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Hitting the Wall

The elusive recovery and how investors should deal with it

Hitting the Wall

A funny thing appears to have happened on the road to recovery—it’s stopped, or at least slowed to a crawl.

After a slow but fairly steady climb back from the recession, U.S. gaming revenues have gotten off to a punk start this year.

January was mixed. February was downright dismal with the worst year-over-year comparisons since August 2009. March came in drab, too.

The tendency is to blame the economy, which surely has not regained vibrancy. Then there is Washington to blame—higher payroll taxes and all those politicians pointing fingers at each other.

But the economy has been getting steadily better, as evidenced by higher auto sales, home sales and prices, and generally improving retail sales. Those other sectors have to endure dysfunctional policy settings, too.

Indeed, some of the oft-cited external reasons are starting to sound more like excuses.

There just might be a new reality that regional casinos are reaching saturation in many markets, and that their allure is starting to fade in an economy where people are more somber and might not want to party away their discretionary income as freely as before.

Las Vegas hasn’t been much better, with the expected accelerating improvement in convention business not accelerating at all, and room pricing still flat, which dents the modern mega-resort business model.

A recent University of Massachusetts-Dartmouth survey got attention for finding that a significant number of Massachusetts residents are gambling closer to home, in Rhode Island rather than Connecticut.

Less publicized, but maybe more important, is that the number of casino trips overall declined.

If we have entered an era where gaming has saturated many markets, it will put a premium on those companies that have managed to find paths to growth, those that return capital meaningfully to shareholders, and those that operate the most efficiently.

Returning capital to shareholders often means buying back shares. On the surface, share buybacks sound like a great idea. An investor automatically owns a bigger share of the company if less stock is outstanding.

Unfortunately, it doesn’t always work that way. In many cases, managements, with the approval of their compliant boards, deluge themselves with so many millions of share options that, in effect, they are using cash that belongs to shareholders to enrich themselves, and not to effectively reduce share counts.

The reason given for options is that management interests should be aligned with shareholders, but that’s disingenuous at best in companies where about the only shares executives own come through options. Real shareholders don’t get that privilege.

The other frequently used line is that options are needed to attract and retain top executives. This ruse is especially farcical when used in companies that are primarily family-owned. Where else are the family members going to go?

Finally, management doesn’t always buy smartly. There have been more than a few cases in recent years where companies bought in shares at what proved to be high prices, thus wasting shareholder dollars.

However, it is still worth finding companies that use share buybacks to genuinely and significantly reduce share counts. Among those in gaming is Bally Technologies. Wynn Resorts did so effectively in another way when it forced redemption of former chief shareholder Kazuo Okada’s 20 percent stake.

Share repurchases, it is often said, are better than dividends because they aren’t taxed.

But dividends are protected by low tax rates, and they have the advantage of being an unvarnished return of capital to shareholders.

Two companies that pay significant dividends are Wynn and Las Vegas Sands. Both paid dividends that yielded around 8 percent last year. You can’t beat that in today’s artificially low interest rate environment.

Some companies both pay dividends and reduce share count, IGT being an example.

Finding a path to growth is tricky in this fast-maturing industry. WYNN and LVS have done it, though they are concentrated in Asia, and concentration presents risks.

Penn National, Pinnacle and Isle of Capri all have casino projects, though they are entering competitive markets. PENN and PNK, especially, face increasing competition in existing markets. All of that creates what analysts like to call execution risk.

SHFL entertainment and Multimedia Games have growth strategies beyond their traditional business lines as each expands throughout the U.S. with Class III slot machines.

Little Full House Resorts is buying small properties that both are digestible for its size and that are off the radar screens of big casino companies, but that brings risks, too, as FLL must integrate the new properties.

Boyd has been buying, too. It has done a great job of making IP in Biloxi into a hot property, and more recently purchased regional operator Peninsula Gaming.

That brings us down to efficiency, probably the least glamorous way to improve the bottom line.

Among the companies that run tight ships is Monarch Casino. MCRI is fast bringing its operational efficiency to its newly acquired Riviera Casino in Black Hawk, Colorado, and paying down debt at the same time. BYD likewise operates efficiently and is now focusing on its balance sheet.

Finally, there is the internet. Among operators, Caesars has the clearest strategy with its World Series of Poker, though it is attacking all areas, including social gaming. BYD could enjoy the greatest initial impact among American casino companies thanks to managing the Borgata in New Jersey.

Each supplier company touts its strategy, with IGT placing a big emphasis on social, Bally and SHFL building platforms, and Aristocrat staffed by experienced digital executives.

So there are a lot of ideas. None a slam-dunk, but most worth exploration.

 

 

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