Annual Model Portfolio
2010 Model Portfolio
Gaming stock investors were smiling in 2009 as despite a lot
of volatility, it was a solid rebound off of what was arguably
the worst year in history (2008) to be invested in these names.
2009 was also one of those rare periods where both casino and
supplier stocks ended the year strongly in positive territory,
not only showing the oversold condition they ended 2008 in but
also that there was more money on the sidelines than anyone
expected.
As we said earlier, for 9 months of 2009, gaming stock
investors were having a party but the first quarter definitely
tested everyone’s reserve. The era of easy money which fueled
a building boom, extremely high debt levels and unrealistic
asset valuations came crashing down to reality in the first
quarter of 2009. For two years we had discussed how the
“newbies” to the casino industry had infiltrated the Strip
and how this was a sign of the irrational exuberance we were
looking out for. It was quite fitting that by the end of 2009
all those Newbies were basically either leaving Las Vegas with
their tails tucked between their legs, stuck with land with a
cost basis that may never be reached again, or on their way to
an exit as their creditors take control.
Elad Group’s purchase of the Frontier was the Top of the
Market, just as we had predicted but it wasn’t just Elad who
was leaving money on the table in Las Vegas. Legendary real
estate investors and some over-zealous hedge fund investors lost
hundreds of millions in companies like Riviera Holdings and land
purchases. The Planet Hollywood group was ending 2009 halfway
out the door, learning a painful lesson that owning a casino is
not as easy as it looks. “Newbies” who rolled the dice on
the Sahara and Hooters casinos in LV were pretty much wishing
they could turn back time. Everyone knows now that Jeff
Soffer’s dream of turning the El Rancho into Fontainebleau ran
into the proverbial brick wall while the Cosmopolitan continues
to show why we say it is cursed, inflicting financial pain on
anyone who comes in contact with it. The rusting steel at
Echelon Place shows that even guys in the business can get
caught up in the moment and of course, Colony Capital is about
2/3rds of the way out of the entire U.S. casino business. As
legendary as they are in the real estate business, they did
overstay their welcome in the casino biz. While Colony was a
coast to coast casino owner for many years, they only had one
successful casino investment in all those years and that was
Harveys Casino Resorts more than a decade ago. Colony has the
luxury of being the first casino owner to turn the keys of the
casino to a lender rather than go through a bankruptcy. While
common in the hotel business, their decision to walk away from
Resorts AC is a first there.
Following those massive declines in casino stock valuations
in March of 2009 when push came to shove for CityCenter/MGM and
Las Vegas Sands, investors found out just why it makes more
sense to be a public casino company than one owned by private
equity. There were more bankruptcies involving casino companies
or individual casinos in 2009 than ever before yet only one was
a public company. That company is Trump Entertainment Resorts, a
name that would have shown up on the top of anyone’s list as
the most likely public casino company to declare bankruptcy. The
Chapter 11 filings over the past 12-15 months of Herbst Gaming,
Station Casinos, Majestic Star, and Tropicana Entertainment, to
name a few, and the way MGM and LVS were able to come back from
the brink of bankruptcy shows why public casino companies have
an advantage and that is public equity. Both MGM and LVS were
able to stay afloat with painful at the time, but necessary,
public offerings of stock. Investors in those offerings made
quite a return as LVS quadrupled in price from the offering
price and MGM nearly doubled. Wynn Resorts sold equity to shore
up their balance sheet, also giving those investors a fine
return. Regional gaming companies like Ameristar Casinos, Isle
of Capri Casinos, Penn National and Pinnacle Entertainment were
able to either buy back their debt well below par, or
renegotiate or refinance credit lines or other debt facilities,
taking advantage of their more resilient operations, ending the
year in much better financial shape than they started. Once
again it was the public regional casino companies which received
a much warmer reception from investors.
While the majority of the regional gaming areas had a decent
year, as compared with their resort destination areas, there
were still numerous casinos that end 2009 either in bankruptcy,
behind in their debt payments or about to have an ownership
change as a result of Chapter 11 bankruptcy reorganization. It
was in last year’s issue that we predicted between 6 and 10
casinos in Atlantic City could be part of a bankruptcy or in
financial trouble. As we end the year Tropicana AC is about to
have a change in ownership to Carl Icahn and the reorganized
Tropicana Entertainment, three Trump Entertainment properties
are in Chapter 11, Resorts was foreclosed on with the lenders
taking over and AC Hilton hasn’t made any debt payments in
months. Harrah’s Entertainment was able to avoid major
financial issues with constant debt swaps and refinancings
leaving only Borgata in decent shape. Is it any wonder why we
feel Atlantic City is one of, if not the, worst gaming market in
the United States?
Over in Asia, Wynn Resorts and Las Vegas Sands took advantage
of a strong Hong Kong IPO market to conduct Initial Public
Offerings of their Macau units, raising nearly $7 billion
between selling equity and some bank financing. Those offerings
not only raised them capital that they need to continue to
expand their Macau empire, it validated the valuations their
parent company was trading at, shoring up the overall balance
sheet of the parent and also giving their Macau assets a valid
public valuation.
For investors, the gaming industry ends 2009 and starts 2010
with a much better financial outlook than a year ago. While that
seems a strange thing to say considering the increase in
bankrupt casinos and casino companies out there, we remind you
that this does not impact the public companies as much. We
believe that with the exception of a few, most of the public
casino companies are no longer at risk of bankruptcy. This is a
big difference from the end of 2008 when Wall Street was
pointing to Penn National Gaming as the only company they had
absolutely no concerns over.
Trump Entertainment Resorts may finally be put out of its
misery as a public company in this third reorganization. With
CityCenter just opening as we go to press, we have to include
MGM Mirage as a company that could once again be teetering on
financial collapse if CityCenter cannot be profitable. We expect
Riviera Holdings to disappear from the public markets once
Wachovia decides what they should do with the assets. Wachovia
has been giving Riviera a lot of time considering they have been
in default for like 6 months. The other company that could be
facing financial issues in the next 18 months or so is MTR
Gaming. Right now every one of MNTG’s casinos faces a
competitive threat. Table games being legalized may help Presque
Isle Downs but will hurt their Mountaineer Park Casino in West
Virginia even more than it benefits Presque Isle. The only
chance MNTG has at Presque Isle is if the Ohio casinos from PENN
and Dan Gilbert get delayed for years, bogged down in political
and legal red tape. While that may give MNTG a short life line,
the only way we see MNTG making it is if Ohio can somehow allow
slots at tracks either well in advance of the PENN/Gilbert
casinos being opened or in place of them. MNTG is a classic
example of why we believe ignorance has become bliss in the
corporate bond market when it comes to casinos.
For many years we wondered how so many gaming equity
investors can do so without strong knowledge of the industry. We
pointed to the direction of gaming junk bonds for investors to
really gauge the profitability of a casino or casino company.
All that has changed as we have seen debt investors willing to
invest billions in pipe dreams such as the purchase of Aztar
Corp. by Columbia Entertainment, Herbst Gaming’s strategy of
buying low margin/profit casinos across the country,
privatizations of Harrah’s and Station Casinos at such high
valuations and the biggest red flag of all, the purchase of
notes in MTR Gaming both before and after the mess with slots at
tracks in Ohio occurred and table games were on their way in
Pennsylvania.
Obviously there are always times when investments do not turn
out right in casinos or casino companies but in the past three
years we have seen investors in publicly traded debt, across all
different industries, throw money at many deals that made no
sense at all. In the casino business this has been a lot easier
to spot because of how valuations in transactions like the
purchase of Aztar or the purchase of the Frontier by Elad Group
had risen to unrealistic levels. Of all the classes of
investors, those in debt securities felt a lot of pain in 2009
and may feel even more in 2010 in terms of the gaming business.
It seems right now that unsecured creditors who receive pennies
on the dollar in these reorganizations may wind up lucky because
many of these deals will result in a total loss.
Just about every reorganization, even the ones that are
supposed to have been agreed upon beforehand, are taking much
longer than expected. Unsecured creditors are fighting tooth and
nail for any scraps they can get. In many cases, warrants or
slivers of equity may be given. The end result of all this may
be many of these companies going public again. We are already
seeing it in the lodging arena as many veteran executives who
sold out their public companies during the private equity craze
have raised money in the past year or are filing for IPOs. If we
were to see this happen in the gaming industry again it would be
a good thing as we have seen a change in this industry from an
investor standpoint. If Carl Icahn can accomplish what we think
he is trying to do, basically corner the market for distressed
casinos, his exit strategy may be an IPO when the economy
recovers. We believe he may wind up having to close some
properties, such as a Trump casino or two if he is successful at
winning the Trump bankruptcy, or a casino like Horizon in
Vicksburg for Tropicana Entertainment.
We don’t believe there are enough public casino companies
out there, especially with the opportunity that is becoming
available to those with liquidity. While we believe there are
too many casinos concentrated in certain areas such as the
Eastern part of the U.S., this is only going to get worse as new
markets such as Kansas, Maryland, and Ohio open their first
casinos and established markets such as Pennsylvania and
Delaware add additional game opportunities such as table games
and sports betting and also open new casinos. While we are
confident the end result is going to be some cherry picking of
casinos, where many which need capital investment and are
subject to competition wind up being closed, these
reorganizations will delay this inevitable situation as
bondholders and banks try to salvage their investment by taking
over control of these properties. They will then hire management
companies or other casino companies, something that will be
quite profitable for those getting the contracts but not
something that will help the oversupply. Eventually these owners
are going to want to convert their equity to cash and will begin
to sell off casinos or the whole company. It is then that a
buyer may choose to close certain competing properties to make
their operations more profitable overall rather than trying to
go against common sense.
Isle of Capri Casinos is the public company we believe with
the best chance to get some of these management contracts as
their management has proven over and over again that they can
operate in the most difficult markets. There are quite a few
gaming executives from Harrah’s and other casino companies who
have also formed management companies so competition will be
fierce. At the same time these new owners will decide whether to
sell or go public with their assets and that is when the
opportunity will be created for the liquid companies and
investors.
We are seeing a sort of chess game being played and it looks
like the casino space could be dominated by a few companies in
the future. Carl Icahn is showing he is making a coast to coast
move to take advantage of the depressed valuations and financial
troubles in the industry. Between Tropicana Entertainment,
Fontainebleau and Trump Entertainment, he could have ownership
of casinos in the majority of markets in the U.S. Genting is
making its move in the U.S. between tribal casinos and racinos
and potential new markets. In addition they have taken equity
stakes and purchased debt in offerings from MGM and Wynn
Resorts. PENN not only is still looking out for acquisitions but
also has Greenfield projects in every new market that has been
legalized. Isle of Capri Casinos may get management control of
quite a few casinos that come out of Chapter 11 and was reported
by Dealwire to be named as a potential manager of some of the
Station Casinos properties by some if the bankruptcy proceedings
go that way. Boyd Gaming’s interest in owning some or all of
Station Casinos shows they would like to dominate the local Las
Vegas market. We are quite sure that Wynn Resorts would be right
there showing an interest if companies like MGM or Harrah’s
would need to get rid of higher end properties such as Bellagio,
Mirage, MGM Grand or Caesars and of course Las Vegas Sands has
made it clear they want to be the primary name when thinking
about Asian high end casinos. Harrah’s seems to want everyone
to know they are still out there looking for opportunities no
matter which high yield analysts or newsletters declares them
toast. As 2009 came to a close this all began to unfold.
As for these competitive markets, we continue to believe that
the only two that are hopeless are Atlantic City and Illinois.
AC has half of their casinos which either need billions of
investment or should just close up. The only way we can see
Revel Entertainment making it is if we see 3 or 4 of the
existing casinos close up shop. With table games coming in
Pennsylvania and Delaware and the Aqueduct license in NY
eventually being granted, things will only get worse. What
bothers us the most about this market is that casino executives,
local and state governments continue to be in denial about the
situation. They hold summits, Revel executives point fingers at
who is to blame but the reality is that there is only one way to
change it and that is to reduce the number of positions and only
have the quality ones remain. Borgata, Trump Taj Mahal,
Harrah’s Marina, Caesars, Revel and perhaps the Tropicana in
Atlantic City would all be profitable if the rest of the casinos
would close and become condos or just hotels, convention and
retail space. The remaining gaming space and the increase in
retail and other non-gaming amenities would be a nice balance
with the reality of what the market is today. Unfortunately we
think it will take until Pennsylvania gets table games and
everyone sees how bad it is in the summer of 2010 before this
becomes apparent to those who are closest to the situation.
As for Illinois, this market was destroyed by a combination
of the actions of the state government in regards to taxes, fees
and smoking bans and the actions of some of the casinos made
things even worse. Despite declines of more than 30% in the
Chicago-area casino revenue in the past 2 years, another license
was granted and another casino in the market is being developed.
Adding to this is the constant talk out of Chicago of allowing
another casino in the city. The removal of the loss limit and
success of Lumiere Place has hurt the casinos in Illinois which
compete with the St. Louis properties. We believe at least one
Chicago area casino and one St. Louis casino could close and the
remaining properties would benefit.
While we expect Colorado to be the strongest market in the
first half of 2010, the second half marks the anniversary of the
change in bet limits, hours and new games, and results will be
determined by the economy. Missouri, Mississippi and the local
Las Vegas market will be impacted more by the economy than
anything else. Markets that will be impacted the most by
competition from their borders will be Illinois, Indiana,
Atlantic City, Delaware and Connecticut. Pennsylvania and Las
Vegas will be the markets impacted the most by competition from
within as more capacity has to be absorbed on the Strip by
CityCenter and in the Philadelphia market by SugarHouse and the
Philadelphia Park expansion.
We believe suppliers once again are in a better position than
casinos but the stakes have risen. A rejuvenated IGT will want
to gain back the market share they lost by taking their eye off
the ball the past few years. WMS and Bally Technologies will
want to protect the share they have gained and add to that.
While we believe BYI has a product line that will help them gain
share, they will have a much easier time in the systems market
as we believe the opportunity is there for BYI to become the
undisputed leading systems company. While IGT, BYI and WMS slug
it out in the slot market, upstarts Konami and Aruze will want
to get their percentages in the major markets and Multimedia
Games is moving more into what we call the Class II and ½
markets, the non-traditional class III arenas. Shuffle Master
and Gaming Partners International have a great opportunity ahead
of them as table games expand to new markets in the East and
more casinos open in Asia. These are the two primary companies
that benefit from an expansion of table games.
We expect the pick up in replacement sales to become apparent
by the calendar second quarter of 2010, attracting the interest
of investors but the second half of the year’s success or
disappointment will be determined by the timing of new
opportunities such as Illinois’ video gaming market, new
casinos in Kansas and Maryland, VLTs in Italy, casinos in Mexico
and expansion in Europe and Brazil. We believe the near term
opportunity for investors will be in suppliers but the second
half of the year needs more visibility.
Good Luck and Profitable Investing!!
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