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Changing Times

A few trends could change the face of the gaming industry.

Changing Times

Three underlying trends are happening in the U.S. gaming industry that will have significant effects on investor decisions:

The supplier side of the industry is piling up debt as it consolidates and removes competitors.

The long period of casino expansion that began a quarter century ago has slowed and threatens to grind to a halt, and perhaps even reverse in some places.

Other new forms of betting—online and sports betting—have the potential to dramatically expand business opportunities for gaming companies.

Associated with online gaming is the rise of social gaming, including the free-play version.

In addition, there is a big international question mark: Asia. Is Macau’s run over, or is the city just taking a break until new capacity comes online? Will Japan and/or other countries jump into the integrated casino resort business?

• Suppliers: Alex Bumazhny of Fitch Ratings has noted that the four companies with acquisition announcements—Global Cash Access, Aristocrat, GTECH and Scientific Games—will run up their debt to make the purchases.

In only two years, the average debt-to-EBITDA ratio among them has grown from two to six times in an industry segment that once was virtually debt-free. And this is coming when expectations are that interest rates will rise, driving up the cost of servicing that debt.

Of course, each of these companies accompanied their buyout announcements with promises to cut costs to free up cash to pay down debt and get ratios closer to historic levels. In pursuing those goals, the companies are setting up some new dynamics.

They are making debt look more attractive than equity for some investors.

Another question is whether the companies can achieve their cost savings and still keep a competitive edge in the arms-race environment of today’s game supplier industry, especially as casino industry retrenchment dampens the outlook for future sales.

• Slowing casino growth: Growth of the U.S. gaming industry has slowed, and there are even some signs of regression.

The big headlines go to Atlantic City, which is losing four casinos this year, five if Trump Taj Mahal closes, and six since the Sands was imploded to make room for a casino that was never built.

But the slowdown and retrenchment doesn’t stop there. Caesars has closed a casino in Tunica. Margaritaville has closed in Biloxi. Massachusetts could repeal its casino law. States that just months ago were hot stops for legislative action to legalize casinos, such as Kentucky and New Hampshire, now look dormant.

The notoriously slow start to internet gaming in the U.S. is taking the wind out of the sails of legalization advocates throughout the country.

And while all of that is happening, casinos are cutting costs in ways that reduce their number of slot machines and reduce visitation, leading to less slot play, which affects supplier participation lease profits.

The potential rollback in gaming can also be seen in lotteries, where the Texas legislature has a commission to study the lottery’s future, including the option to eliminate it. Privatization of state lotteries, a seeming slam-dunk opportunity just last year, looks less promising as the first state to privatize, Illinois, already intends to reverse court in the face of disappointing results.

All of these issues interrelate and deserve serious study to understand their investment implications. And those implications aren’t universal.

Scientific Games and GTECH can make a case that combining their lottery businesses with their new slot businesses creates revenue synergies, not just cost synergies.

New casino opportunities remain, such as MGM Resorts’ casino to rise just outside Washington, D.C.

• New forms of betting: Internet betting is off to a very slow start in the U.S., but its potential is great.

More American states are likely to legalize, just as more countries today are legalizing, or regulating, as they like to say with the politically laden term.

And, while attention in the U.S. is focused on legalizing poker and casino games, there already is a stealth online expansion happening as state lotteries dip their toes into online ticket sales.

That trend should accelerate, leading, perhaps, to broader forms of online gambling.

Sports betting, it seems to us, is inevitable. And when it comes, it could cascade. Sports betting has potential to help brick-and-mortar casinos, but to be really big online as mobile devices and real-time—or in-play, to use the current term—betting proliferates.

So there you are: Lots of questions for investors to answer.

• Asia: Not long ago, Macau gaming revenues were growing 20 and 30 percent a year. Now, growth has not only slowed, but has declined for several straight months.

When the declines started, it was common for observers to say growth will resume when the wave of a half-dozen Cotai mega-resorts start opening late next year. Now, there is some fear that all the new building might create excess capacity and drive down profitability.

In other words, there has been a big shift in sentiment.

Our take is that there is truth in both views: Las Vegas Sands, Wynn and MGM Resorts certainly have shown capacity constraints, and their new projects should find enough players eager to visit to boost growth.

However, all of the new capacity could make for slower growth than the straight-line projections commonly calculated just months ago. Potential proliferation of casino resorts throughout the region also could drain away some Macau growth.

Already, the Philippines, whose potential as a competitor has been discounted by many, is showing it can draw VIP junket operators. Ditto NagaWorld in Cambodia.

That suggests tougher regional competition for Macau if South Korea, Japan, Vietnam and Australia become bigger competitors for the best players.

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