Outlook for gaming stocks still dim

Gary Thompson

Thursday, Sept. 24, 1998 | 11:08 a.m.

Gaming executives looking for a ray of optimism from Wall Street got just the opposite at the World Gaming Congress & Expo Wednesday.

Participants in the first of a series of seminars featuring big institutional investors and gaming analysts offered somber views of the short-term outlook for casino stocks.

The experts said casino operators face declining cash flows, a credibility gap and potential hostile or forced takeovers through 1999. They suggested gaming companies need to pay more attention to consumer spending patterns, practice spending discipline and learn to communicate with investors better.

In planning the new wave of resort openings, many operators failed to foresee a major shift in leisure spending away from gambling and toward entertainment, shopping, dining and other diversions, the president of Christian/Cummings Associates said.

"The wrong things are being built," said Eugene Christiansen. "What drives consumer spending isn't more slot machines, but a broad menu of non-gambling attractions."

Operators who heed that trend will lure customers from other properties, he said, noting that a new entertainment-themed project in Atlantic City outperformed other Atlantic City casinos by 30 percent last year.

Part of the reason is that since 1994, the average casino resort visitor has cut the time spent gambling to 3.9 hours a day from five hours, he said.

Adding to the woes facing gaming companies are a lack of new markets for expansion, which will make acquisitions the surest way to grow for casino operators with strong balance sheets, and the erosion of cash flow due to increased competition, he said.

A popular measure of financial performance, cash flow is important in determining a company's ability to service debt. But those narrowing cash flow margins could make highly leveraged companies building large projects potential takeover targets, he said.

"Investing in debt may be more interesting than investing in the equities of some gaming companies over the next few years," Christiansen said.

That was the tack taken by financier Carl Icahn, who bought a majority stake in the discounted first-mortgage bonds of Stratosphere Corp. when the company defaulted on interest payments. Icahn wound up in control of the resort and used a similar technique to take over Arizona Charlie's hotel-casino.

MGM Grand Inc. Chief Financial Officer Jim Murren predicted more mergers and acquisitions in gaming "because there's never been a greater disparity in the cost of capital" among casino companies.

Noting borrowing costs ranging from the mid-6 percent range up to the mid-teens for some recent casino projects, Murren asked, "How can a company that borrows at 15 percent compete?"

But Murren said MGM is more likely to continue its share-repurchase program than spend large amounts on acquisitions.

"MGM is not a good turnaround company, with zero riverboat experience," he said, indicating the company isn't interested in taking over struggling marginal operators, even those whose stocks have fallen sharply in the current slump.

"To grow, we have to look at everything," he said. "But I doubt very much MGM will get into the riverboat market in the future."

Murren said that before MGM launched its recent six million-share buyback, "we did an M&A analysis of every company in the industry. And we decided the stock repurchase was the best move for creating value for our shareholders."

An analyst for CIBC Oppenheimer & Co. said he believes gaming stocks haven't hit bottom yet, even though they've under-performed other industries for the past 2 1/2 years and some have hit all-time lows.

"The operators have to contend with the new supply coming on stream," said David Wolfe, referring to projects such as Bellagio, Mandalay Bay, Paris, The Venetian and Aladdin.

"I don't think the 'E' in the 'P/E' ratios is low enough in our projections for gaming stocks," he said.

Price/earnings ratios, which compare a stock's price to its per-share earnings, are another measure investors use to value publicly traded companies. The lower the earnings, the lower the stock price.

Ken Frankel, a portfolio manager with California-based investment fund U.S. Equities Research, said Wall Street also worries about potential setbacks to gaming companies from ballot issues in several states including California this year.

If California voters approve expansion of Indian gaming there, the impact on Nevada could be substantial, he said, even though constitutional challenges might ultimately overturn the vote.

Another portfolio manager -- George Wendt of Capital Research Co. -- said casino operators need to produce more consistent earnings and do a better job using "the power of cash flow, which should be redeployed to the best benefit of shareholders." He lauded the MGM stock buyback as an example.

Stock repurchase programs reduce the number of shares outstanding, resulting in higher per-share earnings and -- theoretically -- a higher market price for the remaining stock.

Such spending programs are a good example of how companies can exercise the financial discipline gaming must exhibit to regain Wall Street's favor, Christiansen said.

In the past, operators of casinos generating large cash flows opted to build new projects, causing an oversupply problem "that can only be worked out in the marketplace," Christiansen said.

"A lot of projects have been built or are being built that should never have been built, and part of that is our fault," said Wendt.

Impressed by the high returns-on-capital generated by gaming's expansion in the early 1990s, investors scrambled to finance new projects in hopes of profiting from the trend. But as existing markets became overbuilt and expansion opportunities in new jurisdiction dried up, so did the funding pipelines of Wall Street.

Nevertheless, some companies are still using "very aggressive financial projections" for the new resorts they're building in hopes of enticing capital for expansion, Wolfe said.

"But when fundamentals are working the wrong way," he said, "discipline becomes more important."

And discipline, said Wendt, "is the No. 1 trait casino companies need today."

"Disclosure isn't where it should be" in reporting results from different segments of the business, he said, adding that some operators still run the public companies "as private fiefdoms."

In a seminar on investor relations, two corporate communications experts echoed the call for credibility.

"Our most important job is to be honest and credible," said Marc Grossman, senior vice president of Hilton Hotels Corp. "It may not also be what people want to hear, but it's absolutely essential."

He also cautioned corporate executives from "talking down the Street on earnings estimates," a practice some less-sophisticated companies use to warn gaming analysts to lower their earnings projections.

Not only does the practice run the risk of violating Securities & Exchange Commission disclosure regulations, Grossman said, "but the first analyst you call will be on the phone to his trading desk immediately."

The investment banking firm's trading desk will use the information to sell or short stock in the company before word of the expected earnings shortfall leaks out to other traders and investors.

"When you have material information," Grossman said, "you have an obligation to disseminate it as quickly and as widely as possible."

Jeffery Nichols, a principal of investor relations specialist Expert Reports, said the way a company presents itself "can make a big difference in its earnings multiple, its stock price and its access to capital on Wall Street."

"It's especially important to communicate clearly and honestly about the company's strategic plans," he said. "Wall Street wants to know about growth potential, and you have to present a long-range growth plan and then deliver on it.

"It's better to promise too little than too much," Nichols said. "Investors love positive surprises but are slow to forget disappointments.

"You can't hide bad news. This is when you have to be most accessible."

The gaming congress, sponsored by International Gaming & Wagering Business magazine and the American Gaming Association, continues through Friday.

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