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WALL STREET
Sharon Harris looks at how the fate of the gaming industry is affected by the machinations of Wall Street and financial institutions worldwide…
After decades of financial success and expansion, the fate of the gaming industry rests not only in the players’ hands, but also on the New York stock exchange. Several publicly traded corporations own and operate dozens of casinos, so Wall Street impacts their survival. The fortunes of their officers, employees, shareholders and communities soar and slide with the market.
Gaming is confronting an unprecedented financial emergency, stressing US jurisdictions where the proliferation of gaming has injected economic vitality. Gaming has supported everything from senior citizen programs to education to payroll and property taxes.
Going from private to public
Current conditions are a far cry from the early days in Nevada during the 1930s and 1940s. Casinos sprung up in the Las Vegas desert and the valleys in Reno, with small gambling halls in between. Through the 1970s, private Nevada companies operated casinos.
The stock market had little appeal since regulations created an undesirable economic environment for public offerings. Frank Fahrenkopf Jr, president and CEO of the American Gaming Association (AGA), says, “Prior to Nevada’s 1967 Corporate Gaming Act, every shareholder had to be licensed, and every owned share required approval, regardless of quantity. No one wanted to undergo scrutiny.”
Acquiring investment capital often proved difficult. Unfavorable attitudes towards casinos often deterred conventional banks from lending money to casinos. As a business, these companies needed capital, and sometimes entered into unsavory alliances in the 1950s and 1960s.
Bill Eadington, economics professor and director of the Institute for the Study of Gambling and Commercial Gaming at the University of Nevada at Reno (UNR), claims outside financing helped casinos survive. Describing these convoluted partnerships, he says, “The early groups were fringe, or had questionable ties. In the early 1960s, the Teamsters Union accounted for half the capitalization via heavy investments in pension funds. Questionable financing often resulted in guilt by association.”
To offset these conditions that stifled Nevada’s growth and future, lawmakers amended the legislation in 1969. “Regulators realized that public companies could more easily secure capital for improvements. Now, licenses were mandated for shareholders owning more than 10% of the stock. Key employees and those with management authority, including top executives and board members, had to attain a license,” says Fahrenkopf.
The new law opened the door for an investment onslaught. National chains like Hilton, MGM, Hyatt, Del Webb, Ramada and Holiday Inn launched operations in Nevada. Private companies like Harrah’s went public in 1971.
Throughout the 1970s, smaller private companies understood their limited ability to compete and build large resorts. Their size also impacted their opportunity to expand into emerging markets. However, the pioneer spirit of the Old West motivated entrepreneurs like Sam Boyd to buck the trend and develop a new niche as a family-owned company. After years of working in small casinos, he founded Boyd Gaming in 1973. Boyd retained that company culture up to his death in 1993.
Executive Chairman Bill Boyd, the founder’s son, says, “In those days, being a smaller, family-owned company allowed us to pursue projects unrealistic for a public company. Many thought we were crazy to build Sam’s Town on an empty stretch of Boulder Highway in 1979. As a public company, we might not have built it. However, with our family in charge, we developed the property that created the Las Vegas locals market.
“In those days the owner-customer relationship was closer. As a family-operated company, we really emphasized personal service and our commitment to the customer. Since our family name was on the line, we wanted customers to enjoy a unique experience.”
Whoever operated a property, that philosophy dominated Las Vegas. Excluding those venues owned by Howard Hughes, several public and private organizations each operated a few Las Vegas casinos.
As many other companies went public in the early 1990s, they had early involvement with riverboat, mining town and tribal gaming management. Construction flourished throughout the decade, and non-gaming amenities soon received almost as much attention as the gaming floors.
Boyd says, “As gaming reached the Midwest and South, accessing capital would allow us to be a part of that growth. Boyd went public in 1993, just months after my father passed away, easing our access to greater amounts of capital. Many competitors also went public, using the additional money for Las Vegas and nationwide expansion. Going public also provided many of our original stockholders more liquidity. Many were older, and had used their life savings or borrowed money for their initial investment.”
Nevada’s new law crafted a model for all future jurisdictions to open with some public company ownership. New Jersey legalized Atlantic City gaming in 1976. Resorts International, its first casino, opened in May 1978.
Dan Heneghan, public information officer of the New Jersey Casino Control Commission, states: “Unlike Nevada, we never had any ownership laws. Publicly traded companies owned virtually all of our earliest casinos.”
Back to private ownership
Casino ownership has evolved over time. Companies whose equity was not traded on a stock exchange effectively ended up owning several properties. Right now, the only casino companies listed on the stock exchange, with investments in Atlantic City, are Trump and Borgata, which is a Boyd Gaming and MGM Mirage joint venture.
Private equity firms have acquired others. These groups buy a public company and run it long enough to maximize their return. They may then sell it multiple ways, via an Initial Public Offering (IPO), or to another public company, private equity firm or private company.
Several years ago, Corporate America came under federal scrutiny because of massive corruption and fraudulent bookkeeping scandals. These collapses lost billions for shareholders. In response, Congress passed the Sarbannes-Oxley Act (SOX) of 2002. It broadened standards for American public company boards, management and public accounting firms by criminalizing specific accounting practices and holding executives responsible.
However, SOX excludes privately held companies, motivating public companies to avoid the massive paperwork. This new regulatory environment lured companies like Harrah's Entertainment Inc. to close its sale to Apollo Global Management LLC and TPG Capital LP in 2008. The $17.3 billion purchase was financed with only $6.1 billion in equity. However current conditions have made the balance a crushing debt. Station Casinos in Las Vegas was another sale, acquired by Fertitta Colony Partners.
Whether a public or private company, everyone seeks a speedy burst of cash flow. Eadington predicts that without bank loans, casino operations will become more leveraged. Many can endure short term, but a longer freeze of two to three years will threaten the industry’s survival.
New century, new issues
In addition to financial challenges, the new century brought unexpected operational realities, starting with September 11, 2001. For example, the public never patronized the new Aladdin as travel slowed for some time after the attacks. This decline and exorbitant gas prices in 2007 into 2008 changed the dynamics of operating. Its location has always made Las Vegas a “prisoner” of the gas tank.
Eadington claims the recovery and evolving 2004-2005 gaming model focused on all-purpose destinations. It anticipated a multifaceted tourist economy that included time shares and condominiums. Planned public company projects like MGM Mirage’s CityCenter, Boyd Gaming’s Echelon and Las Vegas Sands (LVS) St. Regis residences were prime Las Vegas Strip multiple structure complexes.
However, these projects confronted huge obstacles when the US housing market collapsed. “As condominium sales dipped, the much needed financing dried up, halting projects,” Eadington says.
CityCenter recently got new life when MGM Mirage and partner Dubai World arranged a financing deal with banks to complete the giant complex. However, Echelon is on hold indefinitely.
Las Vegas operators like Sheldon Adelson are feeling similar pain. As chairman and chief executive officer of the Las Vegas Sands Corp. (LVS), operator of The Venetian, Palazzo and Sands Expo and Convention Center, he has watched his personal multi-billion dollar fortune shrink this past year. While gaming accounts for just 35 to 38 percent of Las Vegas Sands' income, visitor decreases have hurt its overall midweek convention traffic.
The LVS stock fell from a 2007 high of $109.45 a share to under a low of $1.38 in early March 2009. (Ed. Note: As of mid-May press time, it averaged $9 per share) Multiple commitments and international projects compelled Adelson to invest another $1 billion into the company in 2008, providing LVS enough collateral for a $5 billion credit line.
On the positive side, LVS opened its highly anticipated $743-million Sands Casino Resort in Bethlehem, Pennsylvania on May 22. Though the original $1 billion hotel/restaurant/retail mall was scaled back, the 3,000-machine casino has rejuvenated the deteriorating former steel town. Situated along an interstate highway, the Sands is convenient to New Jersey and New York.
An uncertain future
The destructive 2008 and 2009 economies were a wakeup call for every American industry. For gaming, the perfect storm of economic disasters included the shocking stock market plunge, unavailable credit and harmful language in President Barack Obama’s February 2009 federal Recovery Act. Also called the “Stimulus Package”, the $787 billion spending legislation banned any federal assistance not only to casinos, but also to groups receiving stimulus money that met on casino gaming property.
These are tangible issues, but the intangible may have an equally negative effect. Evolving public perceptions regarding acceptable executive compensation, plus Obama’s comments about a lack of accountability while visiting Las Vegas “on the taxpayers' dime”, may also impact the industry’s future direction. Will conventions return in big numbers to gaming cities?
How will gaming climb out of this abyss? Fahrenkopf believes the banks are vital to relieving the stress. “The future will depend on when liquidity from the banks once again flows. However, banking will never be the same,” he says.
Eadington agrees, claiming that too many companies got burned. He says, “The industry never saw the across-the-board decline coming, and there are risks of bankruptcy everywhere. I believe the economy will correct itself after two to three years, but who will be left standing?”
Unfortunately, geography is an unpredictable variable. Eadington expects competing tribal gaming in neighboring northern California to cause long term declines in northern Nevada cities like Reno and Lake Tahoe. One casualty could be Boomtown Reno, owned by Pinnacle Entertainment. Its Chairman and CEO, Dan Lee, recently revealed it preferable to close rather than sustain annual losses.
On Wall Street, the picture is mixed. In New York, Deutsche Bank Research Analyst Andrew Zarnett forecasts that in 2009 California, Indiana, Mississippi and Pennsylvania may remain stable or show profitability. On the flat or negative side, Zarnett calculates a downturn for Atlantic City, Connecticut, Colorado, Illinois, Iowa, Louisiana, Missouri, Michigan and Nevada.
Hopefully, the industry can adapt to fundamental long term changes in conducting business. At the 2008 G2E “State of the Industry” seminar, Harrah’s CEO Gary Loveman insisted the era of building and operating extravagant properties has ended.
Boyd agrees, saying, “As a public company, we must be more careful and judicious with our expansion and development strategy. The days of developing new projects on a hunch are behind us. If we’re going to build, we must justify it to shareholders. However, one thing that will remain is our focus on customer service. Keeping the family-owned business culture makes Boyd Gaming unique… and we intend to keep it that way.”
Boyd is adapting to market conditions by delaying construction on Echelon in Las Vegas. Boyd’s Borgata, Atlantic City’s top-grossing casino, is another victim of the recession. In March, the company reacted to declining business by closing most of its year-old Water Club tower’s 800 rooms on weekdays. The company plans to resume a full schedule in late May.
However, for Atlantic City, the Pennsylvania factor will continue, eroding some of its base. In a research note to investors, Justin T. Sebastiano, Morgan Joseph & Co. Inc. gaming analyst, wrote, "Borgata is clearly head and shoulders above all other casinos in Atlantic City, but the new competition in Pennsylvania should hurt its results, too… the Atlantic City market will remain under pressure for quite some time.”
Another variable is player reaction. Has the recession changed player habits? Legendary casino operator Steve Wynn thinks so. In a late 2008 conference call, he described different mindsets affecting winning and risk taking. If Wynn is right, is this a permanent condition? In some circles, there are fears that consumers will grow accustomed to spending less, particularly on leisure and entertainment.
No one can predict the Las Vegas of 10 to 20 years from now because of the explosive growth patterns of the past two decades. In the short term, approximately 18,000 additional rooms will come online on the Las Vegas Strip over the next 18 months.
Some believe that as larger corporations divest some of their holdings to smaller operators, the answer may be to return to an era of broader ownership. For example, Treasure Island in Las Vegas was built in 1993 for $450 million. Its owner, MGM Mirage, is selling the site to investor and Las Vegas developer Phil Ruffin in the second quarter of 2009. The price tag is $500 million in cash and $275 million in secured notes.
While some larger operators struggle, Zarnett expects positive financials for regional operators such as Penn National, Pinnacle Entertainment, Isle of Capri, Tunica Biloxi and Pokagon.
And, as the casinos go, so goes the manufacturing and supply side of the industry. Public companies like IGT have downsized amid declining sales and a management overhaul. WMS Gaming is holding its own with favorable product quality and sales. Bally Technologies is trading at the midpoint between its 52-week high and low.
With the turmoil facing gaming, the next year will prove critical. As gaming strives to redirect itself, the industry must hope the public hangs on for the bumpy ride.
