Casino Stocks Scream Value Play

I am a frequent visitor of Las Vegas, and in my most recent visit I noticed that, despite the recent poor performance of the share prices of such companies as MGM Mirage (MGM), Boyd Gaming (BYD) and Las Vegas Sands (LVS), every single casino was still just as crowded as ever. In fact, I think that every time I go, regardless of what the economic cycles may be, the casinos are even more crowded than the time before. The waits at the restaurants are still an hour and sometime more, people fight for seats at $25 minimum blackjack tables, and the Price is Right slot machines which I so love are always being played by Bob Barker admiring retirees.

I have noticed a change in the crowd in the past year though. There is an influx of foreign visitors, easily identifiable from their various accents. Even with this inordinately high amount of foreign visitors helping to fill the void left by a weakened American consumer base, the clientele of the casinos is still predominantly composed of Americans.

The natural question that I find myself pondering is "with the Vegas casinos just as crowded as ever, why can't the casino operators make as much money as they were making just a year ago?"

I think the answer is a combination of things. One of which is that while Americans may still be visiting Vegas for their vacations despite the overall economic weakness, they may be cutting their gambling budgets as a result of that economic weakness. In previous years, the average gambling budget for a Las Vegas visitor was $559. In 2007, 39.2 million visitors visited Las Vegas meaning that given those figures, gambling revenues for 2007 were approximately $21.9 billion.

Imagine now if that gambling budget were cut by just $100. Even if the number of visitors were 40 million, overall gambling revenues would be brought down to about $18.4 billion. It's hard to tell exactly how much the American consumers are cutting their gambling budgets, but I believe that $100 likely represents a conservative figure.

Another factor that I think may be affecting the results of the casino operators is the tremendous expenditures that they all seem to be undertaking. I have seen firsthand the gargantuan undertaking of MGM Mirage's City Center project and Boyd Gaming's Echelon Place project. I think the undertaking of these projects not only represent large cash outflows for these companies, but also temporary lost potential revenues. This is particularly true in the case of Boyd Gaming which had to sacrifice several of its properties, via demolition and land swaps with other gaming operators, just to make the necessary space for its Echelon Place project.

Though City Center and Echelon Place represent a temporary expenditure for MGM Mirage and Boyd Gaming, these two mammoth projects will bring in massive future revenue inflows. I think these two projects will be new Vegas tourist attractions in and of themselves. This will be especially the case of City Center, as it represents a revolutionary new concept: a hotel, casino and mega resort built to mimic an entire city block.

It's impossible to talk about casino operators nowadays without mentioning Macau, China. There certainly is no slowdown of spending in Macau as gambling revenues for the first quarter of 2008 were up 62% from last year. The biggest issue with the Macau is that, much to the initial surprise of the American casino operators, revenues don't necessarily to go the biggest, most flashy casinos, but rather to the casinos that have the best relationship with the Macau junket operators.

The junket operators are the middlemen in China that serve as intermediaries between the Chinese high rollers and the casinos. Chinese law does not allow the casinos to offer credit to its customers as they do here in the United States, which is why the junket operators are so vital. I think that the American casino operators had initially underestimated the importance of establishing a relationship with the junket operators.

Perhaps the casino operators underestimated the Chinese high rollers' loyalty to their respective junket operators and felt that they would be able to woo high rollers with flashy mega resort casinos. Unfortunately that strategy did not work and it has thus far led to struggles for the American casino operators in Macau as they have lost clients to their Chinese counterparts. I think the tides are starting to turn as the American casino operators are now starting to establish relationships with the junket operators and soon will start to recognize the full potential of the Macau market.

The final aspect that I attribute to the slipping share price of the casino stocks is a general investor distaste for consumer discretionary stocks. Avoiding consumer discretionary stocks is a very natural reaction of investors in times of economic turmoil and I think that the "herd mentality" shows up and sells off these stocks more than may be justified.

I don't think that the current share prices for MGM Mirage, Boyd Gaming and Las Vegas Sands represent the full future potential of these companies. With the tide starting to turn in Macau and future high-earning projects in the pipeline the only remaining criteria for a full fledged turn around would be an end to the current economic situation.

Many analysts believe that conditions have already started to bottom out, which could mean that the casinos will have a full turnaround before the end of 2008. Even if you don't agree that the overall economic conditions are turning around, I still think that the casino operators represent a value play at current levels and it is hard to imagine their share prices falling too much further before there is some type of turnaround, with MGM Mirage, Boyd Gaming and Las Vegas Sands currently trading at 29.02, 9.98 and 45.52, respectively.

There is even a possibility that private equity firms may swoop in with prices at such levels and pay a healthy premium to take one of these companies (most likely MGM) private in just the manner that Texas Pacific Group and Apollo took Harrah's private. I would not trade any companies purely on the possibility of a buyout, but it is an added incentive for companies that are already trading at such low levels.

The bottom line is that the casino operators, in the midst of an American economic slowdown, are trading at levels that should make value investors salivate. I don't think we will see these stocks at such low levels for too long and so that is why I think the time to get in is now. If all of the chips fall in place, I don't think it would be too far fetched to see MGM, BYD and LVS at double their current level this time next year. The way I see it, opportunity abounds in the casino industry.

Disclosure: Long BYD and MGM.

Comments

[chiller:]

What a rediculous assessment. These are value traps just like the banks. They are all too heavily leveraged with excess capacity and high overhead cost in a dwindling market. The interests on their loans are eating into their cash flow(listen to LVS conference) faster than their cost cutting efforts. Furthermore airlines are cutting back their flights to Vegas because of high oil prices which result in high air fares which further influence the spending by peoplewho actually go to Vegas.
As for Macau, the Chinese goverment have more incentive to help Chinese casinos then US because of one simple fundamental reason, they are Chinese owned and their profit will stay in China as oppose the the US casinos. A good comparison is the Chinese auto industry. They will get US companies to invest in their countries just to learn then they will copy the operations and undercut the price.

2008 Aug 01 10:07 AM

[PanamaJim:]

You're kidding right?? Boyd is halting construction of their new casino in Vegas. Would that be because business is booming or even on par with previous years? Blatantly false reporting such as this article should be investigated by authorities.

2008 Aug 01 10:44 AM

[Saurischian:]

...every single casino was still just as crowded as ever.
//////////////////////...
Look at Boyd's earnings report today (8-1-08).
The casinos have no product and no service that people buy except gaming. You can't possibly think that they can pay the electric bill on food, beverages and room rates. Gaming pays the majority of the bills and if there is one thing people like to do its gaming. Getting a "chance" to double their money without having to work. Plus its fun!

2008 Aug 01 11:15 AM

[Moses:]

I can't really understand the valuation on LVS, a price to book ratio of 7 just seems ridiculous to me considering all the risk this company is taking on by expanding through massive amounts of debt not knowing if any of it will pay off.

2008 Aug 01 12:09 PM

[Max Petrisek:]

You may be more optimistic than BYD management who cancelled the big Echelon project and they know that Pa players are leaving the AC area to play at home. So Boyd drops and pops a bit on the 100M $ share buy back. It's the economy and your too optimistic about that. When the players cut back the casino profits tank instantaneously. I doubt that the casino share prices will drop much not take off this year.

2008 Aug 01 12:31 PM

[PhillipKing:]

I would just like to point out to the "TruthMissle" that if you took any time to do any due dilligence rather than just write indignant comments, you would have noticed on the author's blog that this article was written before BYD delayed their Echelon Project. Since they just announced that this morning, it certainly just seems like it was unfortunate timing for the author.
If you did take the time to listen to Boyd's call though, you would have noticed that they are only temporarily delaying the Echelon project not cancelling it. They only expect this to be a short term measure.
On another note, I was just in Las Vegas two weeks ago and I fully agree with the author, it is more crowded than it ever has been. I had a wait of an hour and a half just to get into buffett at the Rio. And the foreign tourists are coming in droves too...these casinos are still making money the way I see it, but they're spending so much too on projects like Echelon and City Center. I fully agree with the author that they'll turn it around as soon as these projects are completed.

Phillip

2008 Aug 01 01:26 PM

[User 236619:]

This just shows what garbage anecdotal assessments can be. If the author had taken the trouble to check the actual numbers he'd find a completely different story. According to the Nevada Department of Employment June Employment report: "Disappointing gaming numbers are also adding to the State’s troubles ... Gross gaming win fell by 15.7 percent in May, the largest monthly year-over-year drop in
over 10 years. Total win fell below $1 billion for the first time in 11 months. All major markets saw declines except Carson Valley. South Lake Tahoe’s win was off by over 24 percent, followed by Clark County at -16.4 percent and Washoe County at -8.8 percent." Casinos have been laying off people at the height of the summer season. A truly Bull sh*t story. But please, do throw your money away on these stocks.

2008 Aug 02 12:54 AM

[jdxx:]

I don't see how a private equity firm could buy out MGM, as the author suggests, when Kerkorian owns over 50% of the stock!

2008 Aug 02 01:30 PM

[ROAMER:]

I do think that BYD is undervalued. One thought here. The buyout bya private equity of Penn Gaming imploded after 14 months. The stockholders got screwed and the Penn execs issued themselves options. Frankly I might have been better off playing the slots rather than investing in them.

2008 Aug 02 02:55 PM

[leh:]

Porter Stansberry just spoke in Vegas a few weeks ago and reports that several cab drivers told him business has been WAY off starting a month ago, slower than right after 9/11.

2008 Aug 02 04:10 PM

[Lyndora:]

Phil: Point taken. Anyone who sits in a Vegas buffet line for 1.5 hours is not spending money at the tables.

2008 Aug 02 11:47 PM

[pennystocks...:]

Sometimes I don't understand stock investing. I bought BYD at $ 11.30, having thought it was a bargain, watched the stock in free-fall and finally threw in the towel at around $ 8.50, locking in my losses forever. Now they mothball their semi-finished 4.5 billion Echelon Place project and suspend the dividend "for the time being" (which is to say forever) - and the stock soars more than 20 % to $12.

2008 Aug 03 02:54 AM

[RECON605:]

huH?!

Did we forget about the energy crisis?

There are less people taking trips on airplanes to goto Vegas because of the hassles and therefore they can go locally in their neighborhoods.

Personally, Atlantic City is a major problem because the idiots in control over there (AC Casino Dev Comm, NJ convention) are run by appointees of Gov. Corzine and they don't have a clue what they are doing there. Most of the commute services to AC are now from the NY Port Authority! In New York City! So if people want to goto AC in New Jersey they now have to go to either New York or Pennsylvania!

So revenues decrease and and the govt. appointees don't have a clue what is going on and they don't care as they get paid whether they are working or not.

It used to be when there was a slowdown in the economy people went to bet at the AC casinos but now a lot of the old-timers don't go because of the transportation system eliminating a lot of bus routes in New Jersey.

So people in Northern New Jersey goto either Foxwoods or the other one up North instead of commuting down to AC, resulting in a decrease in revenue and profits.

2008 Aug 03 06:18 PM

[AF:]

This guy has no idea what he is talking about. I have been living in Hong Kong for years and am very familiar with the Macau gaming market. NO ONE IN THE US including the analysts FULLY appreciate the junket operator issue. I will explain. First the baccarat is at least 70% of the market and virtually all of the play requires a junket operator middleman as the players in the region REFUSE to play cash. The margin for the casino is 2.8% and the macau government gets 40% of the GROSS revenues. The junket operator historically got another 40% and the casino kept 20%. The number of tables in macau have gone from 250 to 4000 and are expected to hit 10000 by 2010. This explosion in demand has increased the junket operators take as the demand for their players has been swamped due to the increased number of tables. This is evidenced by the new MELCO deal that takes the junkets up to 50%- leaving the operator at 10%. There is NOTHING the government can do to change the balance of power here with all the supply coming. Now the bad pt. the operators costs (both to build and operate has exploded). Wynn cost 1BB and Venetian cost 2.7BB but costs are rising at 35% per year bc there are only 500K people in macau. So we have margind declining (with no relief given the supply demand dynamics) and costs exploding. This and Sheldon has 5 more casinos on the way. This is a disaster waiting to happen. The ROIC in the industry in Macau (which once was north of 40% is collapsing) in vegas it is 5-7% barely enough to cover borrowing cost -- wonder why MGM still hasnt gotten city center financed. My prediction is LVS goes bankrupt. Oh one other thing unlike vegas the Chinese do not pay for rooms, food, or shows, bc they dont want to so the billions invested in this is wasted and stranded. This will all come home to roost bc LVS cant turn around as they have ALL the projects being built at the same time.

Last think forgot to mention that they are 50% over budget (if not more in Singapore) and they only have 115,000 sq ft of gaming space. Another disaster. Oh also forgot to mention that all the apartments in macau they claim they will sell are not allowed under the zoning laws that wont be changed till the next CEO of macau comes in in 2010. Oh forgot to mention that by this time they expected to have retail rents close to hong kong. Whooops they are still 25% of that and likely dropping bc no one wants to shop there. I cant understand how anyone owns the stock, but they will be sorry when LVS cant get the remainder of their financing bc of the credit crunch given the above. (forgot that one didnt you).

The above are facts but all the people who write on the subject are in NY and listen to whatever Sheldon says to them. Better yet ask Steve Wynn he will tell you that everything here is TRUE

2008 Aug 12 12:11 PM

[Mike W.:]

The Las Vegas operators are in serious trouble. This is a case of supply and demand being thrown completely out of equilibrium. This never was a recession resistant industry. It was an industry which had limited supply during the last recession. Yes, there was no shortage of regional casinos, but it wasn't until cheap financing came along that these faciliteis were able to afford a face-lift and add amenities that made them competitive. So what did Las Vegas do in response? To stay relevant, they embarked on a ludircrous expansion plan and added features which had no earthly way of generating a decent return. Moreover, they all expanded at the same time (again fueled by morons) and justified the escalating construction costs by emphasizing that they were targeting the high end gamers - many of whom were to come from Asia.

Look at the pathetic return on investment that these projects produced. MGM and Dubai World will be lucky to generate 5-6% on invested capital for the CityCenter project. Even the much adored Steve Wynn is getting smoked. His Encore project was a monument to himself and will never be a serious money maker.

In most industries the solution to this dilemna would be to take out capacity/supply. But how do you do that in Las Vegas? Do you start emploding casinos like the Imperial Palace or Excalibur? Imagine what the Strip would look like afterwards? Gaps between pearly white teeth. How many casinos would you have to tear out to offset CityCenter? Encore? Eschelon? Fountainbleau? You simply cannot take out capacity in any meaningful way.

That leaves you hoping that demand not only rebounds but grows. I won't debate when the economy is going to turn around but I am of the belief that the amount of wealth destruction that has taken place is going to take years, if not decades, to fix and that leaves visitors reluctant to pry open their wallets.

There will be several bankruptcies in the next twelve months. My top candidates are LVS and MGM. WYNN will make it through by virtue of its ability to set room pricing on the Strip and the money that it prints in Macau (which can tax efficiently repatriate to the U.S.).

Carnage pure and simple. The length of the buffett line doesn't change that. A cheap, hot meal will always sell.


On Aug 01 01:26 PM PhillipKing wrote:

> I would just like to point out to the "TruthMissle" that if you took
> any time to do any due dilligence rather than just write indignant
> comments, you would have noticed on the author's blog that this article
> was written before BYD delayed their Echelon Project. Since they
> just announced that this morning, it certainly just seems like it
> was unfortunate timing for the author.
> If you did take the time to listen to Boyd's call though, you would
> have noticed that they are only temporarily delaying the Echelon
> project not cancelling it. They only expect this to be a short term
> measure.
> On another note, I was just in Las Vegas two weeks ago and I fully
> agree with the author, it is more crowded than it ever has been.
> I had a wait of an hour and a half just to get into buffett at the
> Rio. And the foreign tourists are coming in droves too...these casinos
> are still making money the way I see it, but they're spending so
> much too on projects like Echelon and City Center. I fully agree
> with the author that they'll turn it around as soon as these projects
> are completed.
>
> Phillip

Feb 27 12:02 AM