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Investing The Hard Way: Is It 2012 Again?

TAGs: 888 Holdings, Ameristar Casinos, bally technologies, Caesars Entertainment, chris christie, Editorial, eurovegas, investing the hard way, las vegas sands, Macau, mgm resorts international, mtr gaming group, penn national gaming, Pinnacle Entertainment, sheldon andelson

For gambling stocks, 2013 started out much the same way 2012 did: with a bang. The Market Vectors Gaming ETF (BJK), comprising 45 stocks across the gambling industry, is already up 5.4% through three trading sessions in 2013. Gambling stocks started out strong in 2012 as well, en route to a banner first quarter.

Is it 2012 Again for Gambling Stocks?Of course, the catalysts are different; the fast start to 2012 was due largely to the euphoria surrounding the US Department of Justice opinion on the 1961 Wire Act which appeared – at least at the time – to promise legalized iGaming in the United States. And while those gains proved to be short-lived, a booming broad market boosted economically sensitive gambling stocks, which gained some 16% in the year’s first three months.

This time around, the catalyst is again a broad market boost – the S&P 500 rose 4.6% last week, as the US “fiscal cliff” was resolved, or to be more accurate, postponed. But a significant factor for several stocks was renewed optimism about Macau. The Chinese enclave set a new monthly record for gambling revenue in December, and saw 2012 total gambling win of $38 billion. Gambling revenue grew 14% over 2011, a figure that was lower than previous growth rates but better than feared as Macau-facing stocks stumbled over the summer. Those stocks saw a sharp boost last week, with gains of at least 9 percent across the board, led by a 13% rise at Las Vegas Sands (LVS).

The question in the near term is: will the strong first quarter of 2012 be repeated over the next few months? And which gambling stocks will maintain the recent pace; and which have simply been swept up by market-wide and industry-wide optimism?

The Leaders 

Last Monday, I published a long, technical piece covering LVS at SeekingAlpha.com in which I noticed a curious aspect of LVS’ recent performance. From the end of 2010 to the end of 2012, the market value of Sands China, Las Vegas Sands’ majority-owned subsidiary which is traded on the Hong Kong Stock Exchange, more than doubled. Yet Las Vegas Sands – which owns 70.3% of Sands China – saw its stock price grow less than one percent over the same period. As such, over those two years, the market value of Las Vegas Sands’ operations outside Macau – in Las Vegas, Singapore, and Pennsylvania – was halved, going from $24.4 billion to less than $12 billion. Granted, Singapore has been somewhat disappointing of late – its third quarter was terrible in terms of both volume and hold – but that drop is simply nonsensical. The Vegas properties have held up well, Sands Bethlehem has shown strong growth since the 2010 adoption of table games in Pennsylvania, and the Marina Bay Sands property in Singapore remains a duopoly with exposure to the dominant and growing Asian market. And while I certainly did not forecast a 13% gain for the stock in the week following that article’s publication, LVS remains undervalued. There are simply too many avenues for growth for the company, whether they are in Asia, America, or Europe. Sheldon Adelson’s  “EuroVegas” breaks ground in 2013, and opposition politicians are throwing what our Peter Amsel termed “a hissy fit” over the regulations approved for the project, including a diminished 10% tax rate and the right to extend credit. This means far less revenue going to junket operators and tax authorities, and more future profits for LVS shareholders. And, as an anecdotal aside, it’s worth pointing that my article on LVS at Seeking Alpha was my most-read article ever on the site, by some 50 percent, showing that investor interest in the stock remains elevated.

In fact, it still looks like it is difficult to go wrong with any Macau-facing operators, save for debt-laden MGM Resorts International (MGM), who remains dead last in market share on the island. The on-again, off-again worries about the impact of the island-wide table cap are abating, as LVS and others come up with ever-more creative ways to get around the official limits. Worries about the revenue impact of the newly instituted partial smoking ban seem overstated (they certainly have been here in the States.) More importantly, earnings growth will likely outpace revenue growth. The 14-16 percent increase in gambling win that analysts are predicted in 2013 will, on a relative basis, be driven more by the fast-growing mass market than the more mature VIP segment. Those mass market revenues offer higher margins and higher profits; adding in growth in retail and other areas as the Macau government attempts to diversify its economy, operators could easily see earnings growth that exceeds 20 or even 30 percent this year. That kind of growth is simply not found anywhere else in the gambling industry – and in few places in the still-struggling global economy – and investors will continue to pay for a piece of it.

Beyond Macau, leaders in various segments look promising. Bally Technologies (BYI) continues to gain on market leader International Game Technology (IGT); BYI appears to be the best pick in the slot machine manufacturing segment. Despite a bounce last week, Penn National Gaming (PENN) is just shy of its peak set in early December, three weeks after announcing its plans to spin off a real estate investment trust (REIT). As details of that REIT emerge over the course of the year, investor interest in the stock should grow. The acquisition of Ameristar Casinos (ASCA) by Pinnacle Entertainment (PNK) and the high debt levels at competitors such as Caesars Entertainment (CZR) and Isle of Capri (ISLE) should provide plenty of targets for the REIT to purchase and then lease back to the operators, trading upfront cash for a steady long-term revenue stream. In addition, bids for potentially lucrative projects in Maryland and Massachusetts remain outstanding; success in either or both locations could boost PENN to all-time highs.

The Laggards 

With Penn spinning off its REIT and Ameristar and Pinnacle combining into a US regional powerhouse, the US regional market looks like it may be splitting into the ‘haves’ – namely Penn and Pinnacle – and the ‘have-nots.’ Perhaps ‘have a little bit but owe all of it and then some to somebody else’ would be a better description for companies such as Caesars, Isle of Capri, and Boyd Gaming (BYD). Caesars rose 15 percent last week, re-testing recent highs hit after a strong rebound began in mid-November. On Seeking Alpha in late December, I wrote another long and highly technical piece in which I argued forcefully that Caesars’ land-based business is essentially worthless from an equity standpoint, as its $19 billion in debt overwhelms the value of its properties, which looks to be in the range of $15-$16 billion based on the prices paid for Ameristar and even Caesars’ former property in St. Louis. 

What Caesars has done, however, is “carve out” its Caesars Interactive division, which encompasses its Playtika unit, the newly acquired Buffalo Studios, the World Series of Poker brand, and online poker initiatives in the UK and Nevada. That division is not subject to the crushing debt load, and is essentially responsible for all of Caesars’ near $1 billion in equity value. Should New Jersey governor Chris Christie sign the online gambling legislation currently on his desk, CZR stock will jump again given its extensive operations in Atlantic City. But it is false hope. In New Jersey – which would instantly become far and away the largest iGaming market in the US – it seems likely that Caesars will be competing with market leader PokerStars, among many others. While Caesars is fond of promoting the value of its WSOP brand, the fact remains that, in the UK, where Caesars operates a ‘skin’ for 888 Holdings (888.L), the brand has done little to impact 888’s market share. 888 has grown its poker business rapidly, but the company itself has credited marketing investments and technological improvements for the growth rather than its American partner. 

For other regional operators, the question is: why would you want to own these companies? Boyd’s key markets are Louisiana, downtown Las Vegas, and Atlantic City, all facing significant struggles. Isle of Capri is now facing a much stronger regional competitor in Pinnacle/Ameristar; Ameristar retains a marketing agreement with MGM, giving it additional pull with rated gamblers. Another potential short opportunity is MTR Gaming Group (MNTG), a stock which I correctly recommended selling back in June. After a long fall, it has rebounded thanks to optimism surrounding the new Ohio market; but that market seems likely to take revenue from its existing operations in West Virginia. Like Isle, Boyd, and Caesars, MTR is debt-heavy, but it lacks the clout, brand recognition, and marketing power that Ohio competitors such as Caesars and Penn have. With the stock closing Friday at $4.46 per share, any move toward the $5 level should provide investors another opportunity to short MNTG and bet that the recent burst of optimism – which has driven the stock up over 50% in the past month alone – will fade as the new year rolls on. 

As for the gambling sector as a whole: who knows? The industry is closely correlated with economic growth, and it will be the global economy that, for the most part, moves gambling stocks. With the debt crises in the US and Europe seemingly pushed off into the (not-so-distant) future, stocks worldwide could see strong gains over the first quarter, as they did in 2012. Should that happen, gambling stocks will almost certainly come along for the ride – and many of the more volatile names will be among the market’s biggest gainers. But it remains imperative to pick and choose wisely; to stick with growth, branding, execution, and management. Those qualities will usually triumph, no matter what the year.

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