Executive Summary / Key Takeaways

• The Kentucky Derby represents an irreplaceable asset with untapped pricing power: Management's "third inning" comment reflects a decade-long transformation from single-day event into a week-long luxury experience, with new NBC broadcast deals, premium seating projects, and pricing initiatives driving step-function EBITDA growth starting in 2026.

• Historical Racing Machines deliver 21 consecutive quarters of record growth: The HRM segment generated 20% of total EBITDA in 2024, with Kentucky properties expanding margins over 3 points and Virginia's 4,875 machines producing best-in-class 51-52% margins, demonstrating a capital-efficient expansion model targeting 20% unlevered IRRs.

• Vertical integration through Exacta creates a technology moat: The August 2023 acquisition optimizes gaming floors, reduces technology fees, and enables B2B licensing to third-party operators, turning a cost center into a revenue stream while improving same-store performance across all HRM properties.

• Capital allocation discipline amid macro uncertainty: Despite pausing a $900 million Derby project due to tariff-driven cost inflation, management continues smaller high-return investments ($25-30M Finish Line Suites, $280-300M Victory Run) while returning $688 million in free cash flow to shareholders through buybacks and 15 consecutive years of dividend increases.

• Key risk factors require monitoring: Louisiana's Supreme Court ruling eliminated 500 HRMs (since relocated), high debt leverage (4.1x) constrains flexibility, and consumer softness in lower-tier gaming segments could pressure margins if macro conditions deteriorate further.

Setting the Scene: The Business Model and Industry Structure

Churchill Downs Incorporated, founded in 1875 and headquartered in Louisville, Kentucky, has evolved from a single racetrack into a diversified gaming and entertainment conglomerate built around three pillars: the iconic Kentucky Derby, a rapidly expanding Historical Racing Machine (HRM) network, and a portfolio of regional casinos. The company makes money by monetizing scarce, regulated gaming licenses through experiential events, machine-based wagering, and hospitality services.

The industry structure favors incumbents with regulatory moats. Gaming licenses are limited by state law, creating barriers that protect returns for established operators. The shift toward experiential consumer spending benefits Churchill's unique assets—no competitor can replicate the Derby's 150-year heritage. Meanwhile, HRM technology occupies a regulatory gray area between pari-mutuel wagering and casino gaming, allowing deployment in markets where traditional slots remain prohibited. This creates a first-mover advantage that Churchill has exploited aggressively in Kentucky and Virginia.

Churchill's strategy centers on extracting more value from irreplaceable assets while deploying capital into high-return HRM expansion. The Derby serves as both a cash cow and brand amplifier, generating premium pricing power and funding growth investments. The HRM segment functions as a capital-efficient growth engine, delivering 20%+ returns on invested capital through a proven rollout model. Regional casinos provide stable cash flow, though they face competitive pressure in saturated markets.

Technology, Products, and Strategic Differentiation

The Exacta acquisition in August 2023 represents a pivotal technology integration that transforms HRM economics. By vertically integrating the HRM system technology, Churchill eliminates third-party technology fees while gaining the ability to optimize gaming floor performance through data analytics. This directly improves same-store margins—Kentucky HRM properties collectively increased margins over 3 points in Q3 2025—while creating a new B2B revenue stream licensing the technology to third-party operators.

The technology advantage extends beyond cost savings. Exacta's platform enables rapid deployment of new HRM venues, with Roseshire Gaming Parlor opening ahead of schedule and below budget with 175 games in September 2025. The system also supports electronic table games, an initiative management expects to deploy in 2026, further expanding the addressable market within existing HRM facilities. This creates a technology moat that traditional slot manufacturers cannot easily replicate, as HRMs operate under pari-mutuel regulations requiring historical race data integration.

On the Derby side, technology investments enhance the customer experience and pricing power. The Starting Gate Pavilion and Courtyard project, completed for the 151st Derby, transformed 10,000 bleacher seats into 8,500 premium stadium and trackside box seats with improved amenities. This allows Churchill to capture more value per attendee while the new NBC contract, beginning in 2026, adds $10 million in annual EBITDA through expanded broadcast rights and primetime Kentucky Oaks coverage. The technology-enabled experience creates a virtuous cycle: better broadcast quality drives higher viewership, increasing pari-mutuel handle and sponsorship value.

Financial Performance & Segment Dynamics: Evidence of Strategy Execution

The Live and Historical Racing segment's performance validates the HRM expansion thesis. Q3 2025 marked the 21st consecutive quarter of record growth, with revenue up 21% and Adjusted EBITDA up 25% year-over-year. This demonstrates the durability of the HRM model across economic cycles—management explicitly noted the segment "holds up well in tumultuous economic times." The segment now represents nearly two-thirds of total company EBITDA, making it the primary driver of shareholder returns.

Virginia's HRM performance illustrates the geographic expansion opportunity. Despite opening only in late 2024, The Rose Gaming Resort already shows "meaningful sequential increases in GGR per machine per day," while the Richmond venue's 450-machine expansion and Roseshire's 175-machine opening demonstrate the pipeline's velocity. With 4,875 HRMs deployed in Virginia generating 51-52% margins, the state contributed 20% of total company EBITDA in 2024. This implies each Virginia HRM generates approximately $49,000 in annual EBITDA, providing a clear ROI framework for future investments.

Kentucky HRM properties show same-store growth potential beyond new openings. Louisville and Northern Kentucky delivered double-digit EBITDA growth in Q3 2025, while Owensboro (opened February 2025) and Marshall Yards (Q1 2026) expand the footprint. The combined Kentucky HRM margin expansion of over 3 points demonstrates Exacta's optimization impact, proving technology investments directly translate to profitability gains.

The Gaming segment's performance reveals a bifurcated market. While wholly-owned regional properties showed consistent strength from high-end rated guests, unrated play remains soft—a trend management attributes to macroeconomic uncertainty. This highlights the quality of Churchill's customer base: rated players provide stable, high-margin revenue while competitors fight over price-sensitive unrated customers. Terre Haute Casino Resort's performance, delivering nearly $12 million in quarterly EBITDA with top-quartile margins, validates the selective acquisition strategy.

Wagering Services and Solutions, rebranded from TwinSpires, demonstrates the Exacta integration benefits. Record Q3 2025 Adjusted EBITDA was "driven by the continued growth of the Exacta business," with third-party licensing revenue growing alongside internal HRM deployments. This segment's 39% EBITDA margin (Q3 2025) shows the technology licensing model's profitability, creating a capital-light growth vector that complements the brick-and-mortar HRM rollout.

Competitive Context: Moats vs. Scale

Churchill competes with integrated gaming operators like Penn Entertainment (PENN), MGM Resorts (MGM), Caesars Entertainment (CZR), and Boyd Gaming (BYD), but occupies a unique niche none can replicate. While competitors focus on scale and loyalty programs, Churchill's racing heritage creates exclusive content and regulatory access that insulates it from direct competition.

The HRM technology provides a structural cost advantage. Traditional slot machines face 50-70% tax rates in many jurisdictions, while HRMs operate under pari-mutuel frameworks with lower effective tax rates. This allows Churchill to achieve 51-52% EBITDA margins in Virginia while competitors struggle with 20-30% margins in traditional casino markets. The Exacta acquisition amplifies this advantage by eliminating technology fees that competitors still pay to third-party providers.

On the Derby front, Churchill's moat is absolute. No competitor can create a 150-year-old sporting event with the cultural significance of the Kentucky Derby. This enables pricing power that rivals cannot match—management targets "step function growth" in 2026 from ticket pricing and premium experiences. While MGM and CZR compete for entertainment dollars in Las Vegas, Churchill owns a "bucket list" experience that commands premium pricing regardless of economic conditions.

The regional gaming footprint, though smaller than competitors', demonstrates superior capital allocation. Churchill's properties target specific demographics with high-rated player concentrations, avoiding the commodity competition that pressures margins at Penn and Caesars properties. The focus on HRMs over traditional slots creates higher returns on invested capital—management's 20% unlevered IRR target for new projects exceeds typical casino returns of 12-15%.

Outlook, Guidance, and Execution Risk

Management's guidance reveals confidence in both near-term execution and long-term opportunity. For the 2025 Kentucky Derby, results are expected to be "comparable to 2024's extraordinary Derby 150 across key financial metrics," setting a high bar. More importantly, 2026 is positioned for "step function growth" driven by the new NBC contract ($10M EBITDA increase), ticket pricing power, and the Starting Gate Pavilion's full-year impact. This signals the end of the investment phase and the beginning of accelerated cash flow generation.

The HRM expansion pipeline remains robust. Marshall Yards (Q1 2026) and Casino Salem (2027) represent $180-200 million in project capital, with management maintaining "firm grip on schedules and budgets" despite macro volatility. The Wichita, Kansas third-party opening in December 2025 demonstrates Exacta's B2B potential, creating a licensing model that requires minimal capital while expanding the technology's footprint.

Capital allocation priorities reflect disciplined execution. The pause of the $900 million Derby project in Q1 2025, while initially concerning, demonstrates management's commitment to returns over growth at any cost. By waiting for macro stability, Churchill avoids cost overruns that would dilute returns. The $280-300 million Victory Run project, targeting a 20% unlevered IRR by year three, shows the company can still find high-return opportunities within its core asset.

Leverage guidance provides a clear path to financial flexibility. Bank covenant net leverage of 4.1x at Q3 2025 is expected to "decline below 4x in 2026" as EBITDA growth outpaces investment. The federal tax bill's $50-60 million annual cash tax savings through 2026 provides additional deleveraging capacity, while the 7% dividend increase (15th consecutive year) signals confidence in sustained cash generation.

Risks and Asymmetries: What Could Break the Thesis

The Louisiana Supreme Court ruling eliminating HRM operations demonstrates regulatory risk. While the 500 affected machines were successfully relocated to Virginia and Kentucky, the ruling cost Churchill approximately $8-10 million in annual EBITDA and highlights the political vulnerability of HRMs. Future expansions depend on favorable regulatory interpretations—Virginia's "whack-a-mole" battle with illegal gaming machines shows the constant threat of competitive and regulatory disruption.

Consumer softness in lower-tier segments poses a margin risk. Management acknowledges "hesitancy with just the volatility in the macroeconomic environment" is "most evident in our lower-tiered or unrated play." While rated player strength supports near-term performance, a broad economic downturn could pressure the 51-52% HRM margins if promotional spending increases to maintain volume. The Gaming segment's 1.1 point margin decline in Q3 2025, excluding Louisiana impact, suggests this risk is materializing.

Debt leverage constrains strategic flexibility. At 4.1x net leverage and $5.1 billion in total debt, Churchill carries significantly more debt than regional gaming peers like Boyd (0.96x) and even exceeds leveraged operators like Caesars (6.47x) on a relative basis. While interest coverage remains adequate, a 1% increase in SOFR rates would reduce annual cash flow by $15 million, limiting capacity for opportunistic acquisitions or accelerated buybacks if macro conditions deteriorate.

The $900 million Derby project pause, while prudent, delays a key growth catalyst. If macro uncertainty persists beyond 2026, Churchill may miss the window to capitalize on peak experiential spending trends. Competitors like MGM and Penn continue investing in their core properties, potentially ceding market share if Churchill's Derby enhancements remain on hold too long.

Valuation Context: Pricing a Unique Asset

Trading at $111.61 per share, Churchill Downs commands a premium valuation that reflects its unique asset mix. The enterprise value of $12.86 billion represents 4.46x trailing revenue and 13.69x EBITDA—multiples that exceed regional gaming peers like Boyd (2.18x revenue, 7.21x EBITDA) but trail the high-growth HRM pure-play multiple that doesn't exist in public markets.

The price-to-free-cash-flow ratio of 29.52x appears elevated versus traditional gaming operators, but justified by growth trajectory. Churchill generated $9.22 per share in free cash flow in 2024, up 33% year-over-year, and Q3 2025 FCF of $2.34 per share grew 13% despite macro headwinds. This 30x FCF multiple prices in sustained high-single-digit growth, which management's HRM pipeline and Derby pricing power appear capable of delivering.

Return on equity of 37.04% demonstrates capital efficiency that peers cannot match. Penn's negative ROE (-36.13%) and Caesars' low single-digit ROE (10.29%) reflect scale-driven strategies with lower returns. Boyd's superior 87.02% ROE comes from a more mature, capital-light locals model, but lacks Churchill's growth runway. The 0.39% dividend yield, while modest, has grown for 15 consecutive years, providing a foundation of shareholder returns while the company reinvests in high-ROI projects.

Debt-to-equity of 4.83x remains the primary valuation constraint. While management is committed to reducing leverage below 4x in 2026, the current ratio of 0.57x and quick ratio of 0.37x indicate limited liquidity cushion. This capital structure justifies a modest valuation discount to a hypothetical unlevered entity, though the tax shield benefits and growth ROI likely offset the risk premium.

Conclusion: Two Growth Stories, One Compelling Whole

Churchill Downs has engineered a rare combination: an irreplaceable asset with accelerating pricing power and a capital-efficient expansion engine generating 20%+ returns. The Kentucky Derby's transformation into a week-long luxury experience, amplified by NBC's primetime broadcast commitment and $280-300 million in premium seating investments, positions the company to capture step-function EBITDA growth starting in 2026. Simultaneously, the HRM segment's 21 consecutive quarters of record performance, driven by Exacta integration and geographic expansion, provides a high-growth, high-margin foundation that traditional casino operators cannot replicate.

The investment thesis hinges on two variables: management's ability to execute the Derby's pricing power initiatives without disrupting the event's authenticity, and the HRM pipeline's capacity to sustain 20%+ returns as Virginia and Kentucky markets mature. The pause of the $900 million Derby project, while prudent, delays a key catalyst that could test investor patience if macro conditions remain uncertain. However, the company's demonstrated ability to generate $688 million in free cash flow while maintaining 37% ROE suggests capital allocation discipline that should preserve long-term value.

Trading at 29.5x free cash flow with a 4.1x leverage overhang, the stock prices in sustained high-single-digit growth that appears achievable through 2027. The primary risk lies in regulatory disruption—Louisiana's ruling provides a template for other states—and consumer softness that could pressure the 51% HRM margins. Yet Churchill's unique moats, vertical integration advantages, and management's proven execution track record create a compelling risk-reward profile for investors willing to accept gaming industry volatility for exposure to a truly irreplaceable American asset.