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Preparing for the Rebound

What to look for and where to invest to get the most bang for your buck

Preparing for the Rebound

Gaming stocks have had a rough couple of years after a decade of outperformance, but business volumes appear to have stabilized and valuations have come down to levels approaching historic norms.

Still, there is no clear growth theme as there was when riverboats began to proliferate, or when big companies began buying out the riverboat operators, or when Las Vegas casino operators decided to become developers of lavish real estate projects and euphoria drove stocks to the point of the collapse from which we’re now recovering.

Thus, without tides to lift or lower all boats, 2010 and the foreseeable future look like a stock- picker’s market. Still, there are events and trends to watch in doing that stock-picking. Here are some things to watch:

Genting and Las Vegas Sands are making multibillion-dollar bets on an untested market and resort model. Analysts are projecting each will generate in excess of $700 million a year in cash flow. That would be an extraordinary number.

    If they are right, it’s off to the races for Genting Singapore and parent Genting Bhd, as well as LV Sands.

    It also would become a model other nations, such as Japan and Taiwan, would probably emulate, and that would spell opportunity for Genting, LV Sands and other mega-resort developers, such as Wynn.

    Unemployment rates and consumer sentiment
    These are the two economic statistics that casino operators follow to project trends in their consumer-discretionary industry.

      The reasons are pretty clear. A jobless person doesn’t have money to spare and a worried consumer doesn’t want to spend what he has.

      United States gaming expansion
      States legalizing casinos is no longer a certain driver of higher profits. There are so many casinos in so many states that new properties now cannibalize others to a greater or lesser degree.

        But expansion is good for companies that get casinos in big markets like Ohio, where Penn National has landed two casinos.

        Massachusetts will be lucrative for whoever ends up there if the Bay State legalizes resort casinos.

        International gaming expansion
        Suddenly, Latin America is hot with Mexico becoming a Class III market, Brazil about to legalize casinos, and Italy out of nowhere becoming a 57,000-machine VLT market.

          All of that expansion is great for gaming suppliers and, although they are priced higher than casino companies right now, there is no fear of cannibalization. And we might be in the early stage of the greatest worldwide proliferation of gaming ever.

          Las Vegas and Macau make the headlines, but combined represent less than 10 percent of the market for suppliers. As a top executive at one of the leading suppliers told us, growth in Native American gaming is more important to his company than what happens on the Las Vegas Strip.

          Las Vegas
          The belief has become so pervasive that 2010 will be bad for Las Vegas that it is tempting to take a contrarian view.

            And, indeed, there are signs of improvement. Las Vegas gaming revenues grew in November for the first time in two years, though the market was basically flat factoring out baccarat.

            Visitation to Vegas was up too, while the decline in hotel rates slowed appreciably.

            And 2010 got off to a good start with a strong New Year’s and a Consumer Electronics Show that attracted 120,000 attendees, a 6 percent increase over last year and 20 percent higher than expected just weeks before the show.

            Visitation and stronger convention and trade show business can be harbingers of more normal times ahead, especially for the big mega-resort operators whose business models rely on non-gaming revenue and who have big debt service to pay for all the borrowing that financed their palaces.

            Unfortunately, it isn’t just about visitation and gambling revenue. It’s also about capacity, customer spending and discounting.

            The upscale end of the market has grown 21 percent through the opening of CityCenter. It is slated to grow another 17 percent as Cosmopolitan, Fontainebleau and Caesars’ Octavius Tower open. That’s a lot to absorb in one market segment, especially as consumers are not spending as lavishly anymore.

            And if casinos are luring customers with low room rates, free meals and hefty enough rebates and other enticements to high rollers, a lot of that revenue disappears into expenses.

            One encouraging sign for Las Vegas was the November jump in revenue in the locals market. If that is sustained, it will be good news for Boyd. And it could mean that the Las Vegas economy is finding a bottom from where it can resume growing.


            Earnings leverage
            Almost all gaming companies have significantly cut expenses to the point that when revenues start growing, the bottom lines should enjoy big improvements.

              It has become conventional wisdom in recent months that, between the weak economy and increased competition, regional casino companies face a tough future, except for those that have expansions ahead, such as PENN next
              year in Ohio and Pinnacle this year near St. Louis.

              But Isle of Capri and Ameristar have been especially resolute in reducing costs and stand to gain outsize benefit of higher revenues when consumers return.

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