The Business of Gambling: Part 2

The gaming industry is facing a few major shifts that could spell big change for some companies. This piece examines these opportunities and the positions taken by major US-based casino operators. The coming years may cement the positions of heavyweights like Las Vegas Sands, but it could also be a chance for a company like MGM Resorts International to globalise and come out ahead.

Online Gambling

One of the biggest issues facing gaming companies in the US market is the issue of legalised online gambling. This is a major opportunity and threat to the brick-and-mortar casino business, and the issue has divided the major players. Las Vegas Sands head Sheldon Adelson has been a vocal opponent of legalisation, promising to spend “whatever it takes” to stop this from becoming a reality. He has spearheaded a “six-figure advertising campaign” through his advocacy group, the Coalition to Stop Internet Gambling, according to FT and the Associated Press. Mr. Adelson has the tacit support of Steve Wynn, who has been lukewarm on online gaming for some time. MGM and Caesars have taken the opposite approach, advocating for legalisation through the American Gaming Association (AGA). These companies both sorely need a growth-driving market, and they may sense an opportunity to gain an edge on their larger, more Asian-focused rivals.

So, which is the right course of action for casino operators? This strikes me as a case of Pascal’s Wager. Caesars and MGM are investing in infrastructure to prepare for the possibility of widespread online gaming (Caesars already operates a few websites in New Jersey). If this becomes a widespread reality, they will be in a favourable competitive position to capture a sizeable share of the market and benefit from its growth opportunities. If online gaming is not legalised widely, the companies will have some sunk costs. Think of it like a long call option – the downside has a floor (the amount of money the company invests in online gaming), while the upside is limitless, so to speak (see Fig. 1). Wynn and LVS, on the other hand, are avoiding investment in online gaming – the equivalent of no position, so no upside or downside. If it is legalised, they will be forced to choose either to pour money into an online presence or to miss out on the market altogether. Either way, they lose. As second-movers in such competitive business, they would capture smaller market shares, and missing online gaming completely would be like Microsoft not investing in mobile technology. Mr. Adelson and his cohort is taking a big risk by opposing online gaming.

The lobby against betting online claims that online gaming should be blocked because it could be used by criminal organisations to launder money. This is disingenuous. Messrs. Adelson and Wynn are concerned that online gaming will harm business for their casinos in Las Vegas and throughout the US. Most research does not seem to corroborate this fear. A recent article in Businessweek cites an Econsult Solutions report suggesting that online gambling in Pennsylvania could collect about $110 million in taxes per year through online gambling, “largely without cannibalising casinos’ existing businesses.” This sentiment is echoed in other consultancy reports that I (unfortunately) cannot cite in this article.

Mr. Adelson’s stand against online gaming leaves a bad taste in my mouth. He has spent millions lobbying politicians under the flimsy premise of protecting Americans. On a Bloomberg News video on YouTube, Mr. Adelson insists that money is “not the consideration,” talking instead about how children would gamble online and compares legalisation of online gambling to legalising heroin. The casino magnate has even allied himself with conservative Christian groups opposed to gambling to push his agenda. The whole ordeal makes Mr. Adelson seem untrustworthy. As we say in Mexico, mañoso – slick, tricky, or cheating are the closest translations I can think of.

Next Stop Japan

Japan presents an opportunity for the ‘next Macau’ to take shape. The government seems poised to adopt legislation legalising gambling ahead of the 2020 Summer Olympics, and licences will likely be awarded in Tokyo and Osaka. This untapped market is expected to be worth more than Singapore and could surpass Nevada to become the world’s number two gaming market. This makes Japan a massive opportunity for whichever company nabs a licence. The large, affluent domestic market makes this a solid case of “build it, and they will come.” While some high-roller Japanese gamblers are currently travelling to Korea, Macau, or Singapore to gamble, thousands more would be compelled to spend money if the casino were a short train ride away. Bloomberg also notes that Abenomics has weakened the Yen, making overseas vacations more expensive for Japanese citizens (see Fig. 2).

Source: Bloomberg Fig. 2

Source: Bloomberg
Fig. 2: The Yen has weakened against the US Dollar

If MGM or Caesars can secure financing, building a resort in Japan might be a grand power-play to expand in Asia. Caesars appears to be making plans for a potential development in Tokyo, while MGM has drawn up proposals for a resort in Osaka. The potential growth of such a market would markedly improve these companies’ competitive positions. Caesars has no properties in Asia, while MGM has just one casino in Macau. Unfortunately, neither of these players is equipped to be competitive in the fight for licences that will inevitably play out if gaming legislation passes. Japanese officials have shown a desire to work with casino operators that have experience with integrated resorts of the kind found in Singapore. Integrated resorts are designed to cater to a wider demographic, featuring a spa or theme park in addition to casino facilities. This means Las Vegas Sands and Genting Singapore – owners of the two resorts in Singapore – may have an advantage in courting the Japanese government for licences. The risks for MGM and Caesars could be compounded by the financing hurdles of such a project, which could bind them under unfavourable debt arrangement and eat into profits. Both companies are highly-levered, and more debt would present a major credit risk. Nonetheless, owning a property in a major market like Japan could make a huge difference for these companies.

Of course, Las Vegas Sands is making bold moves to secure the favour of Japanese officials. Mr. Adelson has pledged to spend $10 billion on the market, hoping to secure a licence in Tokyo. This may be theatre: Reuters cites a recent Morgan Stanley report predicting that a resort costing over $5 billion would “offer a return on investment of below 20 percent due to rising costs and a struggle to attract enough high-rolling Chinese VIP customers.” Regardless of how much money winds up being spent, it is clear that Las Vegas Sands has a major advantage in Japan. Less-sophisticated companies may be left with fewer licences to battle over.

Casinos in the US: Beating a Dead Sick Horse

Here’s an idea I don’t like as much: opening resorts in every one-horse town from Pennsylvania to Oregon and hoping more gamblers will materialise and deepen the US market. The Sands Bethlehem (in Pennsylvania), the MGM Grand Detroit, and plans for a Wynn resort in Everett, Massachusetts – these are all fine ideas, but the market won’t define companies the way Macau did. At some point, gamblers may have so many local options that they will avoid Las Vegas altogether. Some observers have suggested that the market is saturated – looking at revenue per casino does not support this assertion outright, but it does seem that growth in revenue per casino is levelling out. The number of casinos in the US has only grown about 2% since 2005, and revenue per casino has increased a solid 12% since then. Again, growth does seem to be decelerating, but saturation may be some years off. As resorts get more expensive and return get smaller, though, I would opine that casinos in the US market won’t be a very attractive market in the next few years. There are plenty of struggling casinos to illustrate that point: Atlantic City has been in decline for some time, and this article highlights casino troubles in a number of other states. The market doesn’t have great prospects, so casino operators would probably be better served by investing in international markets.

Fig. 3

Fig. 3

The gaming industry is in an interesting situation. While the US market is mature and lacklustre, global opportunities (Japan, at the moment) could be a major source of growth in the years to come. Casino operators should focus heavily on competing in these new markets to maintain growth and diversify their businesses. Macau was a defining investment for Las Vegas Sands, and Japan could pose a similar opportunity for the companies that are successful there. The growth this fresh market would deliver can’t be matched by online gaming or casinos in the US. Time will tell if MGM or Caesars seize on the moment.

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


The Business of Gambling: Part 1


Las Vegas

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.

Marina Bay Sands

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.

Paris Las Vegas Room

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.

Google Finance

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.