciplined about how we promote our product. In the fourth quarter of '19, I think our free play to GGR was around 18%, and we were under 12% in the fourth quarter. That we continue to see continuing. We don't react quickly to massive changes in the market. And I think most of our competitors for the most part have been pretty disciplined in that regard. In terms of amenities coming back, I really don't see massive amenities coming back. In fact, I think most of our buffets we are converting to quick-serve casual. So you go up, you order your food and we bring your food to you, which is a much -- well, it's really driven by 2 things. One, being able to find labor has been difficult as everyone knows. And then when you do find labor, it is more expensive than it used to be. But those amenities are shifting. And I think for the most part, we're seeing pretty good discipline around that in our market too, partly driven by the fact that labor is a challenge. And that's really where some margin rate compression. But when you look at the percentage of revenue we spent on labor, it's not significant, I would say, but the cost of labor inflation is the primary concern that I would say with respect to compressing margins as we look into this year. And on the HHR side, we're ramping those up in our HHR facilities. I think we've had -- we're seeing records every month because the -- really the first 3 years and in the case of Derby City much longer than that, we believe, especially with the expansion and hotel coming on board, we're seeing those take multiple years to ramp. So as we said, we get more volume in, the margins expand. And so those are a little bit of a different animal than the mature casinos.
Your next question comes from the line of Zack Silverberg from Berenberg.
Most of mine have been asked, just a quick one from me. So the casinos in the acquisition, is there any room for margin improvements amongst those 2 once you sort of fully bring them on board to the Churchill Downs portfolio?
Those are great assets with great teams. So we're really pleased to bring those folks on board. We hope so. We hope we can make improvements there over time, modest improvements over time. But like I said, those are great teams, quality teams with really strong people and good assets. So we'll run our programs and our processes and see where we can drive improvement here and there. We're optimistic that we can. But again, we can't make any promises, and we'll just have to let that play out. But certainly, we go into this thinking that we can add to the team.
Got you. And I guess just one more, just looking at sort of the potential for the continued build-out of the HRMs. Can you just sort of remind us of your long-term HRM strategy? Will that involve sort of entering into more states or whatever it may be? Just curious your thoughts on the long-term outlook for the sector.
Yes. We think the HRM product can continue to improve and can get better with more product out there, similar performance attributes to Class III machines, et cetera. So we think the product can improve. So far, in those states that have allowed HRMs, we've liked the environment. We've like the potential for high-margin businesses. So we hope there's more of that. We certainly welcome that. We certainly look for that. And we have some degree of optimism. But again, I always tighten up a little bit when we talk too much about the future. We got to wait for the future to happen, and we got to go out there on the field and make it happen when we get an opportunity. But it is my hope that we'll get an opportunity to do that. We have any other questions out there?
All right, speakers, we don't have any questions over the phone. Please continue.
I want to thank everybody for your support of our company, for your interest in our company. It's nice to get the opportunity to talk with you and answer your questions again. We'll talk soon. Please get your Derby tickets quick if you expect to be there because it's going to be a big one, and it's going to be an exciting one. So we'll be back in touch to update you on that in the company just prior to the Derby in late April. Derby is in early May, but our next call will be in late April. Thanks very much, everyone.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.