Casinos want slot legislation to cut power of top game maker

Gary Thompson

Sunday, Feb. 28, 1999 | 9:45 a.m.

The battle between casino operators and slot manufacturers boils down to this:

Some casino executives want to bury International Game Technology, and they want the Nevada Legislature to help them do it.

The flap reached a head last week when the Legislature's Senate and Assembly judiciary committees asked that bills be drafted to force slot makers to sell, rather than lease or share revenue from, all slot machines.

The bill would also ban linked-progressive games such as Megabucks from being operated by any entity other than casinos.

The committees were responding to pressure from some casino executives who claim to be angry that slot makers are offering their most popular products only on a revenue-sharing basis and aren't paying their fair share of taxes.

The prototypical revenue-sharing game is IGT's Megabucks, which links more than machines at 140-plus casinos around the state. The resulting volume of play enables the game to generate huge jackpots, such as the nearly $27.6 million that a 68-year-old Nevada woman won last November at Palace Station.

A ban on Megabucks and similar games would allow more big casinos to set up their own linked progressives. Some do that today. But because they don't have enough properties to generate the huge jackpots of a Megabucks, they want that game eliminated for competitive reasons.

But in reality, the fight isn't about taxes or revenue-participation games; it's about power -- pure, raw power. Casino executives think IGT has too much of it, and they want to get lawmakers to do what the free market hasn't done -- cut IGT down to size.

However, in their zeal to destroy IGT's hard-won dominance through legislative fiat, casino executives may be ignoring some potentially lethal consequences to the well-being of their own companies.

Megabucks and similar linked products are often called "system games," which differ from stand-alone slot machines in more than just jackpot size.

Slot makers don't sell such system games to casinos. Instead, they install machines at no upfront cost, but they share in the win.

In Megabucks, for example, casino operators get a fixed amount of 8 percent of the game's handle, or amount wagered. IGT takes a smaller percentage to fund jackpots, cover expenses and earn a profit. The rest is paid out to players.

Other games, such as WMS Industries' Monopoly, are provided to casinos on a lease or revenue-participation basis. The average participation agreement calls for casinos to keep 80 percent of the win, while the slot maker gets 20 percent.

Some big casino operators, such as Circus Circus Enterprises Inc., Station Casinos Inc. and Park Place Entertainment Inc., have several casinos each in Nevada. They don't like splitting the win from revenue-participation games and want to use their network of casinos to set up their own proprietary games.

Yet today, gamblers can still walk into a small neighborhood casino -- a Klondike, Arizona Charlie's, Fiesta or Reserve, for example -- and play Megabucks, chasing the large jackpots that ban proponents are unable to match because they don't have enough casinos in Nevada.

The proponents believe the ban would lure slot players away from those smaller casinos and into the bigger ones.

Slot makers also offer a few popular nonprogressive games such as Monopoly or Triple Play Poker on a participation or fee basis only. Big casino operators would rather buy those games outright, paying for them in a few months of play and keeping 100 percent of the win afterward.

Ban proponents complain that slot makers are showing an increased tendency to offer the most popular games only on a revenue-participation basis and aren't paying taxes on the money they get.

Thus far, revenue-participation games account for less than 5 percent of slots nationwide. Put another way, casinos already own more than 95 percent of the slots on their floors.

Megabucks accounted for $134.9 million, or 2.6 percent, of the $5.27 billion Nevada casinos won on slots in 1998. At the maximum tax rate for casinos, that put about $8.5 million into state coffers.

If the bill passes, there'd be no incremental increase in Nevada's tax revenue, slot makers say. It would merely shift the tax burden on a portion of the win to manufacturers from casinos. The result would be a slight increase in big casinos' after-tax profits and a slight increase in slot makers' deductible expenses.

Smaller outlets hurt?

Slot makers argue that the proposed legislation would hurt smaller casinos and bars and restaurants. Such establishments offer participation games installed free; the host sites merely share the win with the manufacturers.

Such participation arrangements allow small casinos to compete with their bigger brethren for the most popular games. And because most lease agreements allow casinos to replace unpopular or under-performing games quickly, they reward innovation. Casinos that have spent $6,000 to $15,000 on a machine purchase are often less inclined to replace older machines -- unless their competitors are getting newer, more popular ones.

Ban proponents claim that small casinos could buy slots on a "bucket-sale" basis -- paying for them over time using proceeds from the win. But that's really nothing more than a participation game in disguise because slot makers would be financing the smaller casinos' purchases based on a share of the revenue. And the legislation would ban that.

Some casino operators also complain that IGT is using information provided from casino customer data banks to develop system or revenue-sharing games. In a Jan. 8 letter to IGT, Aztar Corp. executive Dennis Gomes said casinos had "worked closely with your company to develop games with great customer popularity." Aztar owns the Tropicana hotel-casinos in Las Vegas and Atlantic City.

"Now IGT is charging the casino industry exorbitant fees to purchase variations on these same machines that we helped your company conceive," Gomes said.

In pushing participation games, slot makers are seeking the same thing casino companies want -- recurring revenue -- to avoid profit downturns when machine sales slump and openings of new casinos slow.

"IGT and the other manufacturers will go through highly volatile swings if they are totally dependent on the sale of new equipment, as all capital-goods companies are," says William Eadington, an economist with the Institute for the Study of Gambling at the University of Nevada, Reno.

Slot makers argue that a ban isn't necessary. Nobody forces casinos to accept systems games, they say. If a casino doesn't want them, it can choose not to put them on its floor.

But casino operators know that, in the end, they really don't have that choice. Casino executives don't decide what games are successful; slot players do. And because casino executives know they can't subvert the mechanisms of the free market, they want the Legislature to do it for them.

There seems little doubt that enacting a ban on participation games could hurt IGT, its shareholders and its 3,400 employees, at least temporarily.

But as the world's largest slot manufacturer, IGT is used to playing hardball and is likely to do it again in this dispute.

In one well-publicized incident three years ago, a competing gaming-equipment maker hired six top executives away from IGT when they became involved in a personality dispute with the then-chief executive officer.

Within three months, IGT Chairman Chuck Mathewson had hired back the group, replaced the CEO and, in a demonstration of his commitment to the company, agreed to a $1 per year annual salary. His total compensation for fiscal 1998 included the $1 salary, $3,076 in benefits and no stock options.

Mathewson won't telegraph any possible defensive strategies in the participation-games dispute.

"We've always considered ourselves partners in the gaming industry," the courtly 70-year-old says. "If our customers feel something is out of sorts, we'll sit down and discuss it with them.

"But to continue developing products our customers want," Mathewson says, "we have to be profitable."

So far IGT has been profitable, earning $152.4 million in the year ended Sept. 30 on sales of $824.1 million.

To some casino executives, that's too profitable. And by banning Megabucks and participation games, they hope to reduce those profits and cut IGT's power.

But in a state that derived 65.3 percent of its total gaming win last year from slots, a ban could set off a dangerous chain reaction.

One not so far-fetched scenario could see IGT and allied game makers decide to yank their best products out of Nevada and plunk them down into a more accommodating environment -- say, California, the biggest feeder market for Nevada tourism. "One might argue," UNR's Eadington says, "that you'll end up with a slot product emerging in California that leapfrogs what Nevada casinos can do."

Casino executives such as Mike Sloan scoff at that notion.

"Tourists don't get into their cars to drive to Las Vegas because of the new Elvis machine," says Sloan, a Circus Circus Enterprises Inc. executive and new chairman of the Nevada Resort Association.

"They come because of the new resorts. To be successful in drawing tourists, you have to spend close to $1 billion on a new resort today," Sloan says.

Sloan says Circus has invested more than $2 billion in Nevada over the past decade, joining other hotel-casino developers who plow capital into infrastructure.

"We're the ones who take the economic risk," he says. "We build the casinos and pay the taxes. The casino operators are committed to Nevada. The slot manufacturers are here today and gone tomorrow."

But if Sloan is wrong and Reno-based IGT decides to put its most popular games in other jurisdictions, ban proponents may be taking an unnecessary risk that jeopardizes more than $20 billion of hotels and casinos built in Southern Nevada alone.

Profits squeezed

If cash flows drop because of lower slot win, some highly leveraged, low-margin casino companies might find themselves hard-pressed to service debt. And Sloan argues that casino operators' profits are already being squeezed.

"Last year the industry averaged an 8 percent pre-tax profit," Sloan says. "But that didn't take into account expenses at the corporate level, so the actual number is closer to 5 percent. And that's before you pay federal taxes."

Then why take the risk of losing California customers lured by lottery-sized, wide-area progressive jackpots that, under the proposed ban, Nevada casinos would be unable to match because they wouldn't link enough games together?

"IGT's linked progressive systems enable them to build substantial jackpots with a critical mass of players," Eadington says. "These jackpots generate publicity that's even larger than comparably sized lottery payoffs.

"But no single casino company will be able to do this on its own."

Sloan acknowledges the possibility of slot makers taking their progressives to California, saying, "Proposition 5 is a great opportunity for them."

In another defensive scenario, IGT might selectively decline to sell its most popular games to casino operators supporting the ban, supplying them instead to neighboring casinos in a bid to draw market share away from its attackers.

While IGT could weather a resulting temporary revenue downturn easily, a few quarters of declining cash flow, lower per-share earnings and slumping stock prices for casino companies could cause them to rethink their positions.

Far-fetched? Consider what happened earlier this year when IGT introduced its popular Triple Play Poker machines into Atlantic City.

In a promotion that's a standard practice for new-game introductions, IGT debuted the game at two Harrah's casinos, forcing other operators to wait six weeks before they could get the game.

The competing casinos were irate because Triple Play generates huge daily win figures. Angry at missing out on just six weeks of revenue, Park Place sued over Harrah's exclusive deal, but the case was dismissed.

Sloan is also a passionate critic of IGT's sheer size, which other casino executives complain has imbued the slot maker with an "arrogant" attitude.

"I don't know of anybody in any aspect of gaming who has a 71 percent market share," Sloan says. "People in this business would be outraged if (Mirage Resorts Chairman) Steve Wynn owned 71 percent of the casinos."

Perhaps. But the casino industry itself is in a state of consolidation, with bigger companies buying smaller ones in an effort to ensure further growth.

In fact, some observers say eliminating participation deals would leave many more small casino operators vulnerable to takeover, a move that would benefit big casino operators such as ... well, Circus, Park Place and others who back the proposed ban.

And because they rely on revenue from participation games, some bar and restaurant operators could be forced into bankruptcy, closing their doors to regular slot customers who would then frequent ... well, Circus, Park Place and others who back the proposed ban.

Free-market concerns

"If you're a believer in the free market, you'll say this redistributes income without creating wealth, and therein lies the concern, " Eadington says.

In his January letter, Gomes also warned IGT to stop "exploiting" casinos the way the U.S. auto industry "tried to capitalize on the captive audience it thought it had in the American market" before losing market share to imports.

Sloan also uses the auto analogy, arguing that by insisting on revenue participation games, IGT is "just like a car salesman who won't allow a customer to buy a car but will lease him the vehicle forever."

But, like the auto industry, the casino industry is changing. And if Sloan and Gomes look further into the auto business, they'll find that today 30 percent of new-car sales are leases, rather than outright purchases, according to Bear Stearns & Co. auto analyst Eric Goldstein.

If casinos were leasing slots "forever," you'd still be playing those antique wooden, mechanical-reeled machines you see in museums. But you're not, because as games wane in popularity, they get moved off casino floors. That constant renewal could slow to a snail's pace with a ban.

"The properties have a choice," Eadington says. "They can pay for a game or not pay for a game and suffer the discomfort of their customers. Nobody forces them to accept a game. Now they want the Legislature to step in and give them a third option -- ban something they don't like.

"But if you have a competitive marketplace, it's inappropriate for lawmakers to step into it. This would probably undermine the incentive for new products because you've taken away the incentive to spend money on research and development."

Nevada gaming regulators have not yet weighed in on the issue.

Nevada Gaming Control Board Chairman Steve DuCharme said, "We don't have a comment or a position on this issue until we've studied the language of the proposed legislation."

archive