Analysts transform from bulls to bears

By Liz Benston (contact)

Monday, Oct. 20, 2008 | 2 a.m.

Three months ago a Wall Street analyst did something unusual for his business.

He admitted he was wrong.

Andrew Zarnett, the lead gaming bond analyst for Deutsche Bank, issued an investor report in July downgrading some Station Casinos bonds from “buy” to “sell” and “hold,” concluding, “we were wrong as we were caught off guard by the quick deterioration of local Las Vegas fundamentals beyond our expectations.”

Zarnett is one of several analysts who have been busy downgrading the projected value of gaming investments.

These downgrades have come months after gaming companies first reported earnings declines, making the analysts’ actions appear somewhat delayed.

Analysts in general have been criticized as being cheerleaders for the investments they cover. Being positive may yield better access to company executives. Besides being paid for their research, these firms make money issuing bonds and other financial instruments for companies on their watch lists.

An invisible wall separates these departments, yet analysts are careful how they criticize these companies.

With analysts growing bearish by the day, the result is a widening gap between critics and the bulls. The latter are hanging on to the comforting mantras about Las Vegas: The gaming business is generally resistant to recessions, and business on the Strip will return stronger than it was before the downturn. That’s the way things have always been, after all.

If the bears are to be believed, there’s less value in history when the unprecedented has happened.

Real estate analysts, for example, didn’t account for homeowners being given loans destined for default. Few casino executives factored the recent 20 percent earnings declines into their risk analysis calculations.

In his report, Zarnett says his positive outlook was predicated on new jobs created by the roughly 28,000 hotel rooms expected to open by the end of 2010 and the continued migration of Baby Boomers retiring here. Those trends, he said, are expected to be depressed by high energy and food costs, layoffs and large household debts, among other factors.

“One of the most robust markets in gaming and in America faces a precarious time as spending cutbacks continue,” he said.

If Zarnett raised a red flag before many other analysts, bond rating agency Moody’s Investors Service was waving an even bigger flag as early as February, when the agency revised its outlook on the gaming sector to “negative.”

A Moody’s report in March said the economic slowdown comes at a time when the industry is more vulnerable than it was after the 9/11 attacks. “Fierce competition within and among gaming jurisdictions is requiring gaming companies to spend heavily on promotion and capital investment” at a time when companies are “already facing significant debt service requirements and uncertain access to the capital markets.”

“Compared to other, more well-established consumer-based leisure industries ... there is a higher degree of uncertainty regarding how it will perform during a period of prolonged economic weakness,” the report said.

Companies pay for the ratings they receive from the agencies, which critics say make such firms slow to react to market changes.

Keith Foley, Moody’s senior vice president in corporate finance and one of the report’s authors, says his calls are objective and that the company doesn’t make money by trading investments, like banks do.

Like Zarnett, Foley has earned the respect of the companies he covers for his thoughtful analysis. Even unpopular conclusions are receiving private, though grudging, acceptance.

As one executive speaking anonymously put it recently, “People went to movies and arcades during the Great Depression. But that’s not the same thing as going to Vegas and spending a bunch of money.”