Gambling Stocks Still Look Like Good Bet

November 21, 2006 2:30 PM ET

Gambling Stocks Still Look Like Good Bet

NEW YORK (AP) - You've gotta know when to hold 'em.

Investors recently doubled down on gambling stocks despite a yearlong winning streak, wagering that expansion will spur growth and bettors will keep spending even as the economy softens.

The Dow Jones U.S. Gambling Index has surged more than 35 percent since the start of the year, easily outpacing the broader market as represented by the Standard & Poor's 500 index, which has added about 12 percent.

The gambling index, comprising 67 stocks weighted primarily toward large hotel-casino operators such as Harrah's Entertainment and MGM Mirage, has generally tracked sentiment about the overall economy.

After rising through April, the index gave back most of the gain amid worries consumers would be cash-strapped as oil prices climbed steadily ahead of the summer months.

"Those concerns didn't come to fruition," said Robert LaFleur, a gaming, lodging and leisure industry analyst with Susquehanna Financial Group. "Expectations were that higher gas prices and a softening housing market would pressure the industry, but visitation has remained strong."

Part of the reason is that casino performance does not necessarily track consumer spending, despite investor reaction.

"The Las Vegas strip market is driven more by overall economic growth," said Morningstar equities analyst Sumit Desai. "The stocks are more cyclical than the underlying business," he said.

And gamblers don't necessarily curb spending in economic slowdowns, anyhow. "The high-roller business is always going to be strong because these guys don't worry about short-term factors," LaFleur said.

Either way, there was more good news Monday when a leading economic indicator edged higher, suggesting the recent housing slump was not enough to offset lower gas prices and a rising stock market.

Another boost for the sector, said Frank Fahrenkopf, head of industry trade group American Gaming Association, is casino operators' expansion into other businesses.

"The industry has moved to the total entertainment package," he said. "People come to destination resorts -- they come to shop, to see shows and to play golf."

That trend in Las Vegas, which attracts more families and couples to what was long considered a bachelor's paradise, has turned off some of the city's more committed gamblers, but it has benefited the operators.

"It used to be that a casino's bottom line was about 65 percent gaming revenue," Fahrenkopf said. That's down to around 40 percent now at some companies, even as gaming revenue surged past $30 billion for the first time last year, according to the AGA.

And casino operators are boosting investment into additional entertainment venues. There are $20 billion worth of projects in Las Vegas alone that will be completed by 2010, said Desai.
"They want to offer a resort experience instead of just gambling," he said.

The danger is that new casinos and hotels could lead to excess supply. "That could be a hiccup for the industry, especially if it coincides with an economic slowdown," he said. "But generally the industry does a great job at managing growth."

Driving that growth -- in Las Vegas and Atlantic City, N.J., and also in the numerous other states that license American Indian casinos -- is increased social acceptance of gambling, Fahrenkopf said. The lobbyist traced the start of public softening toward gambling back to the reintroduction of lotteries in 1963 in New Hampshire. Now 48 states have some form of legalized gambling, from lotteries to horse racing to casinos.

But the surge that benefited casinos most came as poker soared in popularity, first through Internet sites and then, starting in 2002, televised tournaments. The Poker Players Alliance, a player-based lobbying group, estimates there are more than 70 million Americans who play poker. The number of poker tables in Las Vegas has risen to 405 in 2005 from 142 in 2003.

"Poker clearly helps," said LaFleur. "It's a tough game for casinos to make money on, but it attracts gamblers."

Harrah's, the country's largest casino operator, has turned the game's popularity into a major revenue source with its annual World Series of Poker. The company is currently being courted by private-equity groups with a $15 billion buyout offer, excluding debt assumption.

The offer, which would be about a 25 percent premium, helped bolster the sector, LaFleur said, because it sets a mark by which to determine the value of other companies in the sector. "The stocks often trade up in anticipation of other deals," he said.

The news helped Harrah's stock recover after it stumbled earlier this year on investor concerns about its lack of a presence in Asia.

Las Vegas Sands Corp., run by billionaire Sheldon Adelson, and Wynn Resorts Ltd., run by Steve Wynn, have licenses to operate in Macau, China -- the former Portuguese colony on the Chinese mainland that is now considered the next gambling paradise.

The expansion overseas marks the first time U.S. casinos have ventured abroad, lured by a strong gambling culture in Asia and the Chinese government's desire to attract foreign direct investment.

"The market trends are very strong in Asia and there are no indigenous companies with the experience to operate on the scale they want in Macau," LaFleur said, adding that Singapore is also a growing market for U.S. casinos.

The attraction of new markets is clear, but Desai warns that intense capital spending could hamstring some companies. "A lot of times investors think you can't lose with these stocks, but Trump went bankrupt two years ago.

"The problem is they require a lot of investment to keep them fresh and new and they have a ton of debt on the balance sheets. They are inherently risky investments," he said.
You also need to know when to fold 'em.

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