Company Focus
Recent articles:
• How insiders can unload stocks in secret, 3/12/2003
• 6 airlines that win if United fails, 3/5/2003
• 7 stocks to shun -- or short, 2/26/2003
More...
| | Company Focus
How to handicap gambling stocks
Cash-strapped states are ready to allow greatly expanded gaming -- and to ratchet up taxes on it, too. Both would have dramatic effects, but not on everyone.
By Michael Brush
Like reckless day traders, state officials around the country fooled themselves into thinking the 1990s economic bubble would last forever -- and they spent accordingly.
Now, tax revenues are plummeting because of the sluggish economy, so states are turning to an easy mark -- the gambling sector -- to plug an estimated $17.5 billion shortfall this year.
What does this mean for gambling stocks? With state governments considering new gambling initiatives on the one hand and new gambling taxes on the other, theres a healthy mix of the good, the bad and the ugly for the sector. Investors, however, are focusing mainly on the bad and the ugly, creating what looks like a buying opportunity for many gaming-related shares.
The best place to look for good stock buys is among the companies likely to benefit from the changes that are on the way. Penn National Gaming (PENN, news, msgs), for instance, owns tracks in Pennsylvania, which may soon get slot machines. Harrah's Entertainment (HET, news, msgs) has a good record of setting up shop in new territories -- which would come in handy if states allow more gambling. International Game Technology (IGT, news, msgs) and GTech Holdings (GTK, news, msgs), meantime, produce slot machines and manage state lotteries.
Another strategy is to go with gaming companies that are immune to potentially damaging changes such as tax hikes. One candidate: Las Vegas-based Station Casinos (STN, news, msgs).
Changes on the horizon
Understanding whats going on in the world of gaming nationwide can be a challenge, as the sector is regulated by the dozens of states that permit it. Each state creates different ways to tap into the industry profits.
In general, states are working to increase taxes and admission fees (the bad). They also are thinking about loosening restrictions to allow more gambling (the good). And then theres the ugly: Politicians, being politicians, are sending muddled signals about when any of the changes will come about. That has left investors with lots of uncertainty, which is poison to the market.
The biggest fear playing on investors is that gaming companies will see a replay of last year, when Illinois increased the top tax rate on gaming profits to 50%. That move sent investors running for the exits as they figured other states might follow. Right now, investors are not going to make enormous bets, knowing what Illinois did last year, until things are completely clear in terms of new taxes, says Joseph Greff, a gaming-sector analyst at Fulcrum Global Partners.
The result: Many gaming stocks have been beaten down to five-year lows, and value investors are sniffing vigorously around the group. We think there is a lot of value in this area, and we are spending a lot of time trying to identify opportunities, says John Miller of Ariel Mutual Funds, which was recently buying Park Place Entertainment (PPE, news, msgs).
The tax threat
To be sure, it seems like theres plenty to worry about. New Jersey wants to raise casino taxes to 10% from 8%. More ominously, it would slap a 7% tax on comps like free rooms, meals and drinks for high rollers. That may not sound too bad, until you realize that roughly two-thirds of hotel rooms in Atlantic City are given away. Back-of-the-envelope calculations by Wall Street analysts put the damage at around 10% of earnings for big Atlantic City players such as Harrahs and Park Place.
Missouri wants to double casino admission taxes to $4 per gambler. (You many not know it, but in many states, casinos secretly count gamblers on entry to calculate this tax.) It also wants to raise casino taxes to 22% from 20%. California is leaning on Indian tribes to fork over more gambling revenue.
Massachusetts Gov. Mitt Romney takes the award for chutzpah. He has asked casino owners and slot operators in neighboring Connecticut and Rhode Island to pay $75 million, or hell try to expand gambling in his state. Maryland initially put dauntingly high tax rates of 64% on the table for slot machines at racetracks.
Overblown concerns
Despite these rumblings, new taxes on casinos probably wont be that bad when all is said and done -- for a simple reason. State lawmakers will figure out that if they tax casinos too much, theyll lose more than they gain because casinos will set up elsewhere. Raising taxes and changing the rules a lot makes us real nervous and slows down investment, says Jack Gallaway, chief executive of Isle of Capri Casinos (ISLE, news, msgs).
Park Place, for example, iced some expansion plans in Atlantic City when it heard of the proposed tax increases. But to really make the case against big tax increases on casinos, industry lobbyists like to cite what has played out in Illinois since it raised taxes sharply last year.
Both Harrahs and Argosy have either canceled or sharply scaled back investment plans, says Illinois Casino Gaming Association chief Tom Swoik. Whats more, the bid on another gaming license in the state plummeted sharply from the $615 million once offered by MGM Mirage (MGG, news, msgs). Swoik estimates the license may now fetch closer to $400 million.
I think that what happened in Illinois last year was the best thing that could have happened to the industry, says Troy Stremming, the head of legal and governmental affairs at Ameristar Casinos (ASCA, news, msgs). Others can point to that and say, Heres what is going to happen if you raise taxes, says Stremming, who doesnt believe states will raise taxes much on casinos. If he is right, his company shares may bounce back; they were depressed in part because of the threat of higher casino taxes in Missouri.
Whatever tax increases do pop up, theyre likely to be accompanied by a loosening of gaming rules to help casinos. Missouri, for example, is considering lifting limits on how many chips people can buy, in exchange for higher taxes. Some states, like Illinois, are thinking about lifting the limits on slots or the number of seats at tables. You can also expect a lot more slot machines at racetracks.
The lure of racinos
States favor racinos -- what you get when you put slots in at racetracks -- for two reasons. First, business at tracks across the country is off, and this would help them. Second, limiting slots to racetracks makes it easier to control where gambling takes place.
States from Maine to Massachusetts and Maryland to Indiana are thinking about letting racetracks install slot machines or increase the number already in place. But Pennsylvania is the most likely state to approve racinos soon, perhaps by this summer.
This would be a big payoff for Penn National Gaming, which has two tracks in Pennsylvania. Shares of Penn National have been weak recently because of a dispute with bondholders over the fate of a Shreveport, La., gaming facility run by Hollywood Casino (HWD, news, msgs), which Penn National just purchased. Magna Entertainment (MECA, news, msgs) is another racetrack operator, with 13 tracks around the country.
The machine makers
As states put in more slot machines, business is booming at International Game Technology, the biggest machine maker in the industry. We think there may be 10 new jurisdictions coming online in the next 10 years, says chief of finance Maureen Mullarkey. But be forewarned: Many analysts think the good news may already be priced into the stock.
GTech Holdings, which handles much of the processing for state lotteries, also stands to benefit. When states put slot machines in at tracks, they typically let the state lottery commissions oversee the new business. That means more work for GTech. To generate more revenue, states are also launching new lotto games, another plus for GTech.
The aggressors
As more states welcome gambling for the first time or let more in, that should help gaming companies with a decent track record of branching out into new territory. Two examples are Harrahs and Isle of Capris Casinos. Yes, they may lose some business as new gaming jurisdictions open up across borders from where they now operate. But since they are good at opening new locations, they should be able to offset any losses with new business.
We can go in and open a casino quickly and staff it easily, says Isle of Capris Casinos chief executive Gallaway. We have a template of operations. When we open a casino, there is no big debate about how to set it up. We can move in very quickly."
The sheltered ones
Because it operates primarily in Las Vegas -- and Nevada isnt expected to raise casino taxes much -- Station Casinos will remain above the fray. They seem to be protected from tax hikes, says Fulcrums Greff. Thats one reason the stock hasnt sold off like that of other operators. Because Station caters mainly to locals, the company is benefiting from the rapid population growth in Las Vegas -- around 5% per year. Las Vegas has been the fastest-growing community in the country for 10 years now, and about 40% of the people moving here are retirees, says Stations CFO, Glenn Christenson. Thats the age group that visits casinos the most.
Station, meanwhile, has some experience with branching out beyond its Las Vegas home turf. Its setting up to manage the Thunder Valley Indian casino in Sacramento, Calif. With this experience under its belt, the company stands to benefit if more states allow more gambling. Senior managers clearly believe in the companys future; they own 40% of the firm.
Tallying the risks
Yes, there are plenty of potential pitfalls with casino stocks. Further economic weakness or acts of terror that limit consumer travel and spending would keep the group down. Also, continued expansion of Indian gaming operations could hurt publicly traded casinos in the long run. At least demographic trends are good; the baby boomers continue to move into the age group that visits casinos the most.
Theres also a chance state legislatures wont pass gaming expansion and tax bills before they close up shop in May or June. That would leave a cloud of uncertainty hanging over the group. At the very least, you can expect states to wait until the last minute to make any decisions.
It is difficult to say whats likely to happen right now, says Ameristars Stremming. Its kind of like an NBA basketball game. Everything happens in the last three minutes.
|
