diminishing returns

Internet gambling is just the latest symptom of the diminishing returns disease afflicting smaller casinos in the US.

More states in the US are deciding that casino gambling is a great source of generating tax revenue for them.  They may be reacting to decline in other sources of gambling revenue, like horse racing or lotteries.  Or they may just feel gambling is a good way to replace lost income tax inflow.  Whatever the reason, they’re granting more casino licenses.

For what one might call “generic” or “no-frills” gambling–that is, not Las Vegas-style resort casinos–there’s a diminishing returns aspect to this activity.  All other things being equal, a gambler seeking a “generic” experience will go to the casino that’s the closest to home.  So while  more plant and equipment gets added to the industry inventory, the new capacity results mainly in a reshuffling of revenues based on the new driving distance calculus.

Therefore, as new capacity is built,  industry-wide returns on capital diminish.  We can clearly see this in what has happened when competition emerged for Native American gambling in Connecticut, as well as when rivals began to sprout up casinos in Pennsylvania and New Jersey.  No prizes for guessing what will take place when new casinos open in, for instance, New York and Massachusetts.  It doesn’t help the situation, either, that new casino licenses are often awarded to politically-connected amateurs who don’t utilize their facilities effectively.

adding new features, not just new floor space–where internet gambling comes in

The response of PA to flagging revenues once the novelty of the state’s slot machine-only casinos wore off was to add table games, which siphoned off additional business from surrounding states.  The main victim here was Atlantic City.

NJ’s initial fix-it attempt was unusual, to say the least.  Trenton authorized the addition of new capacity, in the form of a white-elephant hotel built as a speculation during the real estate bubble.  How this was supposed to help the seaside resort’s overcapacity situation is beyond me.  The casino in question, Revel, has just filed for Chapter 11 bankruptcy.  Unfortunately for AC, the capacity won’t disappear.  The owners just change.

New Jersey’s second response has been to decide to add a new feature of its own–legalizing internet gambling for anyone located in New Jersey when he places a wager.  This action might, at least temporarily, keep gamblers from wandering into PA and bolster the local casino license holders, who will run the internet operations.  If so, however, success will trigger a reaction from the jurisdictions whose revenues are suddenly tailing off.

The investment point here is to expect a declining profitability trend for generic casinos of the save-the-local-racetrack-owner kind as the internet gambling trend develops.

exceptions

national/international tourist destinations

Las Vegas is one.  New York City, where Governor Cuomo appears to be dying to allow the Lim family to open a Las Vegas-style resort casino, is another.  Florida, the scene of intense lobbying reportedly from the Lims and LVS, is a third.  I’m not sure whether Boston counts, but it might be a fourth.

Yes, casinos in all of these places would be subject to the negative effects of the spread of generic gambling operations over more states.  But their location allows them to tap into a very large tourist market.

branded casinos

Think Wynn.  Think Las Vegas Sands.  

Companies like this understand how to run complex  casino-shopping-entertainment hotels.  They should be able earn much higher returns than a generic gambling-only establishment run by a local political donor.

In addition, the brand name may induce people to drive a bit farther than they would otherwise.

Combine brand name with an international resort location, and the attractions of a WYNN or LVS casino are magnified.  Visitors will likely pick the brand name.  They may already be customers in Las Vegas, Macau or Singapore.

On top of all that, assuming they have the requisite physical presence in a given state, the branded casinos have a large leg up in establishing online gambling businesses, in my view.

my take

—For a stock market investor, the easiest ways of dealing with the question of how quickly the US gambling business will deteriorate as internet gambling takes hold are:

–invest in other industries, or

–select companies like WYNN and LVS, where the US operations are an insignificant part of the whole.

—For a purely/mostly US gambling company, make sure that it has a strong brand name, high cash flow and low debt.  A Las Vegas base would be better than anywhere else.  High debt and weak Macau presence probably rule MGM out.

—There will also be companies who will act as hardware/software enablers for the internet efforts of the major gambling firms.  ZNGA, for one, has been the subject of speculation on this score for some time.  It’s not clear what role, if any, ZNGA will play, however.  Personally, I regard it as a “fool me once, fool me twice” kind of name.

Also:  I’ve been taking the view for a couple of years that for companies like LVS and WYNN that have prospering Asian casinos, Wall Street places almost no value on their US operations.  I’ve thought that to be a gross underestimate, and, in effect, the shareholder gets the US casinos “for free.”  For both LVS and certainly for WYNN, I think this remains the case.  But if internet gambling takes off, Wall Street may have been closer to correct than I have imagined.