Every earnings season has a theme. For nearly a year, the theme for casino operators has been achieving and maintaining high EBITDA margins and the rapid, though uneven, return of customers.
Those will continue to be important themes. Maintaining margins will be a challenge as casinos bear the costs of reopening more amenities.
Casinos still await the full return of older patrons, and in Las Vegas the return of convention attendees and international visitors. Indeed, the full return of customers in those three categories could be a huge boost to casino profitability. Older customers comprise a disproportionate share of profitable gamblers. Convention business is a key component to the success of big Las Vegas Strip operators such as Caesars and MGM Resorts. International visitors stay for longer periods of time and typically spend more than domestic customers.
Indeed, the full return of customers combined with operators maintaining spending discipline could mean that 2022 is a boom time for casinos, especially in Las Vegas.
But what makes first-quarter earnings reports and investor conference calls different and especially important will be signs that indicate how well casino operators are withstanding surging inflation and how well gaming technology companies are managing their supply chains.
To date, the bull-bear debate has been dominated by optimism over the return of customers.
But higher operating costs can erode those hard-fought higher EBITDA margins and inflation, at some point, can erode consumer confidence and spending power.
Finally, there is the fear that the Fed might have to, basically, force a recession to quell inflation, and international dislocations caused by the war in Ukraine could both further fuel inflation and worsen any recession.
It might be early to tell if inflation is taking its toll, but it will be worth listening for it on those investor calls and whether companies begin to issue more cautious financial guidance.
All That Glitters…
… is not gold, the old saying goes.
That could be the title of two recent research notes by Carlo Santarelli, the Deutsche Bank gaming analyst who has long been a sobering voice of reason amid the hoopla and hype over online sports betting and iCasino.
In the process, he saved a lot of money for investors who heeded his calls during the now months-long collapse of digital gaming stocks.
In his most recent notes, Santarelli questions the value of using gross gaming revenues and handle as measures of the true total addressable market for digital. As before, he makes his case in no-nonsense presentations supported by data.
Santarelli uses New Jersey, Pennsylvania and several other states to illustrate that, after deducting promotional expenses from gross gaming revenues, net gaming revenues are appreciably lower, suggesting a substantially smaller addressable market than many believe.
Some of the numbers are stunning.
For example, in New Jersey, the average customer lost $320 last year, but the net was really just $120, Santarelli lays out in detailed calculations. In Pennsylvania, year-to-date promotional costs are 63.8 percent of gross revenue. Michigan is 73.4 percent.
Gross revenue and handle amount to bogus and easily manipulated metrics. Relying on them “will simply elongate the process to a steady state, as operators attempt to continue to show gross revenue and handle growth, to satiate investor expectations,” Santarelli says.
Further, the argument that promotional costs will decline as markets mature so far isn’t playing out. In fact, promotional costs are rising even in somewhat mature markets, Santarelli points out.
In Pennsylvania, revenues last football season actually declined 2.5 percent when growing promotional costs are netted out.
Weaning operators off high promotional spending may be more difficult than the several-years-out projections many companies make. Again, illustrated in detailed charts, Santarelli shows that when promotional spending declines, so do gross revenues.
In the end, operators will reach a steady state in which online sports betting will be profitable and higher-margin iCasino more so, though digital profitability will be lower than anticipated, Santarelli says.
Further, in analyzing data, investors will have to acknowledge that when promotional costs finally do drop to the often-discussed 20-30 percent of revenue, the result will be a total addressable market well below many of today’s projections, Santarelli says.
The data and analyses offered by Santarelli support our long-held thesis that sports betting and iGaming will be tougher businesses than their touters contend.
There is another caution that investors should consider—regulatory risk.
Gambling ads flooding the airwaves, making blatant appeals to risk taking and doing it at times and in ways sure to reach youngsters, is an open invitation to sterner regulation and restrictive legislation.
We have only to look at rules being imposed in European countries to see the possible future in America. And we have only to listen to the almost blithe comments of some American casino executives that they are ahead of the problem gambling curve to suspect that they don’t get it.
In the end, state governments might do the job for the industry of bringing ruinous promotional wars under control.