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The Road to Recovery

Has Las Vegas learned its lesson?

The Road to Recovery

As the recession slowly winds down, cities across the United States are seeing positive signs of economic life. But Las Vegas has lagged behind the curve. With tourism and construction the pillars of its economy, Sin City has been hurt by the recession more than many cities, and has struggled to draw visitors to its casinos and keep its housing market afloat.

Economists agree that Las Vegas will continue to face an uphill battle in the months-and maybe years-ahead, but outsiders would be wise not to count the city out just yet.

Winning Streak
The recession, which combined fewer visitors spending less money with gaming companies’ massive overleveraging, sent the Las Vegas gaming industry into a two-year tailspin that is only now beginning to slow.

In four of the last five months, the casinos along the Las Vegas Strip have seen increased gaming win numbers, including February’s remarkable 32.8 percent jump over the same month the previous year. March’s 2.4 percent increase was more modest, but still an improvement.

February’s impressive numbers were a result of kismet-both Chinese New Year and the Super Bowl took place that month; in 2009, Chinese New Year and half of Super Bowl weekend took place in January. Asian gamblers flocked to casinos’ baccarat tables, leading to a 255.2 percent increase in baccarat winnings over February 2008, while sports betting win jumped 984.9 percent over the previous February. Sports betting also increased in March, up 527.5 percent due to the NCAA tournament.

In March, casinos raked in $52.7 million from baccarat, which was more than March 2009 but less than February’s $205 million win. Some analysts are concerned about baccarat’s contributions to the Strip’s gaming win numbers, because unlike slot machines, baccarat’s hold percentage can vary wildly depending on luck.

“Baccarat is the most volatile; that’s the big concern,” says David G. Schwartz, director of the Center for Gaming Research at the University of Nevada-Las Vegas. “For example, in February, Strip casinos had a pretty good win rate. The overall hold percentage was about 17 percent instead of 11 percent. That was good. If they had had a 7 percent or 5 percent hold percentage, it would have been a disaster. They got lucky.”

Schwartz says slot machine play is a better indicator of the gaming industry’s economic recovery, because more people play slots. In February, slot machine win dropped 8.5 percent, but increased by 0.09 percent in March, the first increase in slot win in 20 months.

“The way the business has gotten the size it is isn’t by getting lucky; it’s by doing things through volume,” Schwartz says. “If your slot machines have a 5 percent hold percentage and you’ve got 20,000 people a day playing your slots, that’s pretty good. If you’ve got 10 people playing baccarat and they might win $10 million or lose $10 million, that’s good, but it’s definitely riskier. If this is the future, we’re going to be in for some trouble, because we’re going to have more volatility, and at the bottom line, that’s not going to be good, because you’re going to have these fluctuations. I think investors are going to get nervous because they don’t understand the nature of gaming-that there are fluctuations at the high end.”

Though baccarat’s increasing importance may cause problems for casinos in the future, Applied Analysis principal analyst Jeremy Aguero says the recent gaming win numbers indicate that hope is not lost.

“I don’t care what the reasons are, the fact that we have something positive to point to is encouraging,” Aguero says.

“I think some people tend to forget that we’ve gone through-and continue to go through-the worst period in recent U.S. history, and even during that period, 35 million people decided to get in their car or get on a plane and come to Las Vegas. They spent in Clark County alone more than $22 billion. I think we’re encouraged by that.”

New Kids on the Block
When the economy began tumbling in 2007, three big projects were already well under way. CityCenter, MGM Mirage’s $8.5 billion partnership with Dubai World, nearly led the company to bankruptcy, but opened last December with hopes that the mega-resort would boost visitation to Vegas and fears that the property’s hotel rooms would cannibalize existing product.

According to a recent report from the Las Vegas Convention and Visitors Authority, visitation to the city increased by 0.7 percent in March and the average daily room rate increased by 0.8 percent in the last year. Convention attendance was also up, though the number of conventions declined.

CityCenter’s opening may have contributed to increased tourism, but the resort also reported a first-quarter operating loss of $255 million. MGM Mirage’s overall first quarter revenue declined by 4 percent over the same quarter in 2009. The first-quarter losses are not promising, but Aguero says CityCenter needs more time to prove its worth.

“I don’t know anyone who had the expectation that the CityCenter project was going to come online and would magically turn the economy around,” Aguero says. “The expectation was that it was going to take CityCenter probably two to three quarters to start getting ramped up. The first quarter I would say was pretty much what we would have expected. We continue to see visitor volume growth, we continue to see some ramping up of the average daily room rate, and it seems like the CityCenter project has fit into the existing market as opposed to creating a new market.”

On a recent conference call, MGM Mirage CEO Jim Murren said the company expects CityCenter to continue to improve its performance.

“It is quite clear to us that CityCenter will become the major showcase not only in our portfolio, but in Las Vegas,” Murren said. “We knew the first half of the year would be challenging.”

Las Vegas is currently dealing with a glut of room product, and occupancy rates have declined by 3.5 percent in the last year due to the addition of nearly 8,000 hotel rooms. The Strip will have to absorb more product when the Cosmopolitan of Las Vegas opens this December with 2,995 rooms.

“We don’t need more hotel rooms,” Aguero says. “We need more reasons to fill hotel rooms.”

If Carl Icahn decides to open the Fontainebleau, which he picked up in bankruptcy earlier this year, he will add nearly 4,000 more rooms to the Strip. Analysts speculate that Icahn will keep the Fontainebleau on ice, but Aguero says whatever his decision, it will be a pivotal indicator of Las Vegas’ economic health.

“The Fontainebleau project is going to be somewhat of a bellwether for us,” Aguero says. “The owners are buttoning it up and leaving it halted for awhile, but it does represent a project that is 50 percent completed, and when that project gets going-whether the project is simply demolished or whether it’s sold to another party-I think is largely going to be indicative of what the expectation is in Las Vegas 12 or 24 months from today.”

The stall of growth in Las Vegas may have hurt the city’s largest gaming companies, but the recession has also offered acquisition opportunities to buyers with capital on hand. MGM Mirage sold the Treasure Island to former New Frontier owner Phil Ruffin; Harrah’s Entertainment acquired Planet Hollywood’s debt and then the property itself; and Penn National Gaming continues to look for an opportunity to invest in the Strip.

“I think there was a movement toward consolidation in the industry in the ’90s and early 2000s,” says economic consultant John Restrepo of Restrepo Consulting Group. “I think there’s going to be a movement toward deconsolidation, where you have more players on the Strip.”

‘Economic Purgatory’
Las Vegas’ economy feels the impacts of the larger national and international economies more acutely than other cities due to its dependence on tourism and discretionary income. The U.S. economy appears to be growing, with an increasing gross domestic product and 290,000 jobs added in April, but the nation’s unemployment rate continues to rise. The United States may be hovering in what New York Times economist Paul Krugman calls “economic purgatory,” or a jobless recession.

“The signals are mixed,” says Restrepo. “What seems to be happening here is we’re seeing the rates of decline slowing down in the indicators, or the indicators are flattening out, but there’s a big difference between not declining any further and growing dramatically.”

Restrepo says the economy will likely settle into “new norms” of economic activity-unemployment rates may stabilize at a higher level and incomes at a lower level-and Las Vegas gaming companies will have to apply lessons learned from the recession to future business decisions.

“First, you have to manage your debt,” Restrepo says. “You cannot be overleveraged. Cash will always be king. No. 2: Cheap and easy credit ultimately can become a very addictive drug. No. 3: In making the Vegas experience, the Las Vegas product, available to a wide variety of socioeconomic stratas or groups, you’ve got to offer something more than just all luxury, all the time. You can’t forget the core customer, which is the value customer. I think for a while that was forgotten. The resort industry didn’t care about them, at least on the Strip. ‘So what if they don’t come? They can stay in Indiana.’ I think that attitude has changed. No. 4: I think we’ve learned that the resort industry in Las Vegas is not recession-proof. It’s not even recession-resistant.”

It is clear that many companies have applied these lessons to their business dealings: In recent years, there has been a flurry of debt restructuring and asset sales as companies position their resorts for the future. A future that will likely be devoid of new mega-resorts. Resorts are now focusing on renovating existing product and adding new amenities to up the ante.

“I think you’re always going to have to renovate,” Schwartz says. “Even places like the Tropicana, which has a pretty low average room rate compared to the newer places, has been renovating to stay current. I think that’s always going to be there. As far as people adding rooms, I just don’t see the demand for it in the near future.”

Market State
It is clear that Las Vegas cannot withstand additional growth at this time. Gaming tycoon Steve Wynn, who recently opened his Encore resort in Macau, has indicated that he plans to relocate his headquarters to Macau due to the more welcoming Chinese market.

“I don’t think the Las Vegas market at the moment beckons a large investment,” Wynn said in an interview with Bloomberg Television. “The economic outlook in the United States, the policies of this administration, which do not favor job formation, do not encourage investment at all.”

Boyd Gaming President and CEO Keith Smith had a decidedly more positive outlook on Las Vegas’ economic future when reporting his company’s first-quarter profit last month.

“We continue to be encouraged by improving trends in our business, which clearly reflect the signs of an emerging recovery,” Smith said in a statement. “Our Las Vegas locals market reported the best year-over-year comparison in nearly two years, and business levels are returning to normal seasonal patterns in this region. Given the positive developments in our business, combined with continued improvement in the national economy, we expect to generate year-over-year growth during the second half of 2010.”

MGM Mirage CEO Murren, who fought to keep the company from collapsing under the weight of CityCenter last year, also expressed hope for the city’s future, even as the company recently reported a first-quarter loss.

“We see signs of improvement in the Las Vegas market and expect those to accelerate in the second half of the year and into 2011,” Murren said in a statement. “Our forward bookings continue to improve as our convention bookings continue to gain traction.”

During the company’s first-quarter earnings conference call, Murren said convention bookings at MGM’s resorts, including CityCenter’s Aria, have risen steadily. The Las Vegas Convention and Visitors Authority recently announced that it will host the annual Global Travel & Tourism Summit at Aria in May 2011. Convention bookings translate to more profitable room rates, Murren said.

“As we yield our rooms away from leisure to conventions, the profit impact is profound.”

Las Vegas Sands has also focused on boosting its convention business, and has developed a competition with MGM Mirage for the dollars of conventioneers.

“While the Las Vegas market may not shine as brightly, our conventions business remains compelling,” Las Vegas Sands Chairman Sheldon Adelson said during the company’s fourth-quarter earnings call.

“One of our competitors has been boasting about taking business from us,” Adelson said, referring to MGM Mirage. “Actually, we have taken more business from them than they have from us.”

The LVCVA reported that convention attendance in March was up 5.2 percent over March 2009, though the actual number of conventions dropped by 2.9 percent. One of the LVCVA’s main priorities is drawing convention business to town, and now that the city has become a more affordable destination, it seems likely that the city’s casinos will be able to fill rooms with convention attendees.

“Las Vegas isn’t going to stop doing what’s worked for Las Vegas for a very, very long time, and that is attracting visitors, because it’s a pretty great place to take a vacation,” Aguero says. “We’ve really spent the last five years trying to position Las Vegas as the conspicuous consumption capital of the world-expensive hotel rooms, expensive restaurants, expensive retail. Now we’re sort of repositioning Las Vegas as being a lower-cost alternative: ‘Come to Las Vegas because your visitor dollar goes farther here than it would other places.’ That’s been a pretty effective strategy. I think we’ll balance that out. I also think that expanding the city’s presence with regard to meetings will be important.”

The gaming industry may have learned its lessons from the recession and adapted accordingly, but has Las Vegas? A city that relies on two closely intertwined industries-tourism and construction-as its bread and butter will always be more susceptible to economic booms and busts than cities with diverse markets.

“If we haven’t learned that economic development and economic diversification are important foundations for long-term economic sustainability-if we haven’t learned that from the recession, we’re never going to learn it,” Restrepo says. “People are saying all the right things right now. The question is going to be when we start recovering and things start getting back to some semblance of normality, will that interest in diversification wane or be maintained? We don’t know that yet.”

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