Annual Model Portfolio
2008 Model Portfolio - Introduction
In 2007, investors loved the casino stocks’ story but
didn’t want to discuss reality. The correction we expected
occurred early in the year and it was just as powerful as we had
feared. We believe one catalyst for casino stocks having such a
poor year was due to the companies who won the Philadelphia
stand-alone slot facilities licenses. In something that was very
similar to the early 1990’s in Louisiana, only one public
company was awarded a slots licenses for the non-racetrack
facilities in PA and that was Las Vegas Sands. In Philadelphia,
both Pinnacle Entertainment and Trump Entertainment were bested
by non-public entities, Foxwoods Management and Sugarhouse
Gaming, starting a downward spiral in both stocks which lasted
throughout the year.
While the PNK downward spiral started when they were not
named as a winner in Philadelphia, it continued when investors
seemed surprised that they had negative comparisons with the
2006 Katrina recovery year. For the record, we spent most of the
year astounded that investors were focusing on the year over
year declines at Boomtown New Orleans rather than the strong
results at L’Auberge Lake Charles ahead of an expansion and
the company’s growth plans. Anyone who did not expect a
decline at Boomtown New Orleans and Boyd Gaming’s Treasure
Chest just does not understand casino customers. Just like when
we disagreed with those who said those casinos in Biloxi and
Louisiana who were opening temporary facilities or re-opening a
few months after Katrina were not going to be successful, there
was no way Boomtown and Treasure Chest could keep up the pace
from the year before after the opening of more Mississippi
casinos and Harrah’s New Orleans. This is not something that
doesn’t happen often as even Boyd Gaming did not receive any
type of demand for their stock until AFTER Borgata opened and
investors believed it was going to be successful. The same can
work in reverse.
In the case of Trump Entertainment, one of the worst
performing stocks in the 2006 Model Portfolio, we only have
ourselves to blame for not following our own advice. When we
first added TRMP to the Model Portfolio, it was because we had
confidence in Jim Perry and his crew leading the company and we
felt Donald Trump would stay away from day to day activities and
decisions. The stock took a big hit when they did not win the
Philadelphia license but we still felt that if they went forward
with the Diamondhead casino development and showed all their
eggs were not in the Atlantic City basket, the stock would
recover. First TRMP decided not to go forward with the
Diamondhead development, and then one of Donald Trump’s
“sources” started leaking supposed takeover information to
the press. Then Jim Perry was fired and Donald Trump started
talking like he would run the day to day operations. Just about
everything we had warned about which could change the valuation
of the stock occurred and we did not remain disciplined,
continuing to believe that the sheer value of the company, the
fact that you could buy TRMP and get three casinos for cheaper
than it would be to develop a brand new one in Atlantic City,
would register with investors.
What happened was that Donald Trump and his board of
director’s decision not to go forward in Diamondhead made them
the whipping boy for the negative sentiment towards Atlantic
City. Anyone who fires a CEO during takeover talks shows they
don’t know enough about the “art of the deal” because
turmoil during takeover negotiations show instability which
result in a lower offers and lower stock prices. All that
happened, the deal fell through, along with another one later
on, and despite all that Donald Trump still seemed to believe
that the stock price was not a reflection of him, it was
everyone else. Even though we believe TRMP stock is worth a lot
more than the $5 level it was trading at in December 2006, as
long as Donald Trump has any say in what is going on, we can’t
justify putting it in the portfolio. Management is one of the
keys and we like TRMP’s executive team but as long as the
chairman has a say in what goes on, they can’t get our vote.
2007 was our first down year in the Model Portfolio in the 13
years that we have been publishing it. It was hard to fight a
negative trend in gaming stocks while sticking to our criteria
in selecting companies for the Portfolio. There were only a
handful of gaming stocks which ended 2007 up for the year. Bally
Technologies was one of the best performers but since they were
delinquent in their filings, we couldn’t include them. We saw
their turnaround, watched the coming together of a company that
always had a strong systems business but never a good slot
manufacturing operation. BYI had it all with a management team
led by Dick Haddrill and Gavin Isaacs who should be applauded
for the dramatic turnaround that they engineered in this
company. A couple of years ago we would have loved to have had
Lakes Entertainment in our Model Portfolio when they were
delisted to the pink sheets for being delinquent in their
filings but we wouldn’t feel right having a company in there
that we cannot verify things in “real time”. We can’t
change our rules based on the situation. We just couldn’t
include a company in the Portfolio who is delinquent in their
filings by that long of a period.
We earlier discussed what we felt was an orchestration by
Kirk Kerkorian and MGM Mirage’s board of directors of a strong
year for their stock despite a year that was hardly strong for
their fundamentals. The same could be true of one of the other
gainers for the year, Elixir Gaming Technologies, formerly
VendingData Corp. EGT wound up more than doubling for the year,
at one point in the fourth quarter sporting a nearly $1 billion
market cap on a fully diluted basis despite a lack of revenues
and an accumulated deficit that rose from $93 million at year
end 2006 to well over $315 million. It was a change of
management, excitement over the company being owned by Melco
Development of Hong Kong and a new business direction with slot
routes in Asia which generated investor interest but it was also
a classic example of the different mindset of investors in 2007
compared with other years.
Las Vegas Sands and Wynn Resorts had a pretty decent year,
percentage wise but don’t tell that to investors who bought
the stocks at their highs in the 4th quarter. These two stocks
may have been up for the year but we way off their highs as 2007
came to a close.
What worked in 2007 should have registered with many gaming
stock executives. Companies were rewarded if they had: 1) a
turnaround such as WMS and Bally, 2) aggressive action by a lead
shareholder or top executive such as MGM, EGT, WYNN, 3) business
in a very hot market such as WYNN and LVS in Macau. MGM proved
that you didn’t need exceptional results for your stock to
rally but you needed shareholders and executives that sparked
demand one way or the other. We ask you where Pinnacle
Entertainment stock would go in 2008 if Dan Lee stepped up and
bought 1 million shares of PNK stock. How about if Boyd Gaming
announced a joint venture with MGM or someone else on the
additional acreage they own near Echelon Place and they
contributed the land at a value of $30 million an acre? Faced
with an uncertain market, investors took complacency as a sign
of weakness and coming into 2008, they didn’t seem to be
changing that way of thinking.
Both Shuffle Master and Progressive Gaming pretty much traded
in tandem in 2007 and it was not positive. Accounting, legal and
integration issues weighed on both names but by year end both
companies appeared to have taken steps to correct these
outstanding issues. The steps taken were somewhat painful but
appear to have put them on firm ground to at least be valued
based on their fundamentals and future growth, rather than on
all these other distractions.
For the past decade, it has always paid to own the leading
company in the gaming sub-sector, but this seemed to change in
2007. Domestic slot giant IGT and their counterpart on the world
market, Aristocrat Leisure, seemed to lose their investor
following to Bally Technologies and WMS Industries. While it was
mainly due to the sluggish North American slot market which
showed up more in the results of the two giants than their
smaller competitors, it was also because investors always love a
rebound in the gaming space. If that remains true in 2008, there
are going to be a lot to choose from considering there were only
a handful of good performances in gaming stocks in 2007.
Shuffle Master, Progressive Gaming and Gaming Partners
International are also considered the leading companies in their
sub-sector yet they were punished by investors in 2007 for
various reasons, many which were detailed previously in this
report. The difference between these and the slot makers is that
none of these companies have any serious competition in their
respective spaces so it was just an investor revolt against the
individual issues affecting both companies and also a dose of
reality as investors had previously believed that Macau was the
pot of gold at the end of the rainbow for these companies.
It was not all doom and gloom during the year as there were a
few opportunities, besides those named already, to make a buck.
Table Trac, Inc. kept our streak of speculative winners alive,
rising more than 300% and making up for the decline in our other
speculative name, Siena Technologies. During the year we cherry
picked Las Vegas Sands, putting it in the Portfolio at $75.91 in
May during the height of the pessimism on the late summer
opening of Venetian Macao. We subsequently removed them from the
Portfolio in late October at $138.03.
We did something similar with Ameristar Casinos, patiently
waiting for their decline after the first half correction,
adding them to the MP in mid-August at $24.50 following
investors selling off the stock due to their disappointment that
they were not being acquired combined with weaker than expected
results. We subsequently removed them from the MP in early
November at $32.55 as investors once again started speculating
on ASCA being acquired while ignoring lower than expected
results at their new Resorts East Chicago acquisition and fears
of competition lowering results at their other properties.
2007 was a year where you had two chances to make money in
gaming stocks. The first was if you were lucky enough to only
own the few gainers for the year or started the year all in cash
and selectively built positions during the year. The good news
is the latter strategy can be put to the test in 2008 as the
majority of gaming stocks are ending 2007 much closer to their
52 week lows than their highs. Unlike last year at this time
when we really couldn’t find any names to be enthusiastic
about and were predicting a correction, we now enter 2008 seeing
a lot of names with limited downside but unfortunately, we have
to wait for timing issues and competitive pressures before we
see any explosive growth on the horizons.
Obviously the competition and new markets which are in the
process of starting up or further developing makes it wiser to
be overweighted in supplier stocks rather than casinos. On a
percentage gain basis, you probably have a better chance of
getting higher percentage gains from those that are not actual
slot manufacturers due to their valuations but the outlook for
slot companies are much more defined in terms of visibility. We
could easily see more than 100,000 slot machines added over the
next few years with 50,000 between California, Florida, Kansas,
Pennsylvania, New York, Indiana and Missouri with just a little
luck in the next couple of years. Once you add in the number of
machines that could be added in Las Vegas, Atlantic City,
Biloxi, Louisiana, Macau and Singapore, the potential for the
legalization of slots in Maryland and Massachusetts, and you can
see how that 100,000 additional slots number could prove to be
conservative.
As for the casino stocks, we have mentioned numerous times in
this report that investors are going to have to adjust
valuations and expectations due to competition. Investors must
lower their expectations on certain new casino developments
while being selective as to which opportunities can still
generate decent returns. Most budgets that are initially
announced by companies must have 10%-30% added on to them to
compensate for higher construction costs, design changes and
delays.
Looking at some of the casino developments which could be on
tap depending on voter, legislative and legal developments we
are positive on Pinnacle Entertainment’s new Baton Rouge
casino and Lake Charles expansion, along with their proposed
Atlantic City development; Penn National’s Hollywood Slots
permanent casino in Maine; Massachusetts casino developments;
and Las Vegas Sands’ Singapore casino. We believe MGM Mirage
has taken most of their risk out of the CityCenter development
while we have turned more positive on Boyd Gaming’s Echelon
Place development due to the changes that have occurred in Las
Vegas. The fact is that if things don’t change, in terms of
transportation infrastructure in Las Vegas, most of the people
attending conventions at the Las Vegas Convention Center will
either have to stay at the LV Hilton, in one of the non-gaming
hotels that may be developed by Marriott International on
Convention Center Drive, or if you want to stay on the Strip,
Echelon Place or the Kerzner International/MGM joint venture
near Circus Circus. Traffic is getting so bad on Las Vegas
Boulevard that it takes too long to get from the center of the
Strip to the Convention Center and the Monorail has just not
worked out the way it was expected.
It is kind of ironic to see what is happening in the Eastern
part of the United States regarding casino competition. For
years there has been competition in the Midwest and Southern
gaming markets but it was never like what we are seeing in the
East. What we have now is a zero sum game where each state may
wind up trying to stay one step ahead of the other. We see the
near term future of gaming areas East of Nevada being a question
of whether they will be reactive or proactive.
West Virginia obviously waited too long to legalize table
games to offset the declines in slot volumes from the start up
of operations at nearby Pennsylvania racinos. Atlantic City kept
blinders on, refusing to believe that their 4 hour a day
customers from Pennsylvania would rather drive 20 minutes than
an hour to play the same slots. By the time they realized it, it
was too late and AC operators wound up doing what they do best,
promoting themselves into lower profit margins.
In the next few years we may be seeing more casinos and
additional slots at existing properties in Pennsylvania, more
racinos in Florida along with full scale LV casino style gaming
at the Hard Rock casinos from the Seminoles, slot operations
starting up in Maryland, casinos coming online in Kansas,
racinos in Indiana, the legalization of slots or full scale
gambling in Kentucky, more VLTs in NY and three massive casinos
in Massachusetts. While this more than makes our case that the
suppliers are the more logical bet to prosper in coming years,
it also brings up the question of what the casinos will do in
this environment.
You can be the best casino operator in the world but if the
state you are in keeps their head buried in the sand, you will
have competitive issues. Right at press time West Virginia was
finally responding to the decline in slot revenue by starting up
full scale table games, something that will be watched very
closely by racinos in Pennsylvania and Delaware. If West
Virginia is successful, the move will be on to legalize table
games at PA facilities. In the case of Delaware, they could have
the trump card of them all, responding to the competition at
Delaware Park from PA facilities and potential cannibalization
of business if Maryland legalizes slots by legalizing sports
betting. Delaware would have an East Coast monopoly on sports
betting which would bring visitation from residents of
neighboring states during high profile sporting events such as
Super Bowl, World Series, NCAA Final Four, etc..
Racino states have advantages that places like Atlantic City,
Connecticut, and Indiana don’t. These states really cannot do
anything to help their casinos, it is really up to the casinos
themselves to provide a competitive product. Indiana casinos
could be hurt by the addition of more gaming positions and
additional casinos in the Chicago area of Illinois and
legalization of casinos in Kentucky. Atlantic City casino
executives took too long to change their business model to more
resort and higher end, longer staying casino customers and it
hurt them. Connecticut casinos will be pretty much helpless if
Massachusetts allows three integrated casino resorts as the
state is large enough and the resorts would be lavish enough
that Foxwoods and Mohegan Sun could not compete. That is the
reason why they have hooked up with partners to try to win the
casino licenses.
States like Missouri should use the impending opening of
Kansas casinos to remove the $500 loss limit without hurting the
casinos with higher taxes. States like Delaware should move now
to implement sports betting, and/or legalize live table games
before Maryland legalizes slots, rather than after. The Atlantic
City council members and NJ politicians should realize that
incentives should be given to the casinos to implode most of the
casinos on the Boardwalk for re-development. This would attract
more investment and make it much more attractive for companies
like Wynn Resorts, Las Vegas Sands and Penn National Gaming to
enter the market. Smoking bans nationwide are inevitable for
casinos but each state should consider the impact to existing
casinos and try to lessen it as much as possible. We know that
the AC City Council probably think they did that with only a 75%
floor space initial ban but the timing, right after the start up
of slots in PA, was ridiculous.
As for how to invest in these casino stocks with these
competitive concerns, you really have to weigh each on a
separate basis. Look at which casino stocks are trading at the
lowest valuations relative to existing operations and what they
have to look forward to. A company like MTR Gaming should be
considered in the context of having a difficult year due to the
declines in slot revenue at their facility in West Virginia, low
margins at the start up of their facility in Erie, PA and losses
at their Binion’s facility. To decide whether MNTG would be
worthy of investment in 2008 should be based on whether you
believe the table games in West Virginia will cause results to
be better at Mountaineer Park in 2008 versus 2007, if margins
will improve in Erie and if the sale of Binions and their other
LV assets will be completed. Then, even if you are satisfied
that 2008 will be a growth year for MNTG, you must decide
whether you will invest based on long term or short term. That
question has to be asked due to what will happen with the
expected rebound at Mountaineer Park if Pennsylvania legalizes
table games and what will happen to their Erie facility when new
competition comes on line. All we can say is that it was a lot
easier making investment decisions in gaming when there was at
least 100 miles separating each casino area.
Fundamentals versus rumors, consolidation versus integration
and momentum versus common sense will continue to determine near
term stock prices in 2008. The difference is that at the end of
2006, these stocks were mainly at their highs so the chances of
getting hurt were a lot greater than now, when these stocks are
closer to their lows. We’ve given plenty of reasons why these
stocks had the correction they did in 2007 but in some cases it
is up to each individual company as to whether they have what it
takes to rise from the ashes and show that 2007 was just an
aberration. This year’s portfolio is somewhat surprising since
it is tilted more towards casino stocks rather than suppliers.
This is due to our belief that there are more value plays on the
casino side and that you can get more bang for your buck,
percentage wise on the suppliers which took such a beating last
year. In 2008 we plan to be a lot more reactive than proactive,
setting tight restrictions on the companies we have in the
Portfolio. Due to the declines in gaming stock prices we once
again have included a Speculative section for stocks under $5.
Unlike previous years, these are not start ups or unknown
companies, these are established companies who generate decent
revenues and earnings but have either had events which have
depressed the stock price or have been a victim of the harshest
tax loss selling period we have ever seen in 2007. As always we
do not suggest having more than 10 or 15 percent of your total
gaming stock investments in speculative names due to their
volatility.
Good Luck and Profitable Investing!!
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