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Marking Time

A perfect storm of negatives weigh heavily on gaming stocks

Marking Time

After suffering through accelerating declines from 2007 through early this year, gaming stocks appear to have settled into a range, albeit a low one.

Unfortunately, the prospects for a quick rebound do not appear to be in the making.

Indeed, while the worst of the financial and credit crises might be behind Wall Street, the deepening recession may be just starting to dampen Main Street. And, with their new revenue models that count on customers spending liberally outside the casino floor, this industry is no longer recession-proof.

The first place to look for an impact on consumers is in gaming revenues, which should be the most stable part of the casino business. That picture has not been pretty.

Revenues declined in almost every gaming state in America in January and March. February figures were up, but only because leap year added 3.7 percent more gaming time, and a Friday, at that.

But even with that help, revenue in Nevada fell. Interestingly, revenue dropped double digits in the Boulder Strip and North Las Vegas districts, while rising slightly in affluent areas around Las Vegas, perhaps adding to the idea that working families are financially stressed, especially in the wake of the housing bubble bursting.

Here are some factors that make an early turnaround unlikely:

Increasing competition. Atlantic City is the poster child for what happens when competition increases. Revenues have declined while the cost of enticing players has increased. Eventually, Atlantic City will work out as it replaces low-value day-trippers with bigger-spending overnight guests. But that will take time, and cost billions of dollars to build must-see properties and add enough hotel rooms.

Macau and Las Vegas also face new competition. In Macau, this may be just a matter of absorbing new capacity as the market grows. But in Las Vegas, there is concern about filling 40,000 new hotel rooms, all aimed at the same upscale market segment.

Expanding too slowly. Ironically, while gaming is expanding rapidly in meccas such as Macau and Las Vegas, growth is excruciatingly slow in the hinterlands.

It is difficult to legalize casinos even where popular support and a strongly pro-gaming governor exist, as has been seen this year in Kentucky and Massachusetts. And even where gaming is new, development and ramp-up can be slower than expected, as we see in Florida, Illinois and Kansas.

Credit markets. Casinos face two problems with credit markets: 1) There is little or no money available for new projects; 2) if it is made available, it will be at rates so high that the old standard of 20 percent returns is long gone.

In that environment, casinos have several unhappy choices: Put in more money as equity. Borrow at high rates and accept lower returns on investment. Shelve the projects.

To date, downsizing, delaying and shelving have been the choices. It is difficult, after all, to put more money into a multibillion-dollar project that may get just a 10 percent or 12 percent return, if it gets even that, or to attract investors or lenders in that environment.

Smoking bans are coming fast throughout the country, and they definitely have negatives effects. Just look at the double-digit revenue declines in Illinois. Or the devastation done to Nevada’s slot route industry.

The day will come when the impacts of the smoking bans are reversed, but that process will not start for a least a year after the bans are implemented, and then growth will resume from a lower base, and some business, especially at the high end, may be lost forever.

Tax increases are always a risk to the casino industry, as we’ve seen in state after state.

Now, we have two new phenomena. States now considering legalizing casinos are proposing 50 percent and 60 percent tax rates that simply make full-fledged casinos unattractive investments. And Nevada, of all places, might raise its tax by 44 percent from 6.75 to 9.75 percent.

The Nevada tax would be small compared to other states, but the multibillion-dollar, extravagant mega-resorts that make Las Vegas a worldwide destination are based on the economics allowed by the low rate.

And if Nevada increases its tax, as seems sure to happen if left in the voters’ hands, will New Jersey be far behind?

So what is an investor who wants to take advantage of what is still a growing industry
to do?

Gaming suppliers are one thought. All those new and expanded casinos in the world, from the Far East to Las Vegas mega-resorts to Indian Country, need slot machines and gaming tables.

That should make a bright future for IGT, Bally, WMS, Aristocrat and Shuffle Master, among others, despite what might be a slow 2008 as casinos cut back buying to save money.

Among the suppliers, investors should look at companies whose products save money for casinos or increase plays. That should be true of all the companies mentioned above, as well as Progressive Gaming International and some
others.

As for casino companies, now could be the time for truly long-term investors to buy solid big-cap names such as MGM Mirage, Wynn and Las Vegas Sands, and ride out the storm.

Frank Fantini is the editor and publisher of Fantini’s Gaming Report. A free 30-day trial subscription is available by calling toll free: 1-866-683-4357 or online at www.gaminginvestments.com.

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