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The Power of Patience

Fundamentals are good, but the gaming industry faces slow rebound

The Power of Patience

Casino companies are both labor-intensive and capital-intensive, a bad combination today when we have what might be called a consumer recession and a financial crisis.

Casinos are labor-intensive for two reasons: it takes a lot of workers to clean thousands of hotel rooms daily and staff casino floors 24/7; and casinos compete on providing excellent experiences for their customers.

Thus, cutting labor costs is difficult. Some little-used areas of the gaming floor can be closed during slow hours, restaurants and showrooms can be dark on slow nights, unused hotel rooms can be idled.

But no casino operator wants to cut staff to the point that his operation becomes less attractive than a competitor, or that dissatisfied customers decide not to return. Thus, the temptation is to maintain staffing levels.

Simply put, a casino is not a factory. An operator can’t shut down an entire shift or facility to slash costs.

Complicating cost-cutting is the need to bring customers in the door. As gamblers in almost every market know, casinos are spending fiercely to entice their business. Room rates are falling. Gamblers are being lured with free play or liberal tournaments. Comps are flowing, despite efforts by

casinos to rein them in, or target them to proven gamblers.

The credit freeze and financial crisis are less visible, but very considerable problems.

One school of thought is to welcome the lull it has created in new development as casino developers can’t get financing for new projects.

Certainly, a lull can be welcome to Las Vegas operators who face considerably increased competition in a weak environment as Encore, CityCenter, Fontainebleau, Cosmopolitan and an expanded Hard Rock come on line over the next two years.

And when credit markets do return, a number of prospective casino developers may be long gone, leaving incumbents in strong positions.

But tighter credit has a downside as well. Pinnacle Entertainment, for example, can boast a great growth pipeline, but an awfully slow one until the markets turn around.

And Boyd investors can’t be happy about the continuing costs to carry an Echelon project on which construction has been suspended.

The impact on Atlantic City is not as difficult as in Las Vegas because, except for Revel, projects in AC either have been completed or are yet to start. In other words, the city can continue on as before, and even enjoy the benefits of new hotel towers and added amenities at Borgata, Harrah’s and Trump.

In past economic downturns, governments have turned to gaming to raise revenues without raising taxes, creating a source of industry growth.

But those days are mostly history.

Today, most gaming expansion is coming as slot parlors that are taxed at 60 percent and more of gaming win, meaning not much opportunity for investors in publicly owned companies.

Certainly, that lesson is clear in Florida, where Gulfstream has been a drag on Magna Entertainment, Pompano Park has not been the transforming property Isle of Capri had hoped, and Boyd Gaming shelved plans for slots under the circumstances.

New York is another example, with taxes so high that most slot parlors limp along and a couple nearly shut down until taxes were liberalized earlier this year. Their main contribution, it seems, has been to draw convenience gamblers away from the destination resorts of Atlantic City and Connecticut.

And even if good opportunities do come along, companies may find it difficult to get financing, or to afford to build resorts as attractive as has become standard.

Finally, there is another aspect of the credit crisis that isn’t much discussed, but is important-carrying existing debt.

Casinos have lived in a favorable environment where they have been able to refinance debt to lower levels.

Today, as debt matures, there’s some need to refinance. The cost of debt is coming in higher, meaning their future expense base is higher, or they need to use cash to pay down debt.

In some cases, companies might have to raise fresh capital. And that is difficult to do when stock prices are low and lending tight.

It also may mean that debt for future projects or to complete current projects becomes more expensive.

The good news for the casino industry is that its fundamentals remain healthy, despite the current economic slowdown. People will always gamble and will always seek out entertainment.

In that regard, the casino industry is less sensitive to the economy than some others, though it obviously is affected by the availability of discretionary income, as has been evidenced this year.

The key word for everyone-governments as well as casino operators-is patience. The casino industry is fundamentally sound, and while it may face a development lull, it will come out the other side.

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