FANTINI’S FINANCE: Growing Problem

Investors who expect the gaming industry to grow are going to be disappointed in the short term, as revenues continue to decline in almost all sectors and competitive technologies bring gambling into restaurants, bars and homes.

This is not a time to be a growth investor in the gaming industry.

Regional gaming revenues continue to decline, long after the severe winter, long after joblessness can be blamed, long after adjustments in promotional activities have been made.

New casinos can be blamed for cannibalizing old ones, but new casinos aren’t generating their anticipated revenues as can be seen in Ohio.

More recently, mainline casinos have begun to blame little hole-in-the-wall Internet cafes and slots in taverns and clubs, as in Illinois.

In South Florida, by some estimates, internet cafes take 15 percent of slot revenues away from casinos.

Internet cafes were supposedly closed down by law last year, but they have since reopened, and neither state nor local governments seem in a mood to crack down on them.

In Illinois, the nearly 17,000 VLTs in liquor-licensed establishments generated over $54 million in revenues in May, or half of what slots in the state’s 10 casinos took in. And, while the number of gaming positions in casinos is capped by law, VLTs continue to ramp up, and might double before reaching maturity.

Then there are competitive issues. Casinos continue to open, cannibalizing existing operators. Penn National will open two racinos in Ohio later this year. Caesars opens a Horseshoe in Baltimore and MGM Resorts is building a major property 30 miles south near Washington, D.C. New York is adding casinos, including, possibly, near northern New Jersey, one of Atlantic City’s last markets not poached by new comers. New Jersey itself might finally allow casinos outside of AC.

And, of course, there is Massachusetts if the state’s casino law withstands a November repeal referendum.

In other words, the regional casino industry might be near the point of having the worst of both worlds—competitors everywhere coupled with the high tax rates that were justifiable when casinos were oligopolies.

Historically, casino cannibalization might have been bad news for operators, but it was good for suppliers, as every additional casino meant more slots, table games and systems.

Today, the decline in gaming revenues for operators also means a decline in revenues from slot machines that are on participation lease, a big source of income for suppliers, especially for IGT.

Further, yield management and technology are combining to allow casinos to operate with fewer slot machines, thus taking away much of the benefit of casino expansion.

Finally, the proliferation of competitors in the supplier space has fractured the market, leading to lower market shares while costs remain high to compete in an arms-race environment where each company invests heavily to out-best the other.

Most recently, growth addicts could turn to Asia for their fix, specifically Macau.

But Macau growth has slowed this year and VIP play is actually declining.

Not to worry, the bulls say. The higher-margin mass-market continues to grow more than 20 percent annually, and Macau casinos serve just a fraction of the Chinese population and its burgeoning middle class.

But some caution might be wise. First, in Macau itself, capacity will increase dramatically as all six concessionaires open multi-billion dollar mega resorts starting next year.

The assumption that they will simply tap into the never-ending well of Chinese players needs to be tested against their ability to absorb so much new capacity so quickly.

Further, nations in the region are ready to appeal to Chinese players. The Philippines is showing early signs of being a bigger competitive threat than believed as its four Entertainment City casinos open.

Korea might expand. Australia is getting ready to enter the Chinese game. Japan might legalize. Taiwan, too. Ditto Vietnam. The Vladivostok region of Russia has drawn two experienced developers in Melco Crown and NagaCorp as it targets northern China.

Heck, a casino mega resort is even proposed in Laos.

At some point, only so many straws can suck money out of Chinese gambling before they start sucking air.

And what if all the new foreign competitors succeed? Will China then decide it can’t rely on one market, such as Macau, and decide to open another, perhaps the beach resort zone of Hainan Island?

That would be akin to New Jersey officials finally opening up casinos in North Jersey saying it’s too late to defend Atlantic City as the time has come to win back money now going to Pennsylvania and New York.

Of course, as the old saying goes, it’s an ill wind that doesn’t blow somebody some good. And so it is with gaming. But future opportunities are more likely to be in total return and value plays rather than growth stories.

That, of course, is fodder for future columns.