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MACAU JUNKET COMMISSIONS APPROACHING JUNK BOND YIELDS?

  • This is a gross exaggeration I know, but I am increasingly alarmed by the junket price war. My source indicates that LVS may have boosted its commission again, from an implied 1.25% of roll to 1.3%. I believe MGM may have moved even higher than LVS. No indication on Crown but if I had to guess I'd say MPEL will or already has followed suit. This chart examines the relationship between escalating junket commission rates and declining theoretical EBITDA margins on VIP revenues. I estimate the casinos break even on VIP business around a commission rate of 1.5%.
  • No word yet on WYNN but I am skeptical they can hold out any longer. WYNN has proven to be the best operator in Macau and their performance resilient despite an uncompetitive junket rate. At some junket rate, price will win over product, at least with some junkets and players. I am not sure we are there yet but any market share loss or softening of its junket position could be a major dent to this Bugatti. WYNN's stock has been a massive outperformer relative to the group and deservedly so. Could WYNN's stock become a victim of its own success? Follow the junket rates and market share.

MORE MARGIN CONTEXT FROM A SLIGHTLY OLDER ANALYST

Margin mean reversion is a scary thought. Revenues get all the attention since they are released monthly. However, I do not believe enough focus has been placed on the margin side of the equation. Hotel margins in Las Vegas have expanded almost 10% in 15 years while F&B margins increased 15%. We all know hotels and restaurants are two of the most cyclical industries out there in consumer land. In fact, other than in 1998, the only other year that hotel margins contracted were during the 9/11 induced travel slowdown in 2002. While casino revenues are certainly not recession proof, they have proven to be somewhat recession resistant. Hotel and F&B margins were significantly above their 15 year mean in 2007 while casino margins were less than 1% above.
  • Some on the sell side have defended the recent only modest drop in Las Vegas' monthly casino revenues. The fact that casino revenues are down just slightly is not terribly surprising considering the historical resiliency of the casino to economic cycles. However, the revenue and margin contribution of Hotel and F&B has never been higher than now. That is terrific in an expanding economy, but last we checked the US consumer was facing stronger headwinds than they have in the past 15 years. I am obviously concerned about falling airline capacity, the rising airfares to Las Vegas, housing, inflation, etc but I'll leave that analysis for a later posting. Here I've looked at what happens if margins revert to the average of the last 15 years. F&B contribution falls by 67%, hotel contribution by 10%, and total EBITDA by $869 million or 17%. Take it a step further and assume 2002 margins, EBITDA for the industry in Las Vegas would fall by a whopping $1.9 billion or 37%.
  • Gaming companies have done a phenomenal job transforming the product and developing other profitable revenue sources. The downside is that they have tied the industry much more to the economy. I'm really showing my age here but I still remember when Las Vegas was the city of great deals: $3.99 buffets, $75 hotel rooms, and $0.25 craps. Those days are long gone and good riddance. There hasn't been a time over the last 5 years that I've gone to Las Vegas and haven't been astonished at how expensive everything is. Indeed, hotel and F&B margins expanded 590 and 400bps in the last 5 years alone, all due to pricing. How will pricing and margins hold up with the US consumer under siege? We haven't had a consumer recession in 15 years but I have a feeling we are going to find out.

MEAN MARGIN MEAN REVERSION: A LITTLE LV CONTEXT FROM AN OLD ANALYST

First the good news: Las Vegas property level EBITDA margins have expanded 10 out of the last 15 years and were 4% higher in 2007 than the average over that period. The bad news: Mean Reversion is probably rearing its inevitable head. Why am I concerned about mean reversion? The impressive margin expansion was driven primarily by the hotel and the food and beverage product lines (casino margin has been stable) which should contract first and most dramatically as consumer spending slows and probably recedes. The following chart clearly shows the relevant trends.

In 2007, rooms and F&B contributed 40% of revenues and 38% of total departmental profits in Las Vegas, big contributors for sure. Room rates are already under pressure and casinos won't drop occupancy to hold rate. ADR's are the highest margin revenue source in Vegas. Do you see where I'm going? I'm not sure F&B traffic and pricing can hold up in this environment either. Restaurant traffic certainly hasn't across the country.
My partner Keith McCullough constantly reminds me that context is not just the last few years. Context in this case is at least 15 years. Unfortunately, when it comes to margin mean reversion, this context is not very comforting.

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WHALES AND MINNOWS

(previously posted under Keith McCullough: 06/08/08 10:12 AM EST)


Main Street vs. Wall Street: Whales vs. Minnows

I ate a $38 steak (the cheapest on the menu) at Sleek Restaurant at Lumiere Place in the city of St. Louis, of all places. As I looked at the suits and fashionable dress shirts in the restaurant and the t-shirts, baseball caps, and blue hair in the casino, I was struck by the contrast.

The obvious disconnect between the quality of this new US Gaming facility and the quality of the customers got me thinking about the Main Street vs. Wall Street dynamic in our current economy.

More important to the US Gaming investor than St. Louis is the gaming Mecca of Las Vegas. It's been at least 10 years since Las Vegas has been considered anything approaching cheap . Prior to the cheap money leverage boom of capacity builds, Vegas was always resilient because you could spend $3.99 for the buffet, $80 for a nice room, and drink for free.

Sure you lost a bunch in the casino, but that never factored into the decision to go to Vegas because it's so cheap . Even as the operators jacked up hotel rates, food & beverage pricing, and table minimums, the consumers were perfectly willing to lever up their balance sheets to spend, spend, spend. Why not? The value of their houses were probably going up 20% a year forever right?

The new new Vegas was built for Whales, Dolphins posing as Whales, and Minnows posing as Dolphins.

Something's gotta give here. Vegas runs on a model of high hotel room occupancy. My bet is we'll see a resurgence of the food court and the buffet you don't need a credit card to pay for.

THE WINNER'S CURSE PART II

(previously posted under Keith McCullough: 06/03/08 10:33 AM EST)


Yesterday, Ameristar (ASCA) CEO John Boushy resigned to pursue other interests . Hopefully, those interests do not include topping his own record for the worst casino property acquisition ever.

Luckily, for him, in the current environment sellers are probably willing to unload casino assets for under the 12x EBITDA Mr. Boushy and Ameristar paid for Resorts East Chicago. This acquisition was so bad that even private equity was unwilling to hand over $675 million in April 2007 for an asset in a market with increasing supply.

Of course, ASCA was still smarting over its loss to Columbia Sussex in the bidding war for Aztar in 2006, which rates as probably the worst Private Equity gaming company acquisition ever.

ROBIN HOOD REGULATING GAMING

(previously posted under Keith McCullough: 06/08/08 9:56 AM EST)


Robin Hood Regulating Gaming:

The Illinois Supreme Court ruled that it is legal for the state to collect a surcharge from the profitable casino industry and give that money to the unprofitable horse racing industry.

Ronald Reagan once said "Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it."

Horse racing stopped moving a long time ago. How telling is this form of economic populism occurring in Obama's home state?

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