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Intro: Light Up the Darkness
Light Up the Darkness. As Credit Crunch Endures Gaming
Experiences Recession and Leverage Never Seen Before
Deep in the midst of the credit crisis and a US recession, two things we now know for sure --
gaming is recessionary in a consumer downturn and leverage in the high single digits (7x to
9x or worse) is not preferable for gaming assets bought at the top of market. And the
outcome too seems clear -- the days of high multiples paid by private equity and financed
with debt commitments from bulge bracket banks is now over. We expect on a go-forward
basis, multiples to be lower. We also expect financing hurdles for gaming transactions to
require significantly more equity and less leverage.
Recession in Gaming. Until now there was little proof that gaming was recessionary. In
fact, the last time a consumer recession hit the United States was 1990-1991 and the size
and complexity of the gaming industry were entirely different. Mississippi was gaming free.
Iowa did not know of casino cruises. And the gaming debate still raged on in Pennsylvania,
Illinois and Indiana. Back in 1990 only Nevada and Atlantic City offered casino gambling.
Today, the gaming industry is almost three times its size in 1995 and NOW we know -- the
gaming industry without question is RECESSIONARY. In fact, the first quarter yet to be
reported promises to be one of the worst quarters in a long, long time. In January we
estimate revenues on a same-store basis were down 3% to 5% while February was flat,
helped by the extra day from the leap year. And in March revenues have trended back down
– Atlantic City (-9.9%), Illinois (-19.9%), Indiana (-10.9%) and Missouri (-5.6%).
How Long Will It Last? Now the recession debate moves on to length and depth. The
current "new" consensus among prognosticators is that the recession will be short and
shallow (V-shaped) with the GDP contracting in Q1 and Q2 and recovery in the second half of
2008. This view seems to be based on the fact that the last two recessions (1990-91 and
2001) less than nine months each. Others believe it will be a longer (U-shaped) recession
with the contraction lasting perhaps as long as 18 months to mid-2009. We side with the Ushaped
camp based on our belief that financial conditions are worse relative to those two
previous recessions and declining household wealth, coupled with higher commodity prices
(oil almost $120/barrel) , is a huge negative.
Housing Implosion is Main Catalyst. No doubt, we are in the midst of the worst US
housing recession perhaps ever and this housing recession may have not hit bottom. Home
prices are already down by approximately 10% and continue to decline. With home prices
down 10%, $2 trillion of home wealth is already wiped out and 6 million households have
negative equity. Should home prices fall another 10%, a cumulative $4 trillion of housing
wealth will be destroyed and 16 million households will be in negative home wealth territory.
Should the cumulative fall in home prices be close to 30%, $6 trillion of home equity would
be destroyed and 21 million households (40% of the 51 million having a mortgage) would be
underwater. Potential credit losses from borrowers walking away from their homes could be
$1 trillion or more. And as it pertains to the gaming industry, the US consumer is under
pressure, saving-less and overrun by many negative shocks such as falling home prices,
falling home equity, falling stock prices, mortgage resets at higher rates as well as rising oil
and gasoline prices, falling employment and rising inflation eroding real incomes.
How Will Operators Be Impacted? For starters, casino revenues will be down and are
down so far in the first quarter 2008. In Las Vegas, room rates are declining, for the first time
in a long time. While the official results from the Las Vegas Convention Visitors Authority
(LVCVA) are not yet out, our research indicates that current and future hotel room rates are
much softer versus the prior year. Further, while much harder to measure without standing
outside restaurants and polling customers, we believe F&B spend is decreasing as the
consumer is impacted by recessionary pressures.
Bottom Line – What Will Be the Financial Impact? Looking specifically to an individual
property, we believe a 10% decline in revenues, linear across the board, including room rates
as well as casino play, will likely lead to an approximate 20% reduction in EBITDA. While
some of the expenses in running a casino are variable, many are fixed - we estimate
approximately 60%. Those expenses include casino operations, utilities, custodial services,
general and administrative and property taxes. Other expenses such as taxes and license
fees, direct table and slot expenses, customer complimentary expenses and marketing are
variable. The fixed and variable proportion varies depending on whether the casino is located
in Las Vegas and controls a large number of rooms or is a riverboat with a greater proportion
of revenues from slot machines. Tax structures also have a big impact on margin. To date,
operators have been utilizing reduction in labor hours, which will be followed by a reduction
in staffing levels to reduce costs. Some operators have told us that they are sending variable
employees home.
Will Service Levels Be Reduced? Cutbacks lead to reduced service levels and over time
lead to a reduced customer experience. While casinos do not like the notion of paring back
on customer service or maintenance capital, during periods of declining EBITDA the trend
among some has been to make those cuts. The most dramatic service cuts that we ever saw
transpired once Bill Yung acquired the Tropicana Hotel Casino in Atlantic City (Las Vegas too).
Over the course of very few months bathrooms went unclean, customers got stuck in
elevators and more (lots more). Thankfully, these actions are extremely rare. Nevertheless,
reduction in maintenance spend can lead to the devaluation of an asset over time.
Early Victims. Tropicana has been in a legal tangle with bondholders since the beginning of
the year. Bondholders sued the company to accelerate payment on the notes after the New
Jersey Casino Control Commission declined to renew the company’s license due to
violations of state laws by Tropicana owner Columbia Sussex. In March 2008, a Delaware
court found the company in default on $960 million of the 9.625% notes. Tropicana was
given a grace period to remedy the situation, which extends through April 20, 2008. Another,
Greektown Casino, one of three casinos in Detroit, recently backed off plans to issue debt
and will instead seek to finance the balance of its Detroit casino expansion project with
equity. It has a 30-day deadline and the pressure is now on to find that equity. Also, BLB
Investors, the owner of Twin Rivers' in Rhode Island, missed a payment owed to its lenders.
Having missed an interest payment, the lenders agreed to push back a bankruptcy filing until
June 30 dependent on various provisions. The missed payments are due to significantly
lower than expected EBITDA performance and higher leverage. And Herbst Gaming became
the latest victim of the contracting economy. Recently, Herbst received a going concern
notice from its auditors in its 10K, constituting an event of default under the credit
agreement. Herbst has indicated that it plans to enter into discussions with lenders to
negotiate a forebearance agreement as a result of the going concern opinion and probable
failure to comply with financial covenants through 2008. Lenders here will certainly have to
be considering a Chapter 11 filing.
Multiples Coming Down. Given the unwinding of leverage, we believe multiples of gaming
assets will decline as well. The private equity transactions that occurred over the last two
years are a thing of the past. While the rigors of credit analysis are a welcome return, the
willingness to put large amounts of leverage on gaming assets will be curtailed, especially
given the new paradigm in which gaming is clearly cyclical. And that will most certainly lead
to lower multiples for gaming assets. There will be some exceptions. We believe those
premiere Las Vegas assets will always fetch a superior multiple.
Opportunity Does Exist. We believe investors should utilize the barbell approach balancing
investments between higher quality credits that have modest leverage and will maintain their
current yield along with those credits that have strong liquidity and stable long term
fundamentals but have traded off significantly as leverage is high and possibly going higher in
the short term. While there is no need to rush out and buy RIGHT NOW we do believe it is
time to start bottom feeding for those credits that have stable long term fundamentals but
may be experiencing higher leverage as fundamentals soften modestly. Opportunity does
currently exist as investors have, during these turbulent times, thrown out some quality
credits along with the junk. (See page 7 - page 12 for Recommendation highlights)
Table of Contents
Intro: Light Up the Darkness..................................................................................................4
Recommendations and Historical Performance................................................................... 7
Recommendation Abstract .................................................................................................. 13
Relative Value Data............................................................................................................... 22
Credit Comparison: Yield to Worst ..................................................................................... 28
Credit Comparison: Spread to Worst.................................................................................. 30
How Will the Recession Impact Capex Spending in 2008/2009?......................................38
Acquisition Outlook and Review......................................................................................... 44
Capital Markets Under Siege............................................................................................... 48
Margin Analysis..................................................................................................................... 52
Gaming Equity Prices ........................................................................................................... 53
Detailed 4Q 2007 Results – Gaming & Leisure ................................................................... 54
Boyd Gaming .......................................................................................................................55
Fontainebleau Las Vegas......................................................................................................61
French Lick Resorts..............................................................................................................63
Galaxy Entertainment Group................................................................................................. 65
Inn of the Mountain Gods..................................................................................................... 69
Isle of Capri Casinos............................................................................................................. 71
Las Vegas Sands ..................................................................................................................77
Majestic Star Casino LLC......................................................................................................83
MGM Mirage........................................................................................................................86
Mohegan Tribal Authority .....................................................................................................93
MTR Gaming........................................................................................................................99
OSI Restaurant Partners ..................................................................................................... 102
Pinnacle Entertainment....................................................................................................... 112
Six Flags............................................................................................................................ 118
Station Casinos .................................................................................................................. 121
Town Sports International................................................................................................... 131
Trump Entertainment Resorts............................................................................................. 133
Wynn Las Vegas................................................................................................................. 138
2008 Jurisdictional Market Highlights .............................................................................. 144
Jurisdictional Update ......................................................................................................... 146
Monthly Gaming Revenues by Jurisdictions......................................................................... 149
Atlantic City........................................................................................................................... 152
California ............................................................................................................................... 156
Colorado............................................................................................................................... 157
Illinois ................................................................................................................................... 160
Indiana.................................................................................................................................. 163
Iowa ..................................................................................................................................... 167
Louisiana ............................................................................................................................... 170
Mississippi ............................................................................................................................ 173
Missouri ............................................................................................................................... 175
Nevada................................................................................................................................. 178
Pennsylvania ......................................................................................................................... 181
Jurisdictional Maps............................................................................................................. 182
Macau: Debt Perspective – A Fascinating Market........................................................... 202
Highlights of Macau Visit – April 2008 .............................................................................. 222
Financial Summaries – Gaming ......................................................................................... 224
Appendix 1: Economics of the Gaming Industry.............................................................. 280
Appendix 2: State by State Gaming Tax Structure.......................................................... 287
Appendix 3: Magnitude of the US Gambling Industry .................................................... 290
Appendix 4:Casino Games at a Glance ............................................................................. 293
Appendix 5: North American Gaming Facilities by State................................................ 296
Detailed 4Q 2007 Results – Lodging.................................................................................. 315
FelCor Lodging Trust............................................................................................................. 316
Gaylord Entertainment .......................................................................................................... 320
Host Hotels ........................................................................................................................... 326
Starwood Hotels & Resorts Worldwide ................................................................................ 330
Vail Resorts, Inc. ................................................................................................................... 332
Financial Summaries – Lodging......................................................................................... 336
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