Thursday, July 31, 2008

Casino Stocks Scream of a 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 budget 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 dollars.

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 dollars. 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 turn around 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 turn around, 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 Harrahs 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.

Happy Investing


No comments: