Venetian results put expansion in doubt

Word is leaking out that the Venetian's so-called "soft opening" is extending to its financial results, raising concerns about the resort's ability to finance its planned expansion.

The 3,000-room Las Vegas Strip hotel-casino's initial occupancy rate was weak and its casino win figures fell short of the projections the Venetian made in its financing prospectus, analysts say.

As a result, prices of the Venetian's publicly traded junk bonds have plummeted since May 3, as investors grow more concerned about the resort's ability to make interest payments.

Some junk-bond analysts have issued "sell" ratings on the Venetian's $425 million of 12.25 percent mortgage notes, which have fallen to 97 from 106 since the resort opened. Another $97.5 million of senior subordinated notes paying 14.25 percent interest at par (100) have dropped even further.

The price declines have raised the yields on the debt, making it attractive to bond arbitrageurs to whom the high interest rates offset some of the risk -- especially the notes collateralized by a mortgage on the resort. Those notes are yielding about 13 percent at current prices -- "very expensive for mortgages," according to one bond trader.

Despite the price declines, Credit Suisse First Boston bond analyst Steve Patricola believes the Venetian's securities still "appear well overvalued" and are expected to drop even further.

Patricola's projections assume no additional cost overruns for the resort's construction that could impact the Venetian's ability to pay its debts. In the best-case scenario, the CS First Boston analyst sees the Venetian having to make up a $16 million shortfall in funds it needs to make interest payments on its bond and bank debt through November.

"While subject to uncertainties, management may need to stretch construction payables and/or arrange additional equity or debt financing in order to maintain liquidity until the mega-resort is projected to begin covering its interest nut" in the fourth quarter, Patricola said in an analysis prepared for institutional investors that has been leaked to Las Vegas reporters.

Cost overruns, which are not unusual in the construction industry, have resulted in increases in the guaranteed maximum price (GMP) for the hotel-casino complex.

The Venetian has acknowledged construction costs are at least $90 million higher than called for in the GMP and said it has rejected additional claims for costs made by the project manager. It hasn't disclosed the amount of the additional costs in dispute.

Venetian owner Sheldon Adelson and the resort's president, William Weidner, are out of town and not expected back until next week, an aide said. The resort's executive vice president, Brad Stone, couldn't be reached for comment.

But a source says Stone told attendees at a recent high-yield bond conference in Atlantic City that the Venetian had initially posted occupancy rates "in the low 60s."

The resort opened in phases beginning May 4 -- it's retail complex didn't open until June 16. While May and June Strip hotel occupancy rates have not yet been reported, the average in April was 94.9 percent.

According to conference attendees, Stone also said he believes the Venetian can "get to the low 80s in July, but only with lower rates and a lot of wholesale business."

For August, the attendees said, Stone predicted occupancy rates in the 90 percentile range.

The Venetian's room rates are also running below the $167 average daily rate (ADR) company executives predicted when they borrowed $930 million to build the first phase of the resort, which they ultimately hope will include 6,000 rooms.

A survey by Bear Stearns & Co. says the Venetian will be charging free and independent travelers (FITs) -- who traditionally pay higher prices than wholesale customers -- $149 a night for weekend stays for the rest of July. The FIT price drops to $109 a night for mid-week stays, Bear Stearns reported.

At the bond conference, a source says Stone said current group bookings through the fall months account for only 38 to 40 percent of total available rooms, though the Venetian had forecast such business would fill 50 to 60 percent of its rooms.

The source says Stone also told conference attendees the Venetian was posting "average Strip revenues" from its slots, but declined to discuss results for table games. In April, the average win per day for each slot at Strip casinos was $107.

The Venetian had projected average daily slot win at $151 per machine -- 44 percent higher than the Strip average in April.

The Venetian had also said it expected to win $2,463 a day from each of its table games, excluding baccarat. That's 38.6 percent higher than the $1,777 average daily win per table for all Strip casinos in April, according to Bear Stearns.

Another junk-bond analyst who requested anonymity said Venetian officials told him privately they were "comfortable" with estimated casino win figures so far of $95 per day per slot and $1,500 per day per table game.

Casino win and room revenue are the two critical elements in the Venetian's business plan, as Adelson hedged his bets by eschewing substantial upside revenue potential from resort-owned restaurants and retail shops, opting instead for predictable lease payments from outside purveyors.

But if casino win and room revenue stay so far below projections, Adelson will have to find other sources of money to make interest payments.

According to Securities & Exchange Commission filings, Adelson has already borrowed money earmarked for the planned Phase 2 -- construction of another 3,000-room hotel tower called the Lido next to the Venetian.

Some of that money came from Adelson's "equity" investment in the Venetian, derived from $110 million of senior bank loans and another $30 million of junior bank debt arranged by Goldman Sachs and LaSalle National Bank.

And he's counting on strong results from Phase 1 -- the Venetian -- to enable him to borrow the additional money needed to build the Lido.

"Realistically, his ability to finance Phase 2 will depend on the Venetian's performance," said one bond analyst who requested anonymity.

Adelson will probably need more than that if he's going to be able to borrow Phase 2 money at rates that will allow him to compete with some other top Strip operators, who can borrow money 5 percentage points or more below his current cost.

The blended rate for the Phase 1 debt is about 11.1 percent, and some analysts say he may have to pay in the mid-teens or higher for Phase 2 -- unless he can provide evidence of a predictable revenue stream for the complex.

Even a 5 percentage point spread is onerous. A casino financed with $1 billion of debt at 6 percent earns $50 million, after interest payments, before a casino built with $1 billion of 11 percent debt earns its first dollar.

That's one reason why Adelson has threatened to sue the Las Vegas Convention & Visitors Authority to block its plans for a 1.3 million-square-foot expansion.

Weidner, the Venetian president, said on April 27 the LVCVA expansion would result in a loss of "60 to 80 percent of the business" in the Sands Expo Center, which is also owned by Adelson.

The Venetian is counting on the Expo Center to fill the hotel's rooms in the critical mid-week periods with convention and trade show attendees it expects will help it attain the critical $167 ADR.

A loss of Sands Expo Center business to the LVCVA expansion could doom Phase 2 of the Venetian project, and make keeping Phase 1 afloat more problematic.

And it's clear many trade show operators would move to the LVCVA facility, where costs are about a third as high as they are at the Sands Expo Center. At the April 27 meeting where Weidner voiced his concerns, several trade show promoters voiced theirs.

"A number of our exhibitors got together at one of our conferences and took a vote that they would rather be in tents near the Las Vegas Convention Center for our 2001 show than for CES to be forced to sign three years of contracts in order to get space at the Sands for 2001," said Robbi Lycett, a vice president of the Consumer Electronics Show, one of the biggest of the year in Las Vegas.

Unless the Sands Expo Center is booked several years into the future, it's likely Adelson will have to pay even higher rates for Phase 2 money -- if it can be found, at all.

Attendees at the Atlantic City bond conference said Stone indicated Venetian executives are "focused on Phase 1." Stone said construction on Phase 2 won't begin in the fall, as Adelson has said previously, unless there's "a clear path to financing it."

In a recent report, Duff & Phelps Credit Rating Co. (DCR) said the Venetian's decision to open "with only a small percentage of its guest rooms available, without the majority of its restaurants and with the shopping mall and other amenities yet to be completed, is troubling."

"A more experienced and less leveraged operator likely would have waited until the resort was substantially complete ... before commencing operations," DCR said.

"Also of concern, but less troubling, is management's decision to oppose Culinary Union representation for its employees, a confrontational rarity in Las Vegas."

Despite the concerns, several bond analysts who requested anonymity said they remain optimistic that the Venetian will eventually overcome its problems.

"We all know the early numbers are poor," said one, "but we're watching closely for indicators that business is strengthening."

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