Thursday, Oct. 15, 1998 | 11:03 a.m.
And so it begins: the latest, the greatest -- and what many believe will be the last -- tidal wave of new resort openings in Las Vegas.
Tonight's unveiling of Bellagio, the most expensive hotel-casino ever built, begins a two-year binge of resort openings that will boost the Las Vegas-area hotel-room inventory 20.5 percent in the next 24 months.
The critical question: Will those $9 billion of new resorts stimulate enough visitor demand to fill -- year-round -- the 127,542 total rooms scheduled to be open in Las Vegas by 2001?
It won't be solely up to Bellagio, the spectacular $1.6 billion, 3,005-room Mirage Resorts Inc. property boasting a $300 million art collection, 15 of the world's top restaurants, the most costly production show ever staged and some of the highest-end retail shops found this side of Rodeo Drive.
The other new resorts opening over the next two years must be able to buttress Bellagio's implicit promise -- that the "new" Las Vegas offers something far more fulfilling than the slot machines, table games, $2 buffets and second-tier entertainers you can find at any almost casino in the country.
In addition to Bellagio, the new projects include Circus Circus Enterprises Inc.'s Mandalay Bay, Hilton Hotels Corp.'s Paris, Sheldon Adelson's The Venetian, Jack Sommer's Aladdin, the Resort at Summerlin and expansions at the MGM Grand and Rio.
Add to those $7 billion-plus of new resorts another $2 billion more in various stages of planning or early construction, and the total projected new investment in hotel-casinos in Southern Nevada nearly equals the $11 billion spent to build the 200-odd large and small gaming properties now open here.
Most of the new projects were planned -- and financed -- as a result of industry and investor euphoria over the initial successes of gaming's mid-1990s domestic expansion and in the midst of a global economic boom.
But since 1996, growing political and economic uncertainties have prompted investors to close the financing spigots for projects not already funded and sent the galaxy of gaming stocks plunging into Wall Street's equivalent of a massive black hole.
As a result, many observers believe Southern Nevada's existence as a vibrant full-service tourism destination and the financial health and future growth of gaming's biggest companies hinge on Bellagio's ability to transform public perceptions about what Las Vegas is becoming.
New casinos sprouting up all over the country have put gambling within driving distance of most of the population. No longer are slots, craps and blackjack alone enough to draw to Las Vegas the 35 million visitors needed to fill the swollen room count.
Unless Bellagio and the other new resorts stimulate demand by offering an appealing -- indeed, compelling -- mix of shopping, dining and entertainment attractions in addition to gambling, then tourist counts will continue to slump, cash-flow margins will continue to narrow, stock prices will continue to drop and negative ripple effects on the area's economy will continue to widen.
Even in that case, gaming analysts say, companies with newer, "must-see" properties might be winners. But those with tired old properties that can't compete with the new ones will suffer severely.
In an analysis with frightening implications, BancBoston Robertson Stephens' Harry Curtis predicts a sharp decline in cash flow at Las Vegas Strip resorts unless there's a significant increase in visitor volume.
That's important because cash flow, or earnings before interest, taxes, depreciation and amortization (EBITDA), is a widely watched indicator of a company's ability to pay its debt. And with $9.2 billion of casino-industry junk bonds outstanding, any cash flow compression can jeopardize not only debt payments but Wall Street's perception of the entire universe of gaming stocks.
"If we see a 10 or 12 percent growth in visitor volume, Wall Street will breathe a sigh of relief," Curtis says. "It it's any less -- say, 5 percent -- there will be carnage in gaming stocks.
In his analysis, Curtis estimates the 1998 cash flow at the top 25 Strip casinos (excluding Bellagio) will decline to $1.44 billion in 1998 from $1.61 billion in 1997 due to lower baccarat revenue and flat visitor growth.
With the added cost of operating Bellagio, Mandalay Bay, Paris and the Venetian, he says, "we estimate that visitor volume to Las Vegas must increase by 8.4 percent" just to maintain the $1.44 billion cash-flow level.
"To achieve our current cash flow estimate of $1.9 billion (for the year 2000) for this market segment, we estimate visitation must grow by 11.7 percent to 34 million visitors.
"By comparison, visitor volume growth of only 5 percent would result in cash flow of only $873 million, a 54 percent decline from 1998's estimate," he says.
That would put severe pressure on companies that will inevitably lose market share to the newer, "must-see" properties.
"There's not much some of the older properties can do to compete," says Andrew Zarnett of Ladenburg Thalmann & Co.. "You'll see rooms close over the next two years, many of them downtown. They simply won't be able to make their interest payments and will just close."
"Over the next 18 to 24 months, you'll see as many as five hotels closing," predicts Danny Davila of South Coast Capital. "There'll be a lot of blood spilled downtown and on the Strip north of Treasure Island."
Theoretically, that should benefit newer properties by cutting overall hotel-room inventory. But bankruptcy laws will allow some properties "to just keep operating, so I don't see a lot of supply contraction," says Curtis.
On the other hand, Curtis predicts a 15 percent increase in visitor volume would result in $2.27 billion of cash flow, a 63 percent increase over 1998.
Even with his projected number, Curtis sees dangers for some new properties.
"At the Venetian," he said, "11.7 percent visitor growth generates $109 million of cash flow -- just enough to cover interest expense. Visitor growth below 11.7 percent will force a restructuring."
Concerns about booming room supply have consumed Wall Street since mid-1996, when the two-year rout in gaming stocks began.
"People have focused on supply because it's easy to measure what's happening," says Zarnett. "Assessing demand is a whole lot trickier."
"There's a wide range of alternatives that has impacted the demand equation because the novelty of gaming, which Nevada had a monopoly on, has faded," says Salomon Smith Barney analyst Bruce Turner.
In the early stages of casino expansion in the Midwest and Gulf Coast, Turner says, "there wasn't any degradation of revenue patterns in the established markets in Las Vegas and Atlantic City.
"So the argument was that as the population's exposure to gaming grew, so would its desire to visit destination resorts.
"But one thing that was missed or overlooked was the impact in differential quality -- the initial investments in the emerging markets resulted in low-quality projects compared with those in Las Vegas.
"Since 1994, though, the quality has risen dramatically," Turner says. "And so you got a $300 million project in Kansas City, for example, that rivaled the quality of a Luxor or a Treasure Island.
"You've got a lot of those projects now. And in those markets, the basic demand for gaming is satisfied."
As Jack Pratt of riverboat operator Hollywood Casino Corp. puts it: "The growth of other markets is the greatest issue facing Las Vegas. As they build better facilities with more amenities, they will pose an even bigger problem for Las Vegas."
Turner also points to declining cash-flow margins over the past eight quarters as an early indication of "a relatively mature market.
"That has made it more challenging for Las Vegas," he says. "You're going to have to have something pretty special not just to succeed initially, but to hold your success."
That's become increasingly difficult, as the proliferation of casinos nationwide has cut the number of repeat trips by regular Las Vegas visitors sharply.
"Las Vegas is much too large a market to attract an incremental increase in gamblers, so there will be significant shifts in market share toward the new properties," Turner says.
"I'm most nervous about Mandalay Bay because it's got an isolated, disadvantaged location, and that will be challenging. Plus, they've got to get a return on the $1 billion investment, but they've got only $700 million in the hotel-casino itself. The other $300 million is in the surrounding infrastructure."
Zarnett, though, sees a significant rise in visitor volume "because everyone wants to see Bellagio. And Circus will become a big winner because a lot of people will end up staying at its properties."
"The problem is," he says, "once people have seen the new properties, how do you get them back?"
Getting them back will require a change in the public's perception of Las Vegas. And just as Bellagio must redefine the image of Las Vegas, it must also reshape Wall Street's definition of success. Historically, a new resort was deemed successful if it delivered 20 to 25 percent returns on capital.
To do that, however, Bellagio would have to generate $320 million to $400 million of cash flow annually -- a number analysts say will be difficult to reach. In fact, the latest mean estimate among 12 top gaming analysts pegs Bellagio's 1999 EBITDA at $309 million.
That projected 19 percent return has to be put in perspective, and not just against the most successful openings of the past. In the first place, Bellagio starts from a $1.6 billion investment, about three times as high as the typical new project.
Secondly, that percentage would exceed the results of some costly expansion projects in Las Vegas. Casino operators who've recently spent hundreds of millions on renovations but have notched only single-digit or even negative returns would love to hit 19 percent.
And declining interest rates have cut the cost of capital for a highly rated borrower such as Mirage. As a result, the spread between interest expense and return on capital may be comparable to prior successes. The company issued junk bonds yielding 12 percent or more to build its $600 million Mirage, but is paying less than 7 percent for the money it borrowed to build Bellagio.
Finally, the 12 gaming analysts' median 1999 revenue estimate for Bellagio is $947 million. Cash flow of $309 million would equate to a 35 percent operating margin. Among Las Vegas Strip resorts, only Hilton's Flamingo and New York-New York, the MGM Grand-Primadonna Resorts Inc. joint venture, are expected to post higher operating margins on a percentage basis.
Significantly, nongaming operations are expected to generate more than half Bellagio's total 1999 revenue, a shift that should spread to other new Strip resorts, analysts say.
The Strip's nongaming revenue has posted a 10 percent compound annual growth since 1995, compared with 3 percent annual growth in gaming revenue, and that trend should accelerate, says Joe Coccimiglio of Prudential Securities.
"We believe this is healthy for Las Vegas," he says. "The market for people who want to gamble is limited, but the market for adults seeking a destination leisure experience is deep."
For Bellagio, this increased reliance on nongaming revenue would come despite its expected allure among high-end baccarat players, traditionally big contributors to upscale casinos' profits.
Total Strip baccarat win peaked at $556 million in 1997 -- before the impact of Asia's economic turmoil was felt -- but is expected to drop to about $375 million this year, with 95 percent of it split among Mirage, Caesars Palace, MGM Grand, the Las Vegas Hilton, the Desert Inn and the Rio.
Bellagio is expected to dominate the baccarat market in 1999, analysts say.
"The baccarat business will become a market-share game, and Bellagio will fare the best," says Curtis.
"We don't think Bellagio will grow the high-end market significantly, but it will be the one big player acting like a sponge to absorb the lion's share of customers," adds Turner.
"Caesars will be decimated, the Desert Inn will be crippled, and Mirage, MGM and the Las Vegas Hilton will be seriously hurt," he says.
Turner estimates that Caesars and the Desert Inn have held 50 percent of the baccarat business. But Caesars' cash flow fell 30 percent when Mirage opened and took away some of that business, he says. Adding to Caesars' woes is its age -- 32 -- and the fact that "Bellagio is a lot more property than Mirage was," he says.
But Zarnett believes Bellagio will generate enough of an incremental increase in visitor volume to benefit MGM, Hilton and Rio. And those companies won't sit by idly if their regular customers do drift over to see the new megaresort.
"The baccarat business will be very difficult in 1999," says Jim Murren, chief financial officer for MGM Grand. "And we'll fight like hell to stay in the business. If we're losing customers, we'll compete on price. "
Many competitors hope Bellagio will be able to command room prices far higher than those normally associated with Strip resorts, where average daily rates range from the mid-$40s to nearly $100. In theory, higher prices at Bellagio will enable others to raise their rates.
Curtis anticipates Bellagio will be able to charge $190 to $200 per night for at least six months. "But when Mandalay Bay, Paris and the Venetian open, it will become a function of incremental demand," he says.
Zarnett predicts Bellagio's rooms and suites will average $183 a night. He also says that, based on the average Las Vegas visitor stay of three nights, Bellagio's rooms can be filled during 1999 by just over 350,000 extra tourists. Bellagio has already doubled the advance registrations of Mirage before it opened in 1989.
And what of the potential "cannibalization" of Mirage Resorts' other properties resulting from its regular customers demanding to stay at Bellagio?
"We're doing things to market The Mirage and Treasure Island differently," says Mirage Resorts Chief Financial Officer Dan Lee. "We are trying to make sure that Bellagio overflow goes to other Mirage properties.
"We're also working to reach out to different customer bases, but I'd rather not go into detail because our competitors read newspapers, too."
Lee says he expects the company's overall share of the high-end baccarat market to rise, though he doesn't offer specific projections. For the first six months of 1998, he says, Mirage had 20 percent of that market.
Zarnett expects 1999 cash flow at The Mirage to drop about $62 million, or 25 percent from 1997, as high rollers who frequented that resort move their play to Bellagio. Companywide, though, he expects Mirage's EBITDA to rise to $716 million, or five times interest expense, in 1999 from an estimated $418 million in 1998.
"Even if Mirage and Treasure Island room prices slip, there could be benefits to the company because that would offer more people a great opportunity to experience Las Vegas," says Zarnett.
Experience it, that is, if they can get here. But declining air service and clogged highway systems have made it more difficult and costly for visitors to reach Southern Nevada. Those factors plus the expansion of gaming elsewhere and the rise in room inventory have converged at the worst possible time, some analysts say.
The launch of Las Vegas-based National Airlines in 1999's first quarter may help. It plans to increase low-cost, nonstop service to Las Vegas from key feeder markets.
Still, established carriers continue to trim service here because they can make more money on business-oriented routes. That could change if the recent trend by U.S. airlines to cut service to economically distressed countries in Asia and South America continues, for the carriers will likely shift airframes to domestic routes.
Yet any economic downturn that might theoretically divert more planes to Las Vegas could prove to be a double-edged sword.
"In 1997, the average yield for air carriers nationally was 16.7 cents per seat mile, compared with 11.5 cents for those serving Las Vegas," Zarnett says.
"If that 16.7-cent figure goes down, the United States is in a recession. And if the 11.5-cent number goes up, people will have less to spend when they get here."
Nevertheless, says Curtis, "The airline seat capacity problem is solved if developers build properties that stimulate demand."
Salomon's Turner agrees.
"While legitimate, the concerns about infrastructure have been overblown," he says. "The issue is whether the airlines will continue to add airframes to the market.
"As long as there's adequate customer demand at prices appropriate for the airlines, they'll add airframes. But it will cost people more to get to Las Vegas."
Even so, says Lee, that's a function of the "new" Las Vegas.
"People ask us what we're doing about air service," he says. "We tell them we're building a hotel so exciting people will pay thousands of dollars to fly here."
Another big threat looms just west of Nevada -- a November ballot initiative in California that would allow Las Vegas-style casino gambling on Indian reservations. Polls indicate voters favor the initiative.
While approval of Proposition 5 would face long court challenges, the uncertainty over the ultimate outcome will damp any investor enthusiasm the new Las Vegas resorts might generate for Nevada gaming stocks.
"With approximately one-third of all Nevada gamblers coming from California, the passage of this initiative could result in a significant slowdown in the Nevada markets," Zarnett says.
The uncertainties have led investors to adopt a wait-and-see attitude about gaming. If Las Vegas can absorb the new capacity, there could be another bull market in gaming stocks.
If it can't, says Curtis, "There'll be no more capital available from Wall Street or commercial banks. Expansion financing will have to come from internally generated cash flows.
"Management has to realize these aren't growth stocks anymore," he says. "If they want to help their stock prices, they'll have to use cash flow to buy back stock or reduce debt.
"But at current prices, Wall Street is saying, 'It's too early to do that.' Operators have to wait until the dust settles and then, if they have the money to start repurchasing their own stock, that's a signal to investors to start buying."
While cautious about its impact, the analysts and even executives from competing casino companies who've gotten sneak previews of Bellagio are effusive in their praise.
"Bellagio is spectacular," says a top executive with a major hotel-casino operator. "I don't know if I've ever seen a more spectacular hotel anywhere. It simply reeks of quality."
"The building is spectacular, the art is spectacular, the restaurants are spectacular," says Zarnett. "I've seen very small, beautiful resorts in gorgeous locations all over the world, but I've never seen anything like this. It's magnificent."
Zarnett even praises "back of the house" operations such as Bellagio's employee restaurant and shopping mall, both hidden away from public view.
"The back of the house at Bellagio is nicer than the front of the house at Circus Circus," he says.
"Bellagio will have the hottest restaurant seats in town -- forever," says Coccimiglio.
As more people get to experience Bellagio, the praise will continue to mount. But on Wall Street, it's numbers that count. And investors will be watching closely to see if Bellagio and the other new properties in the pipeline will be able to generate sustained visitor demand.
"There will be some indigestion in the next few years," says Turner, "with intense competitive battles for market share and older properties in trouble.
"The final measure of valuation is return on capital," he says. "The reason gaming stocks have bombed is the rapidly contracting returns on capital over the past eight quarters and skepticism about who'll be able to deliver good returns.
"But it's important to remember that there's no stock analyst in the world who can influence the long-term price of a stock. Ultimately, it's up to the company's executives to deliver."
With Bellagio, Mirage has delivered a magnificent resort. Whether it and the other new resorts can deliver the numbers remains to be seen, and that will depend on drawing more people to Las Vegas.
And the people at Mirage Resorts think that will happen.
"I'm hoping each of the new properties has attractions that will drive visitor volume higher," says Lee. "If they deliver on what they promise, we all have a very bright future here.
Meanwhile, sit back and enjoy the ride. As Turner says, "I believe it's highly unlikely that in our lifetimes we'll see development of this magnitude again."