It doesn’t take much time studying the gambling industry to realize that its most important, most lucrative, and fastest-growing markets are in Asia. Gambling revenue on Macau is nearly six times that of the Las Vegas Strip, while the market values of Asia-dominant operators such as Las Vegas Sands (LVS) and Wynn Resorts (WYNN) dwarf those of even leading US-facing companies such as Penn National Gaming (PENN) and the soon-to-be-expanded Pinnacle Entertainment (PNK).
Of course, bigger isn’t necessarily better in the stock market. The fact that Las Vegas Sands is worth $43 billion, and Penn $3.75 billion, doesn’t in and of itself mean that investors should buy LVS and sell PENN. But the difference in value between LVS and Penn National has much to do with the markets in which they operate. Las Vegas Sands’ 2012 revenue will be roughly only about four times that of Penn; but its net income is about eight times higher, and its market value over eleven times greater. This is because the Macau VIPs who drive the majority of LVS’ revenue are more profitable on a per-player basis than Penn’s US customers, and because the massive population and continued economic expansion in China provide a clear pathway to growth for Las Vegas Sands in both Macau and Singapore.
This is all well and good for Las Vegas Sands – whose stock I’ve recommended several times – and its competitors in Asia. But for Penn, Pinnacle, Caesars Entertainment (CZR), and other US casino companies, it’s no longer just a matter of missing out on the gambling industry’s largest market. There are – or, at least, should be – real concerns about the US land-based gambling segment, and a real possibility that the entire sector should simply be ignored by most investors.
Look at the recent news. Monthly revenue in Nevada plunged in November (the most recent month for which data has been released). According to the Nevada Gaming Control Board, trailing twelve-month gaming win in the state rose less than one percent, with Las Vegas Strip revenues gaining just 1.4% over the same period. 2012 revenue fell eight percent in Atlantic City, continuing its multi-year decline. In Louisiana, yearly gambling take rose 1.2%. In Missouri – a major state for regional operators, with 13 different casinos – 2012 gambling win dropped three percent, according to state regulators.
To be fair, there is growth in the US market, mostly from new states that have legalized or expanded gambling, such as Pennsylvania and Ohio. But that growth won’t last forever, and much of that growth is essentially stolen from neighboring states. For instance, Pennsylvania is clearly responsible for much of Atlantic City’s struggles. And going forward, there are few new markets left. Maryland is adding a sixth casino; Massachusetts will add three casinos and a slot parlor; New York state, led by Governor Andrew Cuomo, may add as many as seven new facilities. Kentucky’s on-again, off-again movement toward gambling expansion may make progress next year, while Massachusetts’ expansion has led to the addition of table games in Rhode Island and potential legalization in New Hampshire.
But how much growth can these new facilities really add? Rhode Island and New Hampshire’s moves appear solely motivated by the desire to keep tax revenues in-state, rather than having residents gamble in Massachusetts or at tribal casinos in Connecticut. Similarly, Kentucky has seen its residents travel to Indiana, West Virginia, and now Ohio, and wants to keep that money for itself. But the net result of this movement for casino owners, in terms of profit, is marginal at best. Revenues may go up, as new gamblers are added in Kentucky or New Hampshire, enticed by a casino that is now 30 minutes instead of two hours away. But costs go up as well, as casino operators are also paying for new buildings, and new dealers, and new slot machines.
And, perhaps most importantly, new taxes, and new license fees, and new political costs. Penn and MGM spent $90 million in lobbying and advertising costs in a battle over a November referendum, and now will spend even more competing for the sixth Maryland license. Massachusetts has charged its eleven applicants $400K each simply for the privilege of being vetted by state regulators. The three “lucky” winners will then pay $85 million each to the state for a license, according to The Concord Monitor. Ostensibly, profits from the gambling operations will more than pay for the license; but Massachusetts will take another 25% off the top from those profits before they reach shareholders.
Of course, eleven different companies are vying for the licenses, including powerhouses Wynn, Penn, and MGM Resorts International (MGM). As such, most observers would conclude that there must be some value in the Massachusetts market, even accounting for the state’s steep take and the intense regional competition. But the scarcity of new markets can lead companies to take risky steps, in the eagerness to create the top-line growth that is simply non-existent on an organic basis in the US. And such a process can create what is known as the “winner’s curse.” In an auction, the winner’s curse pertains to the fact that the winner has, almost by definition, overpaid for the item acquired. Simply put, he cannot sell that item for what he paid for it, because the highest price that would be offered for it is that of the second-best bid,. And while the Massachusetts licenses themselves are not up for auction, the bidding process is a competition to see which company can create the most lavish, most impressive, or most locally friendly project. And it may be that a company whose proposal is most attractive to the state and local governments than those of other bidders is a company whose project will wind up being marginally profitable – or worse – as it focuses on the desires of regulators and politicians rather than its own bottom line.
The long-term value of a new license in a market like Massachusetts simply may not be what many might project. Clearly, one well-known company agreed, and backed out of Massachusetts; the aforementioned Las Vegas Sands. Sands is not only out of Massachusetts; it appears to want out of Pennsylvania as well. It has reportedly placed a $1 billion price tag on its Sands Bethlehem operation, its only US location outside of the Venetian and Palazzo on the Strip. The sale is somewhat surprising, if only because Sands Bethlehem is such a minor part of LVS’ business; even if it sold for the asking price, the sale wouldn’t cover CEO Sheldon Adelson’s share of the company’s special dividend paid late last year. But certainly the casino’s best growth is behind it; with table games now legalized and potential competition in New York, the strong revenue and profit expansion Sands Bethlehem saw as it ramped up are likely over. Adelson certainly knows that; and he and other LVS executives may simply see an opportunity to sell at the top.
Whatever the motivation for the potential sale, it’s worth noting that Adelson is considered, even by his many critics, to be one of the shrewdest minds in the casino industry. And it’s worth noting that Sheldon Adelson has stepped away from Massachusetts and is perhaps stepping out of Pennsylvania. He clearly has little interest in the US regional market at this point.
Where is Adelson looking instead? To Europe, and to Spain. Sheldon Adelson – one of the most innovative and brilliant minds in the history of the casino business – would rather invest billions of dollars in a country with unemployment over twenty percent, on a continent with a still-simmering sovereign debt crisis, than put the money to work in the United States. It is a stunning admission, and a startling indictment of just how competitive, over-taxed, and cannibalistic the US regional market has become. And it raises a very important question for investors: if one of the gambling industry’s titans won’t put his money into the US market, should you?
