After Wednesday’s morning keynote at G2E, the “Finance” track offered two sessions that delved into more detail about the challenges facing the Las Vegas and US gambling industries. In the first session, moderator John Restrepo and a panel of financial experts asked a simple question: Is Vegas back?
The answer appeared to be: somewhat. Kinda sorta. Maybe. Union Gaming analyst Bill Lerner noted the split between the Strip and Las Vegas Locals markets, where the Locals market had badly lagged. But the Strip had managed to moderate its downturn in two key ways. First, the international mix grew, driven largely by increasing baccarat play. As important as that game is to Macau, its import to Vegas casinos is rather underrated; Lerner claimed that its percentage had moved from the “teens” to the low- to mid-twenty-percent range in terms of overall revenue. Secondly, the industry began to focus more heavily on food and beverage sales, which rose from 18 percent of revenues a decade ago to 24 percent now. That segment, noted Lerner, offered a more stable base, with only two year-over-year decreases in the last twenty years. The increase in F&B sales is just part of the long evolution of the casino industry on the Strip, which has increasingly focused on non-gaming revenue growth. As Lerner pointed out, “You can gamble anywhere now.” As such, Vegas needs to offer more than just slot machines and table games.
But beyond that, how can Vegas create growth going forward? The panel focused on the oft-discussed but seemingly elusive younger generations: Generations X and Y, along with the so-called “millennials.” Wells Fargo analyst Dennis Farrell noted that Caesars Entertainment’s “Project LINQ” on the center Strip was designed precisely to target those younger consumers, who have shown less interest in gambling than their older counterparts. (Farrell also acknowledged the presence of the world’s tallest Ferris wheel at the project, remarking that Wall Street was “50/50” on the wheel’s profit potential.) MGM Resorts and Entertainment chief financial officer Dan D’Arrigo noted that younger generations, who grew up on video games and more recently social gaming, want “to be part of the experience,” and that the existing products on the gambling floor simply did not appeal to them. “They don’t want to be entertained,” he argued. “They want to be the entertainment.” It was one reason why nightclubs had become among the most profitable businesses on the Strip. “They have more fun on this thing,” he added, holding up an iPhone, “than they do on a box in a casino somewhere.”
Toward the end of the session, the panel touched on the re-start of construction on the Strip, as the SLS Las Vegas rises on the North Strip and Genting plans its new Resorts World Las Vegas nearby, after buying Boyd Gaming’s stalled Echelon project. (Farrell called the project “pretty ambitious,” which is often analyst-speak for “We wouldn’t touch that project with a ten-foot pole.”) While the news of new development was welcome to the city itself, Lerner pointed out that the new capacity was an increase of only about 3 percent in rooms.
As such, Lerner was positive on the impact of Resorts World. He noted the resort’s focus on Asian visitors, which would make it less likely to cannibalize customers from existing operations. (During the session, D’Arrigo repeatedly lamented the industry’s poor job of marketing to non-VIP Asian customers; moderator Restrepo agreed, pointing out that Las Vegas’ McCarran Airport still lacked signage in Mandarin despite the massive numbers – and the massive importance – of Chinese visitors to the city.) He also pointed out that, amidst the dreary numbers and low growth, Strip hotels could be set for a return to profit growth. With supply growing at just 1-2 percent a year, even below-average visitation growth of 3 percent would apply modest upward pressure to room prices. Should visitation levels return to normal growth levels – but supply grow at current levels – the hotels would be able to both increase occupancy and increase prices, which could drive the figure known as REVPAR (revenue per available room) up in the “high single digits” annually. And because that revenue is such high-margin, the extra REVPAR dollars would move straight to operators’ bottom lines, boosting profits.
Overall, however, the tone of the session mimicked that of other sessions at G2E. The industry is recovering, but not as fast as most would like. So to answer Restrepo’s initial question, no, Vegas is not yet back. But it is heading that way, and there’s reason to believe it may get there sooner rather than later.
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The second session again focused on economics, but from a broader, US-wide perspective, looking at how the recent economic crash and sluggish rebound are affecting US consumers, and thus, US casinos. Restrepo – on the panel for this session, moderated by Deutsche Bank managing director Andrew Zarnett – noted that this was “not a consumer-led recovery,” a statement backed by a chart created by Zarnett and Deutsche Bank. Over the past five years, household income had fallen 8 percent, while inflation had risen 14 percent. Those figures would represent about a 20 percent loss in purchasing power over a five-year period, and with casino spending obviously toward the bottom of the average family’s priority list (hopefully), that diminished purchasing power has had a clear impact on gambling industry growth.
As most economic discussions inevitably do (particularly nowadays), the talk turned to politics, notably the Affordable Care Act (aka ‘Obamacare’). The panel noted serious concerns about the program’s effects, most notably its incentive to keep workers scheduled under 30 hours per week. Panelist Jeff Hartmann, the new CEO of Atlantic City’s Revel, noted that his new hometown was essentially a “two to two-and-half-day town,” and was already incentivized toward scheduling heavy with part-time workers who would work just Friday night to Sunday night. Consultant Randall Fine of Fine Point Group concurred, predicting that smart operators might “partner up” and use the same dealer 20 hours a week at each casino, giving the dealer a 40-hour work week but avoiding the health care costs imposed by the ACA on the employment of full-time workers.
Regardless of the cause, the panel clearly felt the US consumer was still massively constrained. Hartmann noted the “bifurcation” of the US economy, a term used often this week (including in the earlier session). Wealthy people have largely recovered from the bust – and then some – as low, Federal Reserve-induced interest rates have re-inflated the values of assets such as stocks and homes. The rest of the country, however, is largely asset-poor, and what assets they do have are now sitting in the bank receiving minimal interest, usually less than one percent annually. (It’s worth pointing out that this effect has also been seen in the retail sector, causing what the Wall Street Journal two years ago called the “hourglass effect.” Luxury brands such as Tiffany and Coach have done well; discount retailers such as dollar stores have similarly well as formerly middle- or even upper-middle class consumers must cut their spending. Everyone in the middle – including legacy names such as Coca-Cola and massive household product maker Procter & Gamble – has seen far more significant struggles in terms of revenue growth. The problem for stagnant or declining markets like Atlantic City, Missouri, and Louisiana is that they are serving a largely middle- to upper-middle class clientele; thus, like their retail counterparts, they are catering to a depleted and distressed customer base.)
In response, casinos have often turned to promotional spend to get customers in the door. Fine noted that this was often derisively called “buying the business,” but pointed out that it could still be a good deal. If comps were properly targeted, an operator could grow its business. “The problem is spending $5 for $1,” he noted, while arguing that casinos – in many cases aided by his firm, which is working with Revel right now – had done a much better job of using comps. They were targeting customers with the right offers while not giving away comps to people who were coming in anyway, a sentiment with which Hartmann agreed. But Fine also added that it was a tough environment: “there aren’t ‘free trips’ anymore,” he explained, referring to people who choose to come to a casino on a whim without some sort of promotional enticement. Hartmann agreed, saying “You earn your stripes every month…it’s all about what shows up in the mail.”
Like the prior group, the panel then turned to the millennials as a potential source of growth. Fine argued that games simply needed to be more exciting. “Reels spinning around” will not appeal to that demographic he argued, no matter what the context of those wheels or what images were on the side of the machine. He posited a game that instead of having a bonus round – as many newer slots do – simply was a continuous series of those rounds, and also wondered why manufacturers couldn’t develop a for-money version of Candy Crush or Grand Theft Auto. Hartmann pointed out that younger people would spend $5,000 for a cabana on his property, but he still couldn’t get them on the gambling floor. The Revel CEO went on to say that he thought iGaming would be a way to get those millennials as customers for the gambling industry, adding later that it was a way to target those younger players who, for whatever reason, didn’t want to go to a brick-and-mortar casino anyway.
And, again, like the previous session, the question of online gambling’s effect on the land-based industry came up, this time in response to a question from the audience. Fine made what appears to be the standard argument: online gambling will grow the overall pie, while decreasing revenues for land-based casinos. The question, of course, is how much of a decrease the land-based casinos will see; for his part, Fine said he thought it would be “catastrophically dilutive,” comparing online gambling to the entrant of a new competitor in a crowded market. The new competitor may do well, and total revenue may go up, but each of the existing entrants will see declines. Zarnett had answered a similar question at the iGaming North America conference back in February, pointing out that the projections for online gambling’s impact in New Jersey simply “depends on which number you believe.”
This time, however, he made a provocative point about the potential for state-by-state legalization beyond the three existing markets of New Jersey, Nevada, and Delaware. On the tax side, he pointed out, states with higher gambling taxes would be loath to allow online gambling to cannibalize existing land-based revenues. He specifically pointed to Pennsylvania, with a 45 percent tax, and noted that online operators were expecting rates of 15 percent. Why, then, would legislators cut the amount of revenue of which they’re receiving 45 percent to add incremental gains at just 15 percent? Secondly, politicians are focused on jobs – indeed, this was a key reason Governor Chris Christie signed the New Jersey bill – but online gambling creates many, many fewer jobs per dollar than does a land-based casino. To extend Zarnett’s point, a high-tax state that legalizes online gambling could be trading a $100 million gain in revenue taxed at 15 percent for a $50 million decrease in revenue taxed at 35 or 45 percent. The end result would be lower taxes paid to the state and fewer jobs created by the industry – two outcomes that most politicians despise.
Zarnett had one more provocative question. Towards the end of the session, after the accumulation of the dreary data about the US consumer, the “squeeze” on the older demographic, and inability to attract younger customers, the Deutsche Bank director asked a simple question. Amidst this turmoil, “Why are gambling companies still looking for billion-dollar projects?” he asked. “I kind of scratch my head” at the logic. He pointed out the last string of major projects in Las Vegas in 2006-2007: MGM’s CityCenter, Las Vegas Sands’ Palazzo, and Wynn Resorts’ Encore. All, he pointed out, had returns no greater than 5 percent annually, well below the 20 percent most gambling companies target. (And that list, of course, does not include the stalled Echelon and Fontainebleau projects, which created massive losses.) “Nobody can remember what happened in 2007,” he argued, “and we seem to be doing it again.”
Fine replied that at the regional level, these projects made some sense, because of the structure of the licensing process. Citing Massachusetts’ decision to limit licenses to specific geographic regions of the state, he responded that “the guy who has the only casino in Boston will make a lot of money,” as the government is, in some sense, guaranteeing revenues. It may hurt Foxwoods or Mohegan Sun, the two tribal casinos in neighboring Connecticut, he granted, but if you’re not Foxwoods or Mohegan Sun, that’s not your problem.
All told, the money guys seemed to take a rather dreary view of the gambling industry, and in particular the regional industry. Yet these stocks have been among the best-performing stocks not just in the gambling market, but the broad market, over the past year or so. If this panel’s attitude toward the industry is representative of Wall Street as a whole, that may change in a hurry.