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Dull and Duller

The economic doldrums of the gaming industry make investment boring

Dull and Duller

Recent months have been fairly drab times for gaming stocks, and the future doesn’t look much more exciting.

The segment that has advanced are the Macau casino companies, thanks to the huge increases in gaming revenue there, and the optimism for Asian gaming generally, thanks also to the fast start of  the new Las Vegas Sands and Genting mega-resorts in Singapore.

Otherwise, the outlook’s been about as dull as dishwater.

Regional gaming markets tread water. The Las Vegas locals market is stagnant thanks to the economic depression that has gripped the metro area. And supplier companies, which constantly see the yearned-for replacement cycle kicking in six months from now, are again seeing it kick in six months from now.

Looking out on trends that could affect the fundamentals of gaming stocks, here are a few things we see:

Lodging is exploding. Investor confidence is booming in gaming’s sister industry. Room rates have begun a recovery and revenue per available room has been growing steadily. The CEO of Sunstone hotel trust recently pounded the table, observing double-digit revPAR growth in strong markets and saying that will be the case in all markets next year.

Much of the improvement is being driven by increased business travel, especially in group and convention business, an important segment for Las Vegas Strip operators.

A number of investors have formed REITs this year and IPO’d to raise funds to opportunistically acquire hotels.

Las Vegas appears to have bottomed. Even though gaming revenues declined in May, they actually grew when unusual items are factored out, continuing a several-month trend suggesting the long decline in business volumes is over.

Casino hotel room rates also have started to turn up, a hopeful sign given that the Cosmopolitan is the only new casino property opening this year, suggesting there may be an opportunity to start the process of absorbing capacity.

One interesting sign: rates quoted to free-and-independent travelers in the weekly JP Morgan survey. Rates compared to last year were up week after week in the summer, though just by single digits.

Regional markets also appear to have bottomed, bouncing back and, like Las Vegas room rates, just a little, but enough to give some encouragement that casinos can begin the slow rebuilding process.

Tea-leaf reading on the economy and consumer sentiment has been mixed, though more down than up among more recent reports.

Still, the idea of free-fall has been all-but-removed, and many economists still discount the chance of a double-dip back into recession.

Asia slowing down? The big bull move might have run its course. Everyone expects Macau growth to moderate in the second half of the year, and there is creeping concern that Chinese economic growth might slow.

So, put all together, there are few catalysts, as the analysts like to say, for stocks moving up soon.

Steve Wynn, in a conference call jab at rival Sheldon Adelson, took aim at an unconventional target—EBITDA, earnings before interest, taxes, depreciation and amortization.

Ambitious LVS reports more EBITDA, but “EBITDA has as much meaning as snow on top of Mount Everest. It’s a worthless number, because you’ve got to pay interest, you’ve got to pay taxes, and depreciation’s as real as the payroll,” Wynn said.

“And when you build all of those facilities, you’ve got to depreciate them and take care of them. So you’d better damn well make sure that they carry their weight,” Wynn concluded.

Hyperbole aside, Wynn has something of a point.

EBITDA is often considered a better measure of a company’s value than earnings for two reasons: it reflects the cash-generating ability of the business, and cash flow is less subject to accounting manipulation than earnings.

It also happens to be the measure prospective buyers use when looking at an enterprise, and is the number lenders use when deciding when to lend, at what interest rate and with what restrictions. Thus, EBITDA isn’t theoretical. It has a bottom-line effect.

But it is also true, as Wynn asserted, that EBITDA isn’t all free cash. Depreciation exists, for example, in the simple recognition that properties and equipment wear out and have to be replaced, and money will have to be spent for that purpose.

One study some years ago showed that Las Vegas resorts spend as much renovating, expanding and refreshing properties in the seven years after opening as it cost to build them in the first place.

So the cash appearing to be freed up by depreciation today is real money spent tomorrow.

And the fact is that companies now report adjusted EBITDA just like they report adjusted earnings, with too many of them recurringly reporting nonrecurring items in a kind of dance around reality.

Similar, perhaps to Steve Wynn, was the answer given by MGM Resorts executive Bill Hornbuckle at an investor conference some years ago when he was asked which measure his company considers more important.

Being majority-owned by one investor—Kirk Kerkorian—the answer is earnings, Hornbuckle said.

And that may be the distinction. A long-term investor who sees himself as owning a part of the business wants that business to produce growing earnings.

Most investors, of course, don’t view themselves as owning a slice of a business. They are more like borrowers of stock, intending to sell it at a profit rather than profit from the business. Even people who describe themselves as long-term investors usually define that as holding a position for just two or three years.

So EBITDA may have more meaning than snow on Mount Everest, but it isn’t the ultimate measure.

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