online gambling in the US–stock market implications

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.


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.

4Q12 for Las Vegas Sands (LVS): Asian good times are back

the report

After the New York close yesterday, LVS reported its 4Q12 earnings results.  The company reported profits of $434.8 million, or $.54 a share, on revenues of $3.06 billion.  EBITDA (earnings before interest, taxes, depreciation and amortization–a measure of operating profits) was $1.002 billion.

Revenues were up 20% year on year, net income up 35%.

As regular readers know, casino company financials are unusual in that what counts as revenue for gambling companies is not the amount bet by customers but rather the portion of that amount that the casino retains or “holds”–that is to say, the amount that customers lose.  The amount bet, which appears nowhere on the income statement (but is normally somewhere in the company press release), is, in my experience, a relatively stable and pretictable function of customers’ income and casino floor space.  The “hold,” on the other hand, is also a function of luck, which can vary considerably over short periods of time.  The first thing an analyst will do in looking at casino earnings is to correct them for these luck variations.

As for LVS, the company was unusually lucky in Macau during 4Q12, but unlucky everywhere else.  Overall, EPS would have been $.63 if the company had had average luck throughout its operations.  That compares with the Wall Street consensus, which I’ve always read as being luck neutral, of $.59.

LVS has also raised its quarterly per share dividend from $.25 to $.35, starting with the March 2013 payout.

As I’m writing this, the stock is up by about 5% in after hours trading.

the details


Sands China generated EBITDA of $622.2 million during the quarter, up 44% year on year.  Subtracting out unusually good luck, EBITDA was $575.4 million, up 32.5% vs. 4Q11.

LVS’s aggressive expansion in developing the Cotai area appears to be paying off.  Because it has developed extra capacity, it stands to benefit disproportionately as both economic recovery on the mainland and better transportation links deliver increasing numbers of visitors to Macau.

Perhaps more important, LVS announced it has been granted permission by the Macau government to add 200 new tables to its casinos, a strong sign that the SAR approves of the way Sands China is doing business.


After having hold-adjusted EBITDA stall, with a slight downward bias, for the last year at around $380 million, Marina Bay posted 4Q12 EBITDA of $406.4 million, up 6.8% yoy and 9.1% qoq.  Although this market is so new it’s impossible to interpret the figures with any confidence, the fact that EBITDA is moving up again is encouraging.

the US

Flattish EBITDA, which is all investors should want.  Hold-adjusted, Las Vegas was down by $8.1 million at $87.9 million.  Bethlehem was up $3.0 million at $25.6 million.

asset value

LVS has a market cap, at the aftermarket quote, of about $45 billion.  It’s ownership of Hong Kong-traded Sands China is worth $29 billion.  If we applied the same valuation to 100%-owned Marina Bay Sands, it would be worth about the same.  But Singapore doesn’t appear to have the explosive growth potential of Macau, at least as things stand now.  Remember, though, this time a year ago there seemed to be no limit to the upward trajectory of Marina Bay’s EBITDA, so we’ve got to keep an open mind.  Trying to be conservative, let’s say that current Singapore earnings are worth a multiple of .6x what Macau’s are.  That would give Marina Bay Sands an asset value of about $17 billion.

Together, the Asian properties explain the entire market value of LVS.

Over the next year, what might we reasonably expect from Asia?  Sands China could be trading at a price 20% higher than it is now, based on Macau market growth and increased Sands China market share.  Revival of the apparently more business cycle-sensitive Singapore gambling market might produce 10%-15% EBITDA growth and a mild expansion of the relative multiple.  If so, even if the market continues to value the US operations of LVS at the current zero, we should expect a substantially higher share price for LVS.


Full-year earnings for LVS in 2012 were $2.14/share.  To me, it seems reasonable to expect $2.50 in 2013–meaning LVS is currently trading on a forward earnings multiple of 22x.  Yes, that’s high, but it’s no longer in the stratosphere.  The stock also yields 2.6%.

Therefore, even on a conventional PE basis, which I don’t think is the right way to value the stock, LVS doesn’t look bad.



Las Vegas Sands: strong 4Q11…and beyond


LVS reported 4Q11 and full-year 2011 results after the close of New York trading on Thursday February 1st.  Quarterly revenue for the company was $2.3 billion, up 26.3% year on year.  Net income was $460.9 million, or $.57 a share.  That was up 38% year on year.  EPS exceeded the average analyst estimate by about $.03.

For 2011 as a whole, LVS posted $9.4 billion in revenue, up by 37% from the %6.9 billion taken in in 2010.  EPS more than doubled to $2.02 vs. $.98 in the prior year.


Sands China in Macau took in $1.33 billion in revenue during 4Q11.  Ebitda (earnings before interest, taxes, depreciation and amortization) was $430.1 million.  These figures were up 22% and 29% year on year, respectively.  3Q11 ebitda was $388.3 million, meaning 4Q results were up 10.7% qonq.

Marina Sands in Singapore had revenues of $806.9 million for the quarter and ebitda of $426.9 million, aided by an unusually high win percentage at table games.  These were yoy increases of 44% and 40%.  3Q11 ebida was $413.9 million, so the qonq gain was 3%.

Las Vegas operations had revenues of $339.5 million and ebitda of $80.9 million.  Revenue was up 9% yoy, ebitda was about flat.  3Q11 ebitda was $94.3 million.  Qonq, 4Q ebitda was down 16%.

my thoughts


Let’s assume US operations will be flat year on year in 2012, ex management fees from Singapore and Macau.  I think there will be some small gains, but the main issue is not the economy.  It’s the severe overcapcacity of hotel rooms and gambling space in Las Vegas.  Dividends from Sands China will probably add close to $1 billion–covering the parent’s dividend payout.

HK: 1928 will soon be opening the first phase of its newest Macau casino, Macau Cotai Central, shortly.  In a market that will likely expand by 25% this year, 1928 will likely easily grow by 30%–probably considerably more.

I don’t know any good way to estimate growth for the MS Singapore.  The casino hasn’t been open that long, for one thing.  For another, after posting continuous increases in ebitda since opening, income seems to have flattened out in 4Q11.  Is this seasonal?  …or something else?   No one knows.  If we assume no organic growth but that the casino continues to generate revenue at the 4Q11 rate throughout 2012, ebitda would grow by 15% yoy.

Repayment and restructuring of debt at lower interest rates will chip in, as well.

Put all this together and I think the analysts’ consensus of $2.50 in eps for this year is a reasonable guess.  We’ll be able to tell more when the official year-end financials are published.

asset value

At today’s level, the market value of LVS is about $38 billion.

Its ownership interest in publicly traded Sands China (1928:HK) is worth around $21 billion.

If we assume that wholly-owned Marina Sands should be valued at 80% of 1928’s ebitda multiple–because of less clear near-term growth prospects–then MS is worth $24 billion.

If so, Macau and Singapore are together worth $7 billion more than the market cap of LVS–implying that, in the mind of Wall Street, the $424 million in annual US ebitda subtracts a ton of value.  That’s silly.  LVS would need to rise above $60 a share in order for the stock price to reflect no value for the US operations.


Both LVS and 1928 have declared initial dividends and signaled their intention to sustain them at at least the current level.  LVS will be paying $1 a share annually, meaning a yield of slightly below 2%.  1928 will be paying HK$1.16, a 4% yield.

Three implications:

–dividends are supposed to be paid from profits.  Both LVS and 1928 are saying they expect to remain at least as profitable as they are now.

–both companies believe they’ll be generating enough free cash flow to sustain the payout

–the companies’ lenders (LVS has about $10 billion in debt) are satisfied that they’ll be repaid and have okayed the dividends.


LVS  isn’t the best casino operator in the world.  That’s WYNN, in my opinion.  But at the moment I think it’s the best casino stock.

Management is highly competent.  And the company is nearing the end of a very ambitious (read: risky) multi-year, multi-billion dollar Asian expansion.  The financial crisis came at the worst possible time for LVS.  Nevertheless, the company has completed its plans.  It’s now entering a period of potentially immense free cash flow generation that will transform the financial structure of the firm over the next two or three years.  I don’t think Wall Street has worked this out yet, as shown by the undervaluation of LVS on a sum-of-the-parts basis.

old soldiers fade away; what about old hotels?–how overcapacity shrinks

supply/demand imbalances…

In many cases, imbalances between supply and demand resolve themselves relatively quickly.

–Fresh produce goes bad.

–Clothing wears out, or is lost or damaged–or fashions shift–constantly creating new demand.

–Workers retrain and change careers.

–Technological change makes production equipment, as well as their output, obsolete.

…are difficult with long-lived assets like real estate

But what happens with real estate?

…where structures can be very expensive, are typically funded with borrowed money, may take years to build, generally can’t be relocated and can last for fifty years or more.  They’re also relatively low tech.

In this post, fresh from my visit to Las Vegas, I’m going to write about what happens with hotels/motels, a special case of this real estate question.


These are easier to analyze than hotels, since they cost less and can be built faster.  Often, they’re designed in modular fashion so they can add extra wings of rooms at relatively low expense, if needed.  They also tend, in the US at least, to draw most of their customers from people who have business within a few miles of the motel.

Therefore, new capacity comes in lower increments and is visible to potential new entrants faster than with hotels.  So overcapacity tends to be less severe.

cost pressure points

There are two big costs for a motel operator that I don’t think are readily apparent–the price of affiliation with a national chain, and the need for periodic refurbishment of rooms.  These expenses end up being the big factors in eliminating existing capacity.

Chain affiliation, which may cost 5% or more of revenues, brings two benefits:  a brand image and access to a reservation system to direct potential guests to the motel.

Although guests don’t think about it much, hotels and motels suffer a lot of wear and tear, both in the rooms themselves and in common areas.  So they require a considerable amount of spending on maintenance.  In addition, to keep the rooms new looking in a way that justifies a higher rate, rooms have to be refurbished periodically–say every five years.

The two expense items are interconnected, since maintaining a specified standard of appearance will also be a condition for retaining affiliation with a chain.

When profits are under pressure, in my experience the first area to suffer cutbacks will be maintenance/room refurbishment.  Once these expenditures begin being postponed, it becomes progressively more difficult to catch up, since returning to the former standard is increasingly more expensive.  At the same time, less favorable online user reviews translate into less repeat business.  This compounds the financial problem.

At some point, a motel may fall below the standards necessary to maintain its affiliation with, say, the Marriott chain.  It may, however, still qualify to be a Best Western or Comfort Inn affiliate.   So it “solves” its maintenance/refurbishment problem by switching affiliations.  The motel effectively removes capacity from a higher-price market segment and introduces new capacity to another, lower-price one.

For a given motel, this journey to less expensive market segments may have several steps.  At some point, the building may be sold for alternate use as, for example, a nursing home.  If so, the capacity disappears entirely.


The same principles apply.  Three differences, however:

–hotels need to achieve a certain amount of occupancy–generally thought of as 30%–regardless of profits, so the building will feel “alive” and safe

–hotels are much larger in scale

–there are no alternate uses.

In Las Vegas, scene of immense overcapacity currently, two additional patterns are evident:

–older and new, but not as conveniently located, properties had been competing on lower price.  Given the new hotels’ need to generate occupancy to create a favorable ambiance, that advantage is diminished.  WYNN, for instance, had been planning to charge $300+/night for its new rooms.  But average room rates are currently around $200, with mid-week rates considerably below that.

–in the case of WYNN, LVS and to a lesser extent MGM,  management fees from Asian operations to the US are supplementing US cash flows, thereby enhancing the location advantage the three have.

signs of strain

You can already see signs of strain–and of capacity leaving the premium segment of the market.  The Wall Street Journal reported yesterday, for example, that Hilton is planning to end its affiliation with the Las Vegas hotel owned by private equity investor Colony Capital.

And MGM is also hoping to be able to blow up its as yet unopened Harmon hotel on the Las Vegas Strip.

walking around in Las Vegas last week

My wife and I went to San Francisco to see the Giants play two weeks ago.  Then we drove down the coast to Los Angeles to visit relatives.  And we stopped in Las Vegas for a day on the way home, just to see how the city looked compared with our last trip early in the year.

Over the years, I’ve learned that you have to be careful in drawing any firm conclusions about the hustle and bustle you see.  As I’ve already mentioned a long while ago in this blog, I once was in Caesars in Atlantic City at a time when the casino was packed to the gills.   (By the way, I’m not a big casino gambler myself.  I find it too much like work.  But the stocks are simple to analyze and usually generate huge amounts of cash flow.)

I called the company the next day and found out that their profits in Atlantic City were weaker than usual, not stronger.  A main set of doors had broken and no one could get in or out easily.  Few people were actually gambling; most were just stuck, and preventing fresh money from getting in.

Nevertheless, for what it’s worth:

–the city seemed to have far more foreign visitors than in January

–WYNN had a lot more casino patrons

–the Fashion Mall across the street was bustling

–the Bellagio seemed quieter; the visibly worn carpeting in retail areas hasn’t been replaced

–CityCenter appeared a lot quieter than in January

–I didn’t detect much difference with LVS

–every retail complex I saw had at least one vacancy, even WYNN;  CityCenter, understandably had the most empty space.


One of the odder aspects of my trip was the controversy that flared up last week over the yet-to-be-completed Harmon hotel in the CityCenter.  MGM is proposing to blow the structure up. (VegasInc has a comprehensive account).  It says the building is a potential hazard in an earthquake, because of construction defects.  Contractor Perini Building Co., which says MGM owes it $200 million+ for its work on the building, asserts any problems are design defects caused by MGM.   Just another day in the desert.