Gaming forecast mixed for Las Vegas

Gaming analysts see increasing competition on the Strip, more dismal days for downtown Las Vegas and further consolidation among big casino operators.

But the booming locals' market is paying off well for Station Casinos and Coast Resorts, a trend expected to continue, the securities experts said.

They also predict the pace of innovation in the slot industry will quicken, led by greater use of brand names from the television and movie industries.

A half dozen of Wall Street's best-known gaming analysts offered their views of the industry's future Tuesday at the World Gaming Congress & Expo, which runs through Thursday at the Las Vegas Convention Center.

Their opinions are important to Las Vegas and Clark County, which host the bulk of Nevada's $8 billion gambling industry. The hotel-gaming industry employs 182,000 people in the Las Vegas area -- 26 percent of the local employment base.

"The competition along the Strip has never been more fierce, with the B and C class facilities fighting to keep their patronage," said Jason Ader of Bear Stearns & Co. "The good news is that the market's growing."

"All properties are benefitting significantly right now," said John Rohs of Schroder & Co. "But a year from now it will be much more evident who the winners and losers will be, as the Strip settles back down to slower visitor growth."

One big surprise has been the turmoil surrounding Mirage Resorts Inc., which has experienced disappointing returns on its two newest projects, stopped disclosing property-by-property results, seen its stock price fall 50 percent and recently lost its respected chief financial officer, Dan Lee.

"The big surprise is that the Mirage has been struggling this year," said Joe Coccimiglio of Prudential Securities. The flagship resort has lost customers to the more upscale Bellagio the company opened last October. And Mirage clammed up on communications with investors, saying its former openness gave too much information to competitors.

"Financial disclosure has pretty much slowed to a trickle," Coccigmiglio said. "They won't comment on third-quarter trends, so we'll have to wait to see if things are improving.

"But (Mirage Chairman) Steve Wynn created this town and has enormous talent. I wouldn't make the mistake of counting him out. The cream rises to the top," he said.

Still, quipped Lawrence Klatzkin of Jeffries & Co., "It's scary to think (Donald) Trump has better disclosure than Steve Wynn."

The wave of new hotel-casino openings -- including Bellagio, Mandalay Bay, the Venetian and Paris Las Vegas -- featured resorts that each cost $800 million or more, noted Harry Curtis of BancBoston Robertson Stephens.

"Yet Bellagio hasn't enhanced Mirage's share prices, the Venetian is struggling, Mandalay Bay hasn't helped Mandalay Resort Group the way we expected," he said. "Only Paris Las Vegas is doing really well."

Curtis isn't optimistic about the downtown Las Vegas market, which has been mired in several consecutive quarters of declining revenues due to increased competition from the new Strip casinos.

"The problem with many downtown operators is that they lack the capital resources needed to enhance their properties," he said.

The surprising strength of the Las Vegas locals' market took many investors by surprise because they didn't recognize the impact of the area's rapid population growth, Klatzkin said.

Ader noted that Station Casinos has generated a 20 to 25 percent return on capital invested in expansion at its four casinos here, compared with a return on investment of about 10 to 15 percent for the four new Strip resorts.

"Station's return exceeded their cost of capital by the greatest margin," which helped fuel a gain in the company's stock price, Ader said. And recent legislation limiting casino expansion into residential areas will make it hard for new operators to compete for local players.

Andrew Zarnett of Deutsche Bank Alex Brown said the Las Vegas locals market exceeds $1 billion, including slot route operations. "But it's difficult to invest in because Station is the only pure play on the equity side," he said.

The analysts said plans by Mirage Resorts, Boyd Gaming and MGM Grand to build resorts in Atlantic City should help reinvigorate that market, as room additions to existing properties by Aztar and Harrah's have helped spark increased visitation.

"It's interesting to note that 8 percent of Atlantic City visitors are there for the first time, while the number is 25 percent for Las Vegas," said Rohs. "This is clearly a destination resort, but Atlantic City isn't and it won't be until it gets some 'wow' resorts."

Ader said he was "amazed" at the business at MGM Grand's new temporary casino in Detroit, citing a line of people waiting up to two hours just to get inside one day last week. He said the new property hasn't had much impact on the nearby casino in Windsor, Canada, leading him to believe the Detroit market can generate $1.2 billion to $1.4 billion in annual gaming revenue.

Coccimiglio and Curtis agreed that the market is big enough for all three new casinos there to do well, though Curtis said MGM and a Mandalay Resort Group partnership will fare better than the Greektown casino because of better highway access.

Curtis said the Biloxi, Miss., area is his favorite emerging market because it's near Florida, casino revenue is growing as new properties open and the climate is less seasonal than in Atlantic City or Las Vegas.

Rohs said Illinois gaming "is going through the roof," due to recent laws removing cruise requirements from riverboats. Coccimiglio said he likes the Southern Indiana market, where five riverboats all post returns on investment above 40 percent.

The only likely new jurisdiction that could threaten Nevada gaming is California, where the new governor and tribes have reached an apparent compromise that would allow expanded gaming on Indian lands, Klatzkin said.

But should a recession hit the country, Rohs said, new jurisdictions could open up quickly as states look for "painless" ways to recoup declining tax revenue.

Coccimiglio and Zarnett said they expect more consolidation among casino operators, especially among the "Big 6" -- Mirage, MGM Grand, Mandalay Resort Group, Harrah's Entertainment, Park Place Entertainment and Sun International.

"When any of those six companies start talking with each other, it generates a lot of excitement on Wall Street," Coccimiglio said. "And there's really no need for six big companies; the industry could have just three. What will get their stocks moving is talks among each other."

"That will happen eventually," Zarnett said. "Park Place will move again once it's completed the acquisition of Caesars World." That's expected to occur in November.

The analysts gave their favorite stock and bond picks, offering a wide range of reasons for their choices.

Park Place is Zarnett's favorite gaming stock because of its geographic diversity and "the best management in the business," he said.

"If you like what's happening with the growth in Las Vegas, you've got to like Mandalay Resort Group because it's got the most rooms on the Strip," said Rohs.

Curtis said he likes Harrah's and Hollywood Park because they have exposure in booming riverboat markets. Ader opted for Park Place because its chairman, Arthur Goldberg, "is now the king of gaming," and Station Casinos because it dominates "the best market for investment in the gaming industry."

Curtis said he favors Harrah's because riverboat states are relaxing restrictive boarding regulations and no new capacity is coming on line to compete, and Boyd Gaming, "which is cheap at $5 a share."

Klatzkin, a debt analyst, said he favors Aladdin Gaming bonds because of the property's location -- it's under construction just south of Paris Las Vegas and across the Strip from Bellagio. He also noted Park Place owns more than 30 percent of Aladdin's debt and will be a ready buyer if investors want to sell, and cited the current 19 percent yield on the bonds.

In an analysts's session covering the slot industry, Sebastian Sinclair of Christiansen Capital Advisors said the gaming-equipment business "has seen more changes in the past 12 months that in the past 12 years."

The dual slowdown in expansion of new jurisdictions and new casinos other than in Las Vegas has sparked a move to boost demand for replacement machines, many of which will take the form of multi-line, multi-coin slots, he said.

And branding, or the practice of game makers to negotiate licensing deals with holders of intellectual properties from other media such as television and the movies, is taking hold in the gaming industry, Sinclair said.

"The result has been a shift to 'hit-driven games,' slots in which a TV or movie hit are linked into a themed game that is more important than the machine the game is played on," he said.

"This means slot hardware will become a commodity business. If manufacturers develop a standard platform, it can play varied software programs on a common device.

"The winners will have to be able to produce a continuing series of 'hits,' much as in the movie and TV business, and will need a strong portfolio of intellectual properties," he said.

Zarnett said he expects more consolidation through attrition, as marginal slot makers fall by the wayside, leaving the field to bigger industry players such as International Game Technology, Anchor Gaming and Mikohn Gaming.

He and Curtis cited the importance of strong balance sheets, as slot makers increase spending on research and development and on licensing agreements.

Curtis also noted the recent developments in California Indian gaming, including the nearly unanimous votes by lawmakers from both houses to expand tribal casinos.

"We think we're well on the way to a legal and unchallengeable expansion of casino gaming in California, which could expand the slot market from the current 12,000 to 20,000 machines up to 43,000," he said. "IGT is in the best position to benefit from that because of its relationship with Sodak."

Sodak Gaming distributes slots to many of the nation's Indian tribes.

Curtis said he likes IGT's stock because the company is a "great value" at its current stock price, has $150 million of cash and is generating another $15 million of free cash flow monthly, and is buying back its own stock.

Zarnett said Mikohn has upside potential because it's introducing new games that could become winners. "When you're a small company with a winning game, it can affect your stock price disproportionately," he said.

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