ITT-Bally rumor fuels gaming stock rampage

Friday, April 5, 1996 | 11:59 a.m.

IN LAST WEEK'S column, I cited the evidence that expanding visitor volume in the wake of little additional room supply is resulting in widespread price gains for room and food and beverage prices.

I said that these factors, in turn, foretell the likelihood that first quarter 1996 operating results for Las Vegas' publicly traded companies will not only make excellent reading but may equate to still higher stock values.

What a difference a week makes in fast-moving markets! The GAX index of gaming stocks traded on the Chicago Board of Options Exchange is a widely followed measure of changes in investor sentiment toward the gaming group. The index began the year at about 217 and closed last Friday at about 262 for a gain of about 21 percent or about three times the change in the Dow Jones industrial average. Pretty good, but not unusual.

Beginning this past Monday, however, the GAX went on a rampage. By Wednesday's close the GAX stood at 290 amidst widespread speculation that ITT would buy Bally Entertainment. The three-day gain in the GAX index of 10 percent would equate to a comparable gain in the Dow of about 550 points. Most unusual.

I've said that gaming stocks, in general, sell for a substantially lower multiple of cash flow (I believe such to be the principal stock price generator) than other entertainment vehicles. During my "day job" as an investment analyst, I continue to pore over a lot of numbers that most folks find pretty dry. In connection with a forthcoming new publication, I had occasion to examine the 1996 estimated cash flow for 22 gaming companies.

The results tell one much about the valuation of gaming securities. It also tells us much about what is likely to occur as the larger companies begin to make smaller companies "an offer they cannot refuse."

Note the data -- specifically the fact that the eight larger companies sell for far greater multiples of cash flow than the small ones. Note also in the chart that the range of current cash flow multiples is a comparatively small 2.1 times for Bally's Grand Las Vegas represents a multiple of cash flow which is only about 20 percent of that of Mirage.

The recent speculation concerning ITT Gaming's possible interest in acquiring Bally Entertainment tells much about the prices of public gaming companies which will be paid as the industry enters a period of consolidation. If all gaming stocks were valued at about the same multiple of cash flow, it would make consolidation efforts difficult if, indeed, not impossible.

That is because the motive for an ITT or a Mirage to use its "paper" to acquire stock in another company via an exchange of stock only makes good financial sense when the acquiring company receives a positive pickup in cash flow as a result of the transaction. The present wide disparity in valuations means that incentives for more consolidation are very substantial. It means also that the better managed of the smaller companies are going to have great opportunities ahead.

This week's feeding frenzy in gaming stocks seemed to center on those companies, perhaps like Bally Entertainment, that might become acquisition targets by larger companies. These may include Bally's Grand Las Vegas, Showboat and Aztar, all frequently mentioned as takeover targets.

It is interesting to speculate on the reason for the most unusual gain in gaming stocks this past week. The speculation about Bally Entertainment and ITT Gaming provided the GAX a major updraft. This occurred, also, in December 1994 when ITT acquired Caesars World.

Perhaps of even greater importance, however, is my belief that the 1996 first quarter operating results will make for some most pleasant reading. The recent increase in room and food and beverage prices will translate to improving profit margins -- just the stuff Wall Street loves.