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Gazing at the Crystal Ball

What will 2022 bring to an industry that needs a comeback in the worst way?

Gazing at the Crystal Ball

It is time to ask what the new year may bring.

The answer to that question may be more questions. Assuming Covid fades and/or society learns to live with it, here are some key questions and answers for 2022:

  • Tepid 20s? Many have believed that the economy would come roaring out of Covid on the combination of pent-up demand and the significant savings and credit availability among consumers who cut spending during the pandemic.

And there has been an impressive bounce-back. But there now are signs of a more muted near-term future, perhaps because the initial pent-up demand has been released, maybe because stimulus money has been spent, perhaps as millions of people have permanently dropped out of the workforce, and perhaps because year-over-year comparisons are now more difficult to beat.

That doesn’t mean consumers will stop spending, but it may suggest 2022 will begin a Tepid 20s rather than a Roaring 20s.

  • Can operating spending remain restrained? The possibility of slowing revenue growth gives greater importance to this question.

Casino operators surprised the investment world, and probably themselves, in the past year by combining major expense reductions with rising revenues to achieve EBITDA margins that in several cases rose past 40 percent.

It would not be surprising to see margins shrink as casinos become more competitive in attracting players, whether through reopened amenities or higher promotional costs. And, of course, there is an emerging new favorite worry—wage inflation.

Here are some thoughts: Select regional markets will be pressured by greater competition as new casinos open. Colorado will continue to benefit from more liberal gaming regulations. The Las Vegas Strip’s bounce-back will continue but be muted by convention attendance not fully recovering until 2023 or 2024. Las Vegas will continue its population boom, meaning good news for locals operators Red Rock Resorts, Golden Entertainment and Boyd Gaming.

Our biggest expectation—operating expenses will creep up, but the discipline to contain spending will remain and margins will be closer to those of 2021 than those of 2019.

  • Can online operators finally bring down marketing expenses?

The crash in certain online gaming stocks like the vaunted DraftKings reflects the sobering up of investors who spent much of 2021 drunk on the promise of capturing gargantuan revenues three, four and five years out.

Now, many of those investors fear tying up money in companies for whom meaningful profits, or any profits at all, are years away, if ever, at a time when inflation is running 5 and 6 percent. The value of money held in these investments thus shrinks while no stock-supporting profits are coming in.

It is interesting to note the relative strength of the stock of Rush Street Interactive, which focuses on more profitable iGaming than the sexier sports betting and whose business model is geared towards earning money with, the company says, new players turning profitable within six months of signing up.

Two other online-related plays are worth attention: Caesars, where CEO Tom Reeg promises 50 percent margins on online revenue at maturity, and Penn National, which also has a profit-driven online model and whose stock has declined to the point where you buy the land-based business and basically get the online business for free.

  • REITs, a safe haven?

The inflation that is helping to drive down the prices of unprofitable story stocks and that threatens the sky-high margins of casino operators could turn investors to gaming REITs.

During inflationary times, investors seek safety in dividends and hard assets that retain their value. The gaming REITs have both. Plus, they have the security of tenants who have proven to be rock solid even in times of crisis, like the Covid panic of 2020.

Gaming and Leisure Properties and VICI Properties also have proven leadership and prudent growth strategies, and they have executed their plans superbly.

  • Macau. A kitten purring or a tiger pouncing?

The coming year may prove profoundly important to the six casino companies as their concessions expire.

It is possible concessions will be extended as the Macau government considers the future structure of gaming, but the public proposal and hearing process has gone smoothly enough to suggest the matter will be decided in 2022.

There is considerable apprehension about the upcoming decisions with investors made nervous by some government proposals such as restricting dividends and planting government operatives in the C-suite. And, of course, it is possible, if unlikely, that new concessions will be put out to bid.

There is also some trepidation knowing that the national Chinese Communist government abhors gambling and has put Macau and neighboring Hengqin into a new economic zone with a charge of developing into a technology innovation and data center. That, by definition, reduces the proportional size, thus importance, of gaming, though as a practical matter, Macau will depend financially on casinos for the foreseeable future.

The casino operators have tried to reassure investors by talking about how prudent and fair the Macau government has been and continues to be.

But until the new gaming regime is announced and enacted, apprehension is reasonable.

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