Nevada companies report strong profits to Wall Street, plead poverty to Legislature

David Strow

Wednesday, March 14, 2001 | 11:16 a.m.

Nevada casino operators are telling two different stories about their financial situation. In one version, business is booming and expansion is needed. In another, business is stagnant and competition tough.

In dealing with the Nevada Legislature, the gaming companies are presenting a picture of declining profitability -- a situation that could worsen immensely if state gaming taxes are increased.

But in talking to Wall Street, Nevada gaming companies have been telling a different story. Investors crave growing profits, and that's what gaming companies have generally been reporting over the past several years.

Although they appear contradictory, both stories are technically correct.

"Companies in any business anymore have several sets of books," said Shannon Bybee, executive director of UNLV's International Gaming Institute. "You have books for tax purposes. Then you have the ones for the (Securities and Exchange Commission), because you have to do that under certain accounting guidelines. Then you have the stuff the investment community is interested in, which may be a different set of numbers in many respects."

In discussions about raising gaming taxes, the casino industry says its profits are declining. And that's what the state Gaming Control Board has been reporting -- $496.8 million in net gaming profits for the state's casinos in the fiscal year ending June 30, down from $1.2 billion two years ago. On the Strip, net profits have plunged from $800 million to $200 million using the same indicator.

However, it's common knowledge that the control board numbers show a profit decline -- on paper -- mainly because of an accounting change and not because casino industry profits are actually declining.

But the numbers, cited in a report this week by the Nevada Resort Association, are meant to convince state legislators that Sen. Joe Neal's proposal to increase the state's gaming tax would be unwise. Produced by the Institute for the Study of Gambling and Commercial Gaming at the University of Nevada, Reno, the report warns that the state faces serious fiscal problems if it doesn't diversify its tax base beyond gaming revenues.

"The implication is that you have to be very careful in terms of public policy," NRA President Bill Bible said. "If you change the business environment, you'll change the willingness to invest more funds in Nevada gaming operations."

But investors demand continued bottom-line growth -- and the gaming industry has presented indicators that show the Nevada casino business has been booming over the past several years.

For example:

* "Cash flow," a commonly used measure of gaming property profitability, rose 22 percent from 1999 to $2.2 billion for 20 of the Strip's largest properties in 2000. Cash flow measures what a property earned before interest and taxes, and the noncash accounting charges of depreciation and amortization.

* The control board reported that Nevada casinos took in $9.6 billion in gaming revenues in 2000, up 6.4 percent from 1999. Since 1998, Nevada gaming revenues are up 19 percent. The picture for the Strip is similar -- $4.8 billion in gaming revenues, up 26 percent from 1998.

* Continued strong business trends is the message for Las Vegas gaming corporations dealing with investors. MGM MIRAGE, in reporting a record fourth quarter, referred to the "continued strong performance from the company's casino and hotel operations," while Mandalay Resort Group said both Mandalay Bay and Luxor "compared strongly against their performance in the prior year's quarter," helping offset poor results from the Midwest. In fact, the Strip's gaming executives have taken pains in recent months to dispute analyst predictions of a considerable slowdown on the Strip this year.

As for the shift in accounting strategies approved by the control board for fiscal 1999, it allowed casinos to shift interest debt expense from the corporation's books to the books of the property for which the debt was incurred. Doing that shaves a considerable amount off the reported net gaming income, which is reported property by property.

But it doesn't account for the entire decline of the past several years, Bible said.

"The reporting change might have magnified it, but it was there before in previous reports," Bible said.

The gaming net-income number is not relevant for state tax purposes, as gaming taxes are based on gaming revenues rather than profit. And it's irrelevant for Wall Street, as the corporations' total expenses haven't changed. Companies report casino revenues and expenses, but don't report a net gaming income number to investors. The state's monthly gaming win numbers are watched with great interest by the investment community, but few take much notice of gaming net income numbers.

"For smaller, private companies, their goal is to write off as much as possible for tax purposes," Bybee said. "For public companies, you want to maximize earnings, because your stock price is a measure of earnings."

In total dollars, overall profits have generally been on the way up for Strip gaming companies over the past several years -- at least, according to the reports these companies file with the SEC.

But that's not the case for everyone, Bible said.

"Some individual companies may be doing better, but some will be doing worse," he said.

But one factor has been universal -- the returns on new properties haven't been as impressive. The last five casinos on the Strip averaged a return on investment of 10 percent to 17 percent annually. Historically, returns have been above 20 percent.

The reason, according to gaming analyst David Anders of Merrill Lynch, is that casinos have built considerably more elaborate properties in an attempt to boost nongaming revenues.

"They (Strip casinos) needed to grow the market ... they were already drawing a customer who wanted to gamble," Anders said. "For meaningful growth, you needed a new kind of visitor. (The reduced returns) is why new development has slowed on the Strip.

"As demand slowly grows, it should permit returns to start to improve, but we still have to deal with the Native American situation (competition from new Indian casinos in California)."

The returns might not be great, but the gaming industry still faces the need to keep investors satisfied with growing profits. Without expansions, an established property won't provide the kind of profit growth investors crave, so gaming companies are faced with the choice of building new properties or buying other companies and pushing up profits through efficiencies of scale.

Higher taxes, analysts fear, would make it more difficult to make those investments. And only new investments will deliver new growth in the future, they argue.

"Increasing taxes on operators is self-defeating," gaming analyst Andrew Zarnett of Deutsche Banc Alex. Brown said. "You ruin their ability to re-invest in that market to continue generating shareholder value. We need something new in that town to keep it going.

"It would be a silly proposition for Nevada lawmakers. That's their golden goose."