I’ve recently read a spate of financial articles arguing that state and local employees, as well as investors via state or a state municipality's bonds, in State X or Y or Z don’t have to worry about default because the State Legislature there recently approved casino gambling. I have a suggestion for those investors and employees being fed this line of bull: Don’t you believe it. There is a smart way to play the increase in the number of casinos nationally, and I’ll discuss it later. But this former path is strewn with the bodies of investors who believed the hype rather than the reality.
I finished high school in Las Vegas and took my first post-high-school job in what was then a thriving “Glitter Gulch.” After many years traveling the world and living elsewhere, I returned to live on the Nevada side of Lake Tahoe 18 years ago. With friends still in Vegas and a home 45 minutes up in the mountains from Reno, I get the local take on how gambling is doing.
Even in Vegas, casino revenues are way down. That means unemployment is up there and housing prices are in a tailspin. This from the city blessed with some of the smartest marketers in the country. Las Vegas is unique. It is a destination gambling resort, with “retail” weekend players coming from California, Utah, and Arizona, vacationers spending a full week or more having flown in from all over the US (and the rest of the world), as well as high rollers rolling in on their private 747s.
“What happens in Vegas stays in Vegas” reinforces its image as Sin City, USA. Major headliners you won’t see anywhere else grace their stages, and every luxury retailer is there for the tourists to gawk at and the high rollers to (dispense their minions to) shop at. (A little Tiffany or Harry Winston bauble for the 7 wives pouting back in Riyadh because they didn’t get to go and play, too.)
And even so, Vegas revenues are down some 20%.
It’s no different for the established gambling destinations, either. Atlantic City’s 11 casinos report that October revenue was down 6.5 percent compared to a year ago – and a year ago was way worse than the previous year -- on way less revenues than Vegas.
Las Vegas has no geographic competition because it doesn’t depend on geography. Sure, LA is only about a 4-hour drive and San Diego and Phoenix about 7, but the only other city within a day’s driving distance is Salt Lake City, and it’s about a third the size of Vegas itself. There are 58 Indian nation casinos in California, and they get their share of the weekend California traffic, but nobody flies to San Francisco to drive to one of the Indian nation casinos.
Atlantic City, on the other hand, is in New Jersey, which is bordered by 3 states, Delaware, Pennsylvania, and New York. Delaware's casinos have just been approved to offer table games as well as slots. Pennsylvania has announced similar plans. Only New York is without casino gambling, but they have pari-mutuel, racetracks, Indian nations, and a state lottery. Atlantic City used to be alone in the Mid-Atlantic – now it is just one of many destinations.
And Vegas revenues are down some 20%.
My own nearest Little Big Town, Reno, has all but given up on attracting high rollers. Reno is still the most convenient gambling resort for residents of San Jose (the 10th-biggest US city) and San Francisco (12th) – but they are now using their big hotel ballrooms and convention centers for special events like attracting the Safari Club or National Bowling Association finals. They have the Reno Balloon Races, the Reno Air Races, the Hot August Nights mega car show, PGA’s Reno Nevada Open and of course the biggest draw of all, Lake Tahoe and the Eastern Sierra less than an hour up the mountainside. If gambling is on the decline here, what makes other states think they’ll find a growing revenue source???!!!
Yet Ohio voters just approved casino gambling and many residents are trumpeting that as their salvation from the decline of their manufacturing and service base. I wish them luck: they have lots of competition. (Only two states have no form of – legal -- gambling: Utah and Hawaii. Las Vegas is the #1 destination for residents of Hawaii -- they call it “The 9th Island” -- and folks from Utah just sneak across the border to Wendover or down to Las Vegas.) Of Ohio’s neighbors, to the north Michigan already has casino gambling, to the east Pennsylvania does, and to the west Indiana does. So what’s so much more cool about gambling in Cleveland, OH than in Pittsburgh, PA?
And Vegas revenues are down some 20%.
Just how much gambling do these state bureaucrats think Americans are going to do? More importantly, what’s a smart investor to do?
First, I would suggest that those investors looking at their own state’s depressed municipal bonds and thinking the ratings, prospects or prices will rise based upon casino gambling are wrong. If I’m avoiding a certain state’s bonds now like the plague, I’m going to continue to.
Entrepreneurs make money; early investors make money; and later investors make money if the business model is a good one and is able to adapt to changing conditions. But bureaucrats and politicians? They take money, they don’t make it! By the time a light bulb goes off over their heads to ride a successful wave, the wave has passed, friends. And they are left out at sea, after dark, with some mighty hungry sharks.
Second, I don’t see the casino companies doing particularly well in this saturated environment. Sure, Wynn Resorts (WYNN), Las Vegas Sands (LVS), and MGM Mirage (MGM) have seen good stock action this year, partly as a result of their foray into Macau. But that’s this year – what do you do for an encore? And while there may be good money in emerging market (versus tired old US cities’) casino gambling plays, you’d better be willing to accept the risk inherent in investing with corrupt 3rd world governance with the added bonus of investing in a cash-based business where “skim” does not refer to milk, mother’s or otherwise. Have fun.
On the other hand, there is one place where I see companies making money from individuals’ propensity to gamble and governments’ propensity to join the party after all the goodies are gone. That would be the makers of slot and video poker machines, the most popular draw at most casinos. Whether the individual gambler wins or loses, and whether the casino can meet its overhead and eke out a profit or not, the makers of these machines will be paid, usually up-front, to produce and install the machines at all these new locations. In addition, they generate recurring revenue by licensing their software, leasing machines, providing repair services, and selling component parts.
I want to own the best-capitalized, best-managed companies in this field that enjoy the best cash flow. Among these, I suggest, for your further research, the biggest, International Gaming Technology (IGT), as well as WMS Industries (WMS), Bally Technologies (BYI), and Shuffle Master (SHFL).
IGT is the big kid on the block, having produced nearly 2/3 of all slot machines in use on casino floors worldwide. Thanks to a tightly-controlled regulatory environment, all existing firms enjoy a high barrier to entry from new companies. Since slots are typically more profitable than table games, and IGT is the biggest factor in slots, and the new casinos being built (whether people will come or not) will be heavy on slots, IGT remains my favorite.
IGT also has deep pockets and a continuing strong cash flow, which allows it to spend more on R&D in an R&D intensive business. They can stay on the leading edge and experiment with and introduce innovations like one of their most recent -- server-based games. The idea behind server-based games is for one server to control all slot machines in the casino via software, allowing less individual machine maintenance and a faster way to change games rapidly to meet fickle player tastes.
IGT has also leased many thousands of machines in exchange for a share of the revenue stream from those machines. IGT takes their piece of every dollar poured into these slots, giving them in recurring revenues of more than $1 billion a year.
Given a choice of buying munis of states rushing to create more casinos in ever less populous and less desirable locations or buying IGT and avoiding or shorting these states – I choose the latter.
Full Disclosure: We and clients for whom it is an appropriate holding are long IGT. Having had difficulty finding an intelligent way to short poorly-run states, we are content to merely avoid them!
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