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Bulls vs. Bears

Can Las Vegas continue to grow to meet investors' expectations?

Bulls vs. Bears

In the never-ending debate between the bulls and the bears, a subject of intense interest is the economic health of Las Vegas.

Bears see a troubled economy today, and worse tomorrow as they fear the housing crisis will worsen, shaking consumers and knocking the legs out from under the locals casino market.

They also worry that the national economy will weaken and consumers, who have been avid gamblers in past recessions, will pull in their horns on the lavish spending of the new Strip revenue model that relies upon $300-a-couple meals, $125 show tickets and cash hotel rates.

Bulls look at all the megaresorts and their 35,000 hotel rooms coming on stream between now and 2011 and see huge demand for more workers to fill them, which means continued population growth and a housing demand that will lift the Las Vegas economy.

Some of the worry was dispelled when Boyd Gaming reported third-quarter earnings and boasted a 9.3 percent rise in EBITDA from the locals market while CFO Paul Chakmak spoke rather bullishly about the market’s growth dynamics.

As in all good debates, both sides have sound arguments.

Bears, for example, can point to these statistics:

  • Nevada reported that taxable sales declined 5.7 percent in August, the biggest drop since 9/11 torpedoed tourism six years ago.
  • Population growth. While 6,142 people moved into Nevada in the last monthly report, that was 22.1 percent below last year.
  • Commercial construction has been strong, with multibillion-dollar properties and infrastructure and services being built to handle the burgeoning population, but the number of permits issued recently fell by 7.6 percent.
  • Further, on recent conference calls of community banks that specialize in commercial lending, executives have talked of a softening of office space next.
  • Industrial properties. Vacancy rates are starting to grow in what has been a strength of the local economy. The rate was a relatively low 4.8 percent in the third quarter, but has been rising over the past 12 months.
  • The absorption-to-completion ratio hit 0.48 percent in the quarter, meaning more than half the new space was empty.

Bulls have their own statistics….. Gaming analyst Joe Greff of Bear Stearns recently compiled a 45-page report in which he showed the impact of waves of new resort construction on the casino industry in Las Vegas.

History should repeat itself, and the deluge of new hotel rooms coming to Las Vegas in the next several years should boost business, he concluded.

Greff expects $39 billion in casino hotels, condo-hotels and timeshares to open between 2007 and 2011, increasing rooms by 5.8 percent a year compared to the 1970-2006 average of 4.7 percent.

History shows room demand growth slowest-3.1 percent yearly-when capacity grew the least-0 percent to 4 percent. Greatest demand growth-10.4 percent-came when room supply increased 8 percent or more.

Greff calculates the coming round of room growth will lead to a 10.1 percent increase in visitor spending, which is actually a click below the historical average of 10.2 percent.

He sees gaming revenue growing 10 percent, beating the historical average of 9.8 percent. Convention revenue should grow 12.7 percent against history’s 14.4 percent. Entertainment and other revenues may rise 9 percent against 9.6 percent.

One interesting aspect of his study is the effect of these major projects on stocks.

Stocks of Strip operators (Harrah’s and MGM Mirage) rose 31.1 percent the year before big capacity additions in the market and 48.7 percent the year of the additions, then dropped 4 percent the year after.

Stocks of locals casinos (Boyd and Station) fell 19.3 percent the year before big capacity additions, rose 28.1 percent the year of, and fell 22.8 percent the year after.

Meanwhile, the development of non-gaming revenue, rather than being a weakness if consumers cut back spending, can be seen as a strength because all the new activities outside of gambling make Las Vegas a much more attractive market.

Of course, bears have another view of the megaresort development. They see 35,000 rooms aimed at the high end of the market as too crowded for everyone to survive.

For example, use Greff’s estimate of $39 billion in capital expenditures on casino resorts. To get just a 10 percent EBITDA return means generating $3.9 billion in gaming revenue, or 10 times what the Bellagio is expected to do this year. A 15 percent return would take 15 new Bellagios.

And forget about the old standard of a 20 percent return. Even the most bullish bull can’t believe Las Vegas can generate new gaming revenue of 20 Bellagios over the next four years.

Those kinds of hurdles are one of the reasons selling condominiums and building, then selling, grand shopping malls are important to help finance these projects.

They also suggest that some projects will not get built, no matter how deep-pocketed and experienced a developer may be. And they suggest some projects that are built will fail. If so, patient investors could pick up the pieces.

Pinnacle Entertainment CEO Dan Lee wants a Las Vegas presence to create a national casino network like Harrah’s. But he has been unwilling to pay the extravagant prices being paid for Strip real estate and per-room construction costs.

However, on a recent conference call, Lee indicated how Pinnacle can get a Sin City megaresort: Wait for the shake-out that overbuilding will bring, then snap up a bargain.

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