Photo: http://www.papillon.com
The Las Vegas Strip

If you’ve ever been to Vegas, you might think you have an idea of what the gaming industry looks like. Just two companies seem to dominate the Strip: MGM Resorts International owns the Bellagio, the Mirage, the Mandalay Bay, Aria, and the MGM Grand (among others); while Planet Hollywood, Paris, Bally’s, and Caesars Palace are just a few of the properties owned by Caesars Entertainment Corp. Conversely, Wynn Resorts Limited only owns two Strip properties (the Wynn and the Encore), while Las Vegas Sands Corp has the Venetian and the Palazzo.

Like the quixotic world that is Las Vegas, though, the gaming industry is not all that it seems. The biggest casino operators are defined not by their Las Vegas properties, but by their holdings in Macau – this is relatively common knowledge, but you would never guess the real juggernauts from a visit to Vegas. While MGM and Caesars dominate the Las Vegas Strip, they are far behind competitors that have built a strong business in China. Indeed, there seems to be a strong positive correlation between the percent of adjusted EBITDA earned outside of the US (read: Macau and Singapore) and a company’s interest coverage ratio – that is, the companies with a greater exposure to Asia are in a stronger financial situation and better able to pay off debt (see fig. 1). This is a pretty weak statistical observation (small sample size), and interest coverage may be a controversial metric to use since it depends on financing mix (which varies by company) – but this scratches the surface as far as the factors that have driven success or failure for gaming companies in the last decade or more.

Fig. 1

The Sands Storm

Las Vegas Sands makes less than 12% of its adjusted EBITDA in the United States and has the largest enterprise value of the companies we are examining (it is the largest casino operator in the world). Under founder Sheldon Adelson, Sands opened the first foreign-owned casino in Macau in 2004. The company kept up the pace of development, opening the Venetian Macau in 2007, the Marina Bay Sands (Singapore) in 2010, and the Sands Cotai Central in 2012. These properties are tremendously successful – the Venetian Macao reports a 91.9% occupancy rate and the Marina Bay Sands an astonishing 98.9% occupancy rate, according to the company’s most recent annual report. The average daily rate at the Marina Bay Sands is a steep $355, higher than all but one of the company’s properties (the Four Seasons Macao). By comparison, its Las Vegas resorts have a 86.1% occupancy rate with a modest average nightly rate of $203.

Photo: Marina Bay Sands
The Marina Bay Sands in Singapore

Sands is far from finished in China. The Parisian Macao is under construction and expected to open in late 2015. This could be an opportunity to cement the company’s hold on the Cotai Strip with an iconic landmark associated with Vegas. Sands may also be poised to begin targeting mass-market gamblers, a demographic traditionally underserved in Macau. A recent Wall Street Journal article notes that average minimum bets in the territory have climbed to HK$1,000 ($129 USD) for non-VIP gamblers. This is astonishingly high, and the market for low-rollers could be a major source of growth for the company in the next few years. There are also major risks to catering to wealthy mainland Chinese VIPs, who may use Macau as a money-laundering hub.

Caesars – Too Much Debt to be Cool

I lost quite a bit of money at Bally’s (a Caesars property on the Las Vegas Strip for you newbies) on a recent vacation. In light of this analysis, I may have done the company a small favour. Caesars Entertainment Corp is in a heap of trouble due largely to its enormous $24 billion mound of debt. The company just recently sold some of its properties to a subsidiary, Caesars Growth Partners LLC, to gain access to some much-needed cash. Restructuring is inevitable at this point, and there is a high risk of bankruptcy in the next two or three years. Robert Cyran wrote for Reuters Breakingviews a few days ago, “The company’s EBITDA is just about covering interest payments. That leaves little if any to update hotel rooms and gambling dens in ultra-competitive Las Vegas.” This is a very important point, and Paris Las Vegas is a perfect example of how this debt issue is destroying Caesars’ business. The hotel is gorgeous from the outside and the miniature Eiffel Tower is a Vegas landmark. Visitors, however, complain of outdated rooms and décor, which distract from the property’s style and ideal location.

Photo: TripAdvisor
A room in the Paris Las Vegas property

Caesars has missed out on the explosive growth of the Macau gambling market. Total property EBITDA has floundered around $2B for the last three years without a clear uptrend, and with interest and principal payments always around the corner, Caesars is certainly running out of options. Looking at EBIT yields a worse picture – depreciation is depressing operating income, signalling much-needed capital expenditure may be neglected as assets are depleted. This all means the company is in a terrible position to invest in Macau: observers have begun questioning when the territory will near saturation, and procuring permits and licences for such an endeavour would be burdensome to say the least. With precious little capital to invest, Caesars may not get to build a palace in Macau any time soon.

Source: Google Finance
The financial picture for Caesars looks bleak

I also must note that Caesars’ financial troubles are largely a legacy of its 2008 leveraged buyout by private equity firms TPG Capital and Apollo Global Management. According to documents filed to the SEC by Harrah’s Entertainment, Inc (the company name at the time), the deal put “approximately $10.7 billion of debt” on what would eventually become Caesars Entertainment Corp. The LBO could not have come at a worse time, as the financial crisis would soon devastate the Las Vegas gaming industry and property market. In July of 2008, the Financial Times quoted analyst Kim Noland as saying, “Harrah’s leveraged buyout piled on debt just as operating results started to weaken.” Earlier, in October of 2006 as the deal was beginning to take shape, the FT had reported that “a private equity takeover of Harrah’s would would be the first large bet that more debt can be piled on to gambling companies without incurring significant risks.” It is now clear that LBOs may not be suited for the gaming industry. The buyout can’t take all the blame – the 2008 recession certainly made things much worse for Harrah’s – but I don’t anticipate seeing private equity shops going after casino operators again any time soon*.

(By the way, read my previous article about why Guitar Center’s LBO went wrong here.)

My next post in this series will focus on the direction the gaming industry is headed, opportunities and threats, and what they mean for these companies.

* = It came to my attention that Blackstone Group LP acquired the Cosmopolitan, a casino resort in Las Vegas, on Thursday (15 May). At $1.7B, this deal is relatively small. No debt has been piled onto Cosmo yet (this was not an LBO), and Blackstone bought a property, not a whole company. I would argue that my point stands.

Disclosure: In early 2015, I took positions in Las Vegas Sands Corp and Caesars Acquisition Corp.