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Annual Uncertainty

The outlook for 2015 is, in many ways, a polar opposite of a year ago.

Annual Uncertainty

Sometimes, it’s instructive to look back.

A year ago, I wrote about the hyper bullishness of gaming investors after a 2013 in which stock prices had soared. Stocks in Fantini’s North American Gaming Index had just soared 74.29 percent. Our World Index had leaped 59.63 percent.

Everywhere, there were events, and anticipation of events driving up stock prices: enthusiasm over internet gaming in the U.S., the belief Japan would legalize casinos, Macau’s seemingly endless growth, financial engineering as in the expectation that casino companies would unlock value by spinning their casinos off into REITs, as Penn National had just done, and mergers driving up supplier stocks.

The good times could not continue, certainly not at the 2013 pace, I warned.

Among my theses: Internet gaming would be slower to develop than the bulls thought. Japan might never legalize and, if it did, might not just hand over the treasure chest to American casino operators. Valuations were stretched. Macau could not be expected to grow to the sky, and there was always the danger of what the mainland Communist government might do to the casino industry. There was potential for unseen negative surprises.

Well, not to be too much of a self back-slapper, but every one of those cautions proved themselves in 2014. The result was wrecked casino stocks. Those same North American and world indices plunged 20.51 percent and 24.76 percent, respectively.

Today, investor expectations are as gloomy as last year’s were euphoric.

All manner of anti-gaming policy is expected to drive down business in Macau. Regional casinos continue not to recover at the pace of the consumer economy. The internet is a fizzle. Japan? Who knows? And so it goes. Young people are so tethered to their mobile devices and social games that they don’t care to play a slot game or try their luck at blackjack. Even the poker boom that had brought so many young players into casinos is now a receding memory.

It would be encouraging to say that, just as investors were irrationally exuberant last year, they are as irrationally pessimistic now.

Certainly, there are important signs of improvement: Consumer confidence and job growth are way up. Gasoline and other oil-related prices are way down. Las Vegas convention business is back. Heck, Macau casinos even had a strong opening week of the new year.

Alas, such cannot be.

In truth, there are no certain drivers of growth, and there are still plenty of risks to be run. And, given the decline in industry fundamentals, today’s lower stock prices are more apt to be about right than they are to be low.

Let’s look at some of the standard issues:

• Macau. The worst might not be over in Macau as the city, no doubt to the delight of the mainland China government, will review the gaming industry this spring. Given the pressure from Beijing, that could mean even tighter rules.

Perhaps a tip-off in what to expect is the likely expansion of Macau’s smoking ban despite declining gaming revenues. As a major Macau official put it, employee health will not be compromised for casino revenues.

The good news is that visitation to Macau continues to grow, but many VIP players are gone, perhaps not to return.

Those increasing numbers of visitors are tourists. They don’t gamble anywhere near the levels of the people they are replacing. And, while it is popular to say the market will transform into a tourist destination just like Las Vegas, it could be a long and painful process.

We’ll get some glimpse into the future when Galaxy opens its Phase II and Las Vegas Sands its St. Regis hotel tower this year. If they grow business, the thesis that Macau is room-constrained could prove out, boding well for future projects.

• U.S. regional gaming. As many false starts as we’ve seen in the long-awaited regional casino recovery, we have to be from Missouri on this one.

The reality is that most casino states are at or near capacity. Serious new growth would require a major state like Texas to legalize, and that isn’t likely.

So, regional gaming will be a matter of the best manager wins.

• Mergers have just about run their course among major supplier companies. And the ones achieved, or still in the works, haven’t done much for the acquiring company’s stock.

More and more, the future is looking like a mature industry, but carrying more debt than before.

• Interactive gaming still has considerable growth potential as more jurisdictions legalize, and as social gaming continues to blossom.

The questions are who the winners will be, whether social gaming is so powerful that it crowds out growth of more traditional gambling games online, and if Americans will ever embrace sitting at home playing slots when real casinos are so much fun.

In addition, online gaming has legislative risks, as operators in the U.K. are learning thanks to the 15 percent point-of-consumption tax.

In brief, online gaming is an unpredictable space.

• United States economy. Finally, we have economic recovery. And who in a discretionary consumer industry like gaming isn’t happy about falling oil prices?

But the consumer economy bounding back robustly isn’t a slam-dunk. There are already murmurs about the inability of near-zero interest rates to lift the economy, so what happens if a recession returns?

In a sense, concerns about the economy are a lose-lose argument. If a recession hits, casino revenues will decline. If the recovery continues but gaming continues to lag, it might reveal that slow—or no—growth is the new normal. Again, in that environment, the best manager will win.

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