Columnist David Ehlers: Secondary gaming stocks continue to dive

David Ehlers

Friday, Nov. 8, 1996 | 11:59 a.m.

THESE ARE UNPLEASANT and difficult days for gaming analysts, particularly so for those who have buys or "outperform" on the leveraged and/or secondary operating gaming companies.

For the last few weeks, I have stressed that the woes of secondary publicly held gaming operators (not those whose primary operations are Las Vegas-related) are extensively impacting the prices of these companies' stocks. Understandably, both company executives and gaming analysts are increasingly unsure of the near-term outlook.

This past week, more evidence became available of the operators' tough times in Atlantic City, N.J., and Tunica County, Miss.

Competitive market influences, in the form of added capacity and more aggressive marketing policies, is illustrated by the Sept. 30 report of Hollywood Casinos. The properties are:

* HWCC Aurora, Ill. (1 1/2 hours southwest of Chicago) properties consist of two riverboats. Newer boats in the Chicago area are siphoning off business in this market.

* HWCC Tunica is being adversely affected by two newer facilities, Harrah's and Grand Casinos. Casino capacity has increased substantially in the last year while the number of customers is about constant. Operators cite intentions to more aggressively market casino entertainment values -- translation: a price cut. Price cuts which do not stimulate final demand are the graveyard of entrepreneurial dreams!

* HWCC Sands, Atlantic City. HWCC stated in a press release: "An unprecedented market-share war continues to rage in Atlantic City. The industry's rate of spending on marketing programs far exceeds the rate of real casino growth. As a result, pressure on revenues and operating margins continues to be intense."

HWCC continued: "We did not see any appreciable lessening of the pressure on marketing and promotional costs during the peak summer season and our competitors continue to put additional pressure on costs as we enter the slower shoulder season." Bally's (soon to be Hilton), in particular, is believed to be leading the vicious price wars in Atlantic City. Reliable sources believe that these pressures will not soon abate.

Note that HWCC's revenues in all three markets declined 6 to 8 percent, while EBITDA margins declined by about one-third. Ugh!

Our contacts with industry executives indicate that margin pressures in these markets are expected to be further aggravated by still more forms of price cutting. Grand Casinos may seek to export its gaming-price practices tested in Las Vegas at the Stratosphere (the "Certified" program) to all the regional markets. LVIA does not foresee an early easing of these competitive market pressures.

The extent of the Atlantic City marketing and price war may be noted from the market-price action of Trump Hotel & Casino Resorts. Trump has fallen about 52 percent in price since a June high of 34. This past week, Salomon Brothers analyst Bruce Turner slashed his 1996, 1997 and 1998 estimates from $1.30, $2 and $2.75 per share to 70 cents, 60 cents and 55 cents per share, respectively.

The magnitude of the decline is particularly noteworthy since the drop in 1997 and 1998 is 70 percent and 80 percent, respectively. Normally, analysts' downgrades are of far less orders of magnitude. My interpretation of Turner's pessimism is his deep skepticism about Atlantic City's outlook. Turner's views may be worth more than just a fleeting perusal -- it was he who accurately predicted Stratosphere's problems.

Gaming stocks have declined in value by about one-third since their June peaks. Meanwhile, all stocks (as measured by the NYSE Composite) have increased in value by about 10 percent. Severely leveraged secondary operating companies are nearly friendless. Many gaming analysts, in my opinion, will cut their ratings and, thus, there does not seem to be any near-term improvement in this carnage.

International Game Technology and the manufacturing companies are not subject to the same laws of economics. IGT will make a presentation Saturday morning at the LVIA Saturday Morning Investment Seminar at the Rio. The turnaround in already cash-rich IGT's fortunes is well grounded in solid long-term business planning. Although selling at its yearly high, IGT's international business is not well understood in Wall Street. The presentation, by IGT's financial and investor-relations executives, will be accompanied by the LVIA research staff's views and the outlook for various companies. For thoughtful investors, this should be a helpful meeting. Call 889-1695 for reservations; last-minute attendees may pay at the door ($35).