It sort of happened without anyone really noticing. After a sleepy second quarter – where gambling stocks rose just two percent and the most news-worthy event seemed to be Sheldon Adelson’s rant against online gambling – the third quarter really didn’t seem much different. Sure, Caesars Entertainment (CZR) announced a spin-off of its interactive assets; but that transaction had been predicted for at least a year. And Bally Technologies (BYI) agreed to buy out Shuffle Master (SHFL), but that deal was the rather logical conclusion to a wave of consolidation in the industry.
But beyond those two moves, little really seemed to change. Online, the US industry – as it has since the February fireworks in New Jersey – is puttering along, with the three states that have legalized the activity moving slowly toward fully functional – and fully competitive – markets. But beyond Nevada, New Jersey, and Delaware, there has been practically no legal or regulatory movement of note for months. In Europe, the usual suspects struggled, as Ladbrokes (LAD.L) posted another dismal trading update as did long-struggling bwin.Party Digital Entertainment (BPTY.L). Back on dry land, US casinos continued to defy gravity, and Macau, well, Macau remained Macau.
And yet, gambling stocks soared in the third quarter, most notably in September:
Again, it’s difficult at first glance to see why gambling stocks took off in September. The broader market (seen in red) didn’t move much at all, and gambling shares usually rise in tandem with, albeit somewhat faster than, the overall market. And, as noted, there was little movement in the industry over the past three months.
There is one big reason for the gains, however: Macau. After being seemingly neglected in media and market coverage over the past few years – and seeing some sharp stock price declines based on fears of a slowdown – the island has posted an exceptional 2013, though one that hasn’t gotten the headlines of previous years. Revenue through the first nine months is up over 16 percent year-over-year; that growth rate is actually slightly higher than the 14 percent rate seen in 2012.
And Macau shares have finally responded. Third quarter gains for shares of the island operators ranged from 15 percent at laggard SJM Holdings (SJMHF) to over 40 percent at Galaxy Entertainment (GXYEY), the island’s long-running best performer. Notably, US parent MGM Resorts and Entertainment (MGM) outperformed its Asian subsidiary, MGM China, as the company’s efforts to lower its debt, and its interest cost, appear to be paying off. MGM’s run has continued into October; shares are now up more than 50 percent from lows in late June. And given Macau’s importance to the BJK ETF – roughly half of the fund comes from Macau-facing businesses – the 17% gain in BJK shares for the quarter makes a little more sense.
But even beyond Macau, gambling stocks saw reasonable gains. 23 of the 25 largest US-listed gambling firms saw their stock prices rise: only long-struggling Delaware operator Dover Downs Entertainment (DDE) and US regional Isle of Capri (ISLE) declined in the quarter. So with a third consecutive positive quarter now in the books, there are some key questions for the gambling sector going forward:
1. WILL THE US GOVERNMENT SPOIL THE PARTY?
The government shutdown – so far – hasn’t dented stock markets too much. The US market closed the week down modestly, but gambling stocks actually continued their gains. So far, market commentary has suggested that investors are not yet seriously concerned about the political wrangling in Washington; but with the so-called “debt ceiling” about to be breached later this month, that could change. If fear returns to the market, gambling stocks will be hit; though, in some cases, that could simply provide a better buying opportunity.
2. WILL CONSOLIDATION CONTINUE?
We’ve seen three major mergers in the past year. Regional operator Pinnacle Entertainment (PNK) bought Ameristar Casinos, Bally bought SHFL, and Scientific Games (SGMS) acquired slot manufacturer WMS Industries (WMS).
A smaller deal was announced last month, as MTR Gaming (MNTG) and privately held Eldorado Resorts agreed to merge. At first glance, the combination of MTR’s assets in West Virginia, Pennsylvania and Ohio with Eldorado properties in Reno and Shreveport, Louisiana would seem to be an odd one. But in a presentation put together by MTR in conjunction with the announcement, the company noted both cost savings from the combination and potential boosts in marketing effectiveness as the companies pool their player databases.
What seems apparent is that smaller operators are wondering if they can compete with the marketing heft and massive databases at companies like Caesars, Pinnacle, and Penn National Gaming (PENN). As such, there could be more mergers between or acquisitions of the industry’s smaller operators. Among potential targets could be Full House Resorts (FLL), Monarch Casino and Resort (MCRI), or perhaps even Dover Downs, with Delaware’s entrance into iGaming.
3. HAVE MACAU SHARES GONE TOO FAR?
I’ve been bullish on the Macau operators for most of the last two years; but those shares are, in most cases, now at their highest levels since the 2008-09 financial crisis. Over the past twelve months, Melco Crown Entertainment (MPEL) is up 145 percent, MGM has nearly doubled, and LVS and WYNN are up more than 50 percent. One wonders if the shares have now priced in all of the good news regarding 2013 growth, leaving their prices susceptible to a steep fall on a disappointing earnings report or lower-than-expected growth in the fourth quarter.
In the short term, a pullback may be in order; but the long-term case that I (and many others, to be fair) have espoused for the island is still intact. Fears of a collapse in China have receded, the higher-margin mass market gambler is growing in importance, and there are still millions and millions of dollars in retail and entertainment profits to be made as Macau begins to wean itself off its almost total reliance on high-stakes baccarat. It wouldn’t surprise me at all to see Macau-facing shares decline in the fourth quarter; but it still seems likely that over the next year or two, these stocks will have more room to run.
4. WHAT WILL NEW JERSEY’S IMPACT BE?
While online gambling in the state will not officially commence until November 26th, the New Jersey market seems likely to dominate market commentary and market sentiment for the rest of the year. It seems likely there are still deals to be made ahead of the launch, but more important will be the constantly updated projections leading up to and out of the late November startup date.
Most notably, Caesars shares – which have derived their valuation almost totally from hopes for iGaming profits in the state – should see some volatility. CZR stock has already seen a number of massive moves that defy logic; one can easily see traders stampeding in or out of the stock based on rumors, projections, or analyst estimates of online spend in the initial days following iGaming’s debut in the Garden State. CZR did get dented last month, dropping over 20 percent in a couple of weeks after its announcements of a (23) debt restructuring and a $200 million stock offering once again raised fears about its long-term solvency. But based on its trading action since Christie’s conditional veto in February, it appears there are more than enough iGaming believers to keep CZR’s share price up through at least the end of November. After that, however, it may be a different story.
