Big-picture thinkers weigh in on gaming’s ﬁscal outlook

3 analysts explain market dip, give it context

By Liz Benston

Thu, Jun 5, 2008 (2 a.m.)

Larry Haverty, portfolio manager for GAMCO Investors in New York

Wahid Chammas, senior research analyst at Janus Capital Group in Denver

Joe Fath, portfolio manager of T. Rowe Price & Associates in Baltimore

With the increased cost of a tank of gasoline equivalent to the cost of a few cocktails, fewer tourists are driving to Las Vegas. With airlines cutting back flights to town, it will be harder to fill hotel rooms. And the Strip has grown posh, making it less attractive to the masses.

But that barely touches on why gaming stocks have lost more than $50 billion in value since their peak last year, when Vegas was hot, financing was easy and gaming outperformed most sectors of American business.

The bigger reason for the plummet is found halfway around the world, where profits by Las Vegas operators in Macau are disappointing some investors simply because they’re not as sky-high wild as they were initially. And back home, investors wonder whether Las Vegas is finally overbuilt.

Those are among the observations of a trio of portfolio managers who have followed the gaming industry for more than a decade.

We asked them to explain what has happened to gaming stocks and what’s on the horizon. Their conclusion: The gaming industry has a bright future — mostly beyond Las Vegas.

For this story, we posed the same three questions to Larry Haverty, portfolio manager of GAMCO Investors in New York; Joe Fath, portfolio manager at T. Rowe Price & Associates in Baltimore; and Wahid Chammas, senior research analyst at Janus Capital Group in Denver.

They manage millions of dollars for institutions such as foundations and pension funds that take a longer, big-picture view than Wall Street analysts, who focus on quarterly returns.

Q: Why have casino stocks lost more than half their value in recent months and what’s the longer-term outlook?

Joe Fath: There’s psychology in play. When there’s hubris and everyone’s excited, investors can drive these stocks up further than they should go. Now the opposite has happened. It makes no sense that this much value has been created and then destroyed.

The stories behind these companies haven’t changed much and yet a lot of short-term investors are piling on and shorting these stocks. These guys will eventually get washed out of the market.

The bottom line is you try to measure risk versus reward and when you have a good ratio, you can invest for the long haul. This other stuff is more cyclical.

Is Macau shutting down casinos? No. Are we like Japan, with an economic decline hampered by a difficult regulatory environment that plays out for many years? While there’s no catastrophe at hand, there is a lot of supply coming and you could have a bad situation get worse.

Larry Haverty: The real problem is inflated oil prices.

If airlines continue to cut capacity then Las Vegas will be overbuilt because people can’t fly in. The incremental price of gas is like one or two extra drinks at the bar, which is going to discourage people from driving but it’s not going to destroy the business.

Longer term, I don’t think the price of oil can sustain anything near $130 a barrel. It’s unleashed hell on the economy and something has to give. This isn’t being driven by demand. There’s plenty of oil to go around, but commodity speculators are driving up oil prices. Eventually there will be too much product and not enough demand and the speculators will drop out.

Also, the industry was too aggressive in raising prices on food and beverage, which need to come back to reality.

The bottom line is that operating profits are down 20 percent or so on the Strip, but they’re still generating lots of free cash flow and stocks are set to rebound significantly.

I think the sell-off is also a function of fund managers who tend to be young and inexperienced. It’s short-attention-span theater, with nearly every mutual fund in the industry turning over 100 percent of their portfolio in a year and hedge funds turning theirs over more than once a month. This can be a significant buying opportunity for the rest of us.

Wahid Chammas: Las Vegas needed to build enough properties to drive enough visitation and create the demand. That’s the first phase of growth.

When Las Vegas diversified away from gaming and transformed into a true destination resort town, that’s when it also bolstered profit margins, which is the second phase of growth we witnessed, starting in the late 1980s.

Las Vegas created a captive audience because, as visitation grew, everyone wanted to be there. Eventually people were spending more than three days per trip, hotels were cashing in on more profitable venues like rooms and spas, and more than 50 percent of revenue came from nongambling sources.

The third phase of growth occurred when land and asset values grew, securitization developed and companies could further leverage their assets. So you’re not just earning in your buildings, you’re using those buildings to raise money for new projects or pay down debt.

From the 1950s to 2007, these three phases propelled these stocks.

Other locations outside of the United States realize the magic of creating a resort destination model and that you don’t necessarily need to rely on hard-core gamblers for it to work.

Once demand returns, I think there’s also room to grow in America because there are many fewer people who gamble here than in other markets, like Australia and Scandinavia.

If we’re in a consumer recession, it’s going to be extremely difficult for Las Vegas operators to beat what they did before in phases 1 through 3, which is a tough act to follow.

Companies need to hunker down and focus on returns on invested capital, which may mean delaying projects or spending capital they generate in Las Vegas elsewhere, where returns are better.

Casinos are capital-intensive and don’t seem able to sustain returns in the long term as their fixed costs increase. Is this a concern?

Fath: As construction costs go up and projects get more complex, returns will drop.

Vegas is a saturated market. You can’t just be the new guy on the block. You have to be the next best thing — that’s how you beget more demand.

It wasn’t that long ago that you could easily make more than a 10 percent return because your cost of capital, after deductions, was so cheap. So you saw projects built at a lower cost structure that wouldn’t get built today.

If you’re new to Vegas, the odds are against you that you’re going to get a good return on your investment. That’s why investors are focused on emerging markets, like Singapore and Japan.

Haverty: The price of poker has increased. The price of entry in Las Vegas is probably $1.5 billion, which helps established operators. It would probably cost $4 billion to build Bellagio today. That means Bellagio’s return goes up over time but the return on the second Bellagio won’t be as high. The cost of financing is rising, but things like CityCenter and Echelon were financed last year at extraordinarily low cost.

Chammas: Returns have diminished in the United States. I expect these companies to use incremental dollars to invest in jurisdictions or in other ways, such as buying back stock, that give them better returns. So long as companies earn strong returns that exceed their cost of capital, they could be worthy of investment for years.

What’s going on in Macau and why should we care?

Fath: Macau is already bigger than Vegas in gaming — and growing at a 60 percent clip. The problem is, Wall Street wants instant gratification. The analysts will put out a hugely optimistic growth rate of 70 percent and if it comes in at 68 percent they think it’s slowing.

The May gaming numbers from Macau will probably be in the 30 percent range, but that’s coming off 70 percent growth a year ago. Some analysts complain about shrinking returns, but the fact is that they’re still phenomenal. Wynn Resorts is earning more than $500 million in operating profit in Macau, much stronger than anything in Las Vegas.

Haverty: Macau represents a mind-boggling growth opportunity. What’s troubling for investors is that too much cash is going into the hands of junket operators, who put up little money to bring high rollers to the casinos and skirt the rules of currency conversion.

That’s why some returns have been disappointing. Eventually regulation is going to become more investor-friendly and once Sheldon Adelson builds out the infrastructure on the Cotai Strip, Macau and Cotai are going to become fantastically successful propositions for investors.

Chammas: Growth in Macau and in other new markets like Singapore is a very big factor in the valuation of some of these stocks. Investors haven’t yet appreciated the profit potential of visitors who will eventually stay in Macau for longer periods of time, nor do they appreciate the potential of using these resort assets to finance additional capital and pay down debt. Macau is an island with very limited land availability — the real estate story is fantastic. Also, as Chinese currency appreciates against the dollar, profits in Macau, where casinos take in the majority of their money in renminbi, could rise significantly.

Discussion: 9 comments so far…

By Laker

6/5/08 at 8:30 a.m.

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Another problem with the Las Vegas picture is that everything was built for "the whales" and the average joe, who was looking for a comfortable bed on the strip to rest after spending a dozen hours on the strip gambling, has been pushed out of the picture.
We haven't been back to Vegas for almost a decade for that reason ...
By cignetti

6/5/08 at 10:02 a.m.

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Well we used to visit Vegas 4 to 6 times per year and now we have been there twice in 2008 and will not return as long as air fares are at their present level. In march 2008 two of us traveled via air to Vegas for $400.oo. Now you cannot find an airfare from our location for less than $450.00 per person. I like to visit Vegas but not at these prices even if the rooms are free.
By SPFPAUNIONYES

6/5/08 at 10:19 a.m.

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With the increased cost of a tank of gasoline equivalent to the cost of a few cocktails, fewer tourists are driving to Las Vegas. With airlines cutting back flights to town, it will be harder to fill hotel rooms. And the Strip has grown posh, making it less attractive to the masses.

MGM Mirage Should Also Be Worried About Their Image once the SPFPA and Other Unions who are UNITED WITH US Start INFORMATIONAL PICKETING at various MGM MIRAGE Casinos to Protest Their Union-Busting Tactics Against Their Casino Security Professionals

As for MGM Mirage's Position on Union-Busting

An MGM Mirage spokesman said the company, though preferring that guards remain nonunion, respects the right of employees to seek union representation and has conducted itself within the limits of federal labor law.

“Those same laws also allow the company to express its viewpoint and, if necessary, Aggressively promote management’s belief that our best relationship with our employees is always face-to-face, without a third party intermediary,” spokesman Gordon Absher said.

Source: Las Vegas Sun

“Those same laws that also allow the company to express its viewpoint and, if necessary, Aggressively to promote management’s belief Will Also Apply To THE UNION! "

Stated Steve Maritas SPFPA International Organizing Director

As to Informational Picketing at MGM MIRAGE'S Casinos
J. Terrence (Terry) Lanni Chairman and CEO of MGM Mirage Casinos was once quoted as saying

"The last thing you want is for people who are coming to enjoy themselves to see pickets and unhappy workers blocking driveways,"

Mr. Lanni said. "I swore then that we would never have such problems again."

We Will See If Your Right Mr Lanni.

http://www.spfpalocal7777.org/INFOMATION...
By LVBear

6/5/08 at 4:12 p.m.

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Las Vegas casinos have been fleecing the suckers for too long with lousy games, bad odds, and general hostility towards the patrons. As a long-time resident, I am ashamed of how our industry has taken advantage of the gullible public. Other gaming locations are much more patron-friendly. Maybe we are now paying the price for years of sickening greed and arrogance by the local casino bosses.

Opinions and Commentary on the Gaming Industry: www.TheBearGrowls.com
By SPFPAUNIONYES

6/5/08 at 8:01 p.m.

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PRESS RELEASE

The International Union, Security, Police and Fire Professionals of America (SPFPA) has Officially Filed Charges through our attorneys with the Department of Labor against

MGM MIRAGE Subsidiaries Mandalay Bay Resort and Casino and Luxor Resort and Casino and their Labor Consultants for Failing to file their LM-10 and LM-20 Reports as required by law within 30 days of entering into agreement to undertake persuader activities.

MGM MIRAGE (NYSE: MGM), one of the world's leading and most respected development companies with significant holdings in gaming, hospitality and entertainment, owns and operates 17 properties located in Nevada, Mississippi and Michigan, and has 50% investments in four other properties in Nevada, New Jersey, Illinois and Macau. MGM MIRAGE is developing major casino and non-casino resorts, separately and with partners in Las Vegas, Atlantic City, the People's Republic of China and Abu Dhabi, U.A.E. MGM MIRAGE supports responsible gaming and has implemented the American Gaming Association's Code of Conduct for Responsible Gaming at its properties. MGM MIRAGE has received numerous awards and recognitions for its industry-leading Diversity Initiative and its community philanthropy programs.

For more information on WHY MGM MIRAGE subsidiaries and their labor consultants have failed to file their LM-10 and LM-20 Reports with the U.S. Department of Labor contact:

MGM MIRAGE
CONTACT: Investment Community, DAN D'ARRIGO, EVP & Chief Financial Officer, +1-702-693-8895, or Media, ALAN M. FELDMAN, Senior Vice President of Public Affairs, +1-702-650-6947, afeldman@mirage.com, both of MGM MIRAGE

To View Letter to the U.S. Department of Labor Visit the website below

http://www.spfpalocal7777.org/LM20REPORT...
By casinokid

6/5/08 at 8:30 p.m.

Suggest removal

I wonder if the three analysts are looking at the picture that all of you have painted? and if they did would it be considered a small picture,

Because what you are saying is true i feel the same way.
Also is the Big picture that we never see a fictitious thing like the Jackalope, Bigfoot,.
The real truth is the Dollar is worth less today than it was pre war debt days thats why gas cost more and its passed down to the end user, People will put needs ahead of vacations.
So why are they asking money managers for insight as to where i might spend money.
They are money managers not fortune tellers.
By pele

6/6/08 at 9:06 a.m.

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Well I can say that those people who would of flown to Vegas or driven to Atlantic City from the Pittsburgh area pretty much put a stop to it since we opened slot gaming here in Pa. The numbers that the Pa casinos are seeing are just beyond anything I would of expected. It doesnt matter what time of the day you go to the Meadows casino there will be a crowd, and thats in a temporary building with 1850 slots. The fix casino building will house 5,000 machines with the possibilty of table games.

All you hear from people is why do I need to go to Vegas or AC when we have slots here. Again Vegas and AC are "apples to oranges" compared to slot only casinos in Pa but do the math.
By MrCdnVegas

6/6/08 at 11:37 a.m.

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First off to SPFPAUNIONYES this current down turn in Las Vegas has little if nothing to do with unions. I would guess that the majority of people who visit Las Vegas are NOT union, and would not care about a picket line, and would have no problem crossing one.

Second I travel to Las Vegas 4-5 times a year. As of late, and the reason that my 2008 visits will not be as many are two fold.

1)Flights that used to be 275-300 are now 425-500 as every airline has added a fuel surcharge.

2)The level of service and value for money spent at the Casinos in Las Vegas has gone to hell. The room rate have been high, the payouts low, and the game odds have been getting worse and worse.

One more item to point out. I work in the oil and gas sector, and IMO Larry Haverty does not knows what he is talking about in reguards to the cost of oil not staying at $130 per. Outlook for this year is still that oil will hit $150 and that it will not drop below $110. Actual oil reserves are not the issue, but processing is and there is NO WAY IN HELL that north america is going to be in a position where we have a surplus of gas/diesel/jet fuel any time soon.

Jet fuel is not going to drop in cost any time soon and thus flights are not going to get cheeper, in turn it is going to take a lot cheeper vegas FRB to get people who fly willing to pay the higher flight cost.
By Schmeilgershon

6/6/08 at 12:06 p.m.

Suggest removal

I have been visiting and conducting business in Las Vegas since 1950 and it has always had its doomsayers about overbuilding. This time it will take a longer period to absorb the supply of rooms but the operators must realize that they must lower their sights on the room prices in order to keep a 90% occupancy. They are all chasing the big spenders with a $250.00 room rate and Vegas was built on reasonable rates to attract conventions and now they are cutting their own throats. The companies are sending two people to attend in place of ten and this is very short sighted. We need someone to look at the mid range visitor.