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Let the Games Begin

Whither the U.S. economy? An uncertain question, with which many economic pundits continue to grapple. With this in mind, now is a good time to take a look at the overall state of the casino industry in the United States from the perspective of some industry experts.

Because Indian casinos are privately owned, Wall Street equity analysts do not provide direct coverage of their operations; such analysts cover only publicly traded stock companies. Their perspective on the industry as a whole, however, is useful for two reasons. One, they are able to observe and quantify economic trends affecting the entire casino industry, including both Indian and non-Indian players. Two, many of the companies currently managing Indian casinos are publicly traded entities and are thus required to file public disclosures of their operations with the Securities and Exchange Commission. Review of such filings can provide an excellent measurement of the industry's overall health and direction.

Upon review of several research reports, the consensus is that the future of gaming appears to be generally positive. David W. Anders and Salvatore F. Di Pietro, gaming analysts at Merrill Lynch & Co., draw parallels between the economic conditions of the early 1990s and today.

'History often times has a way of repeating itself and in the gaming industry, we believe that we are about to witness such an occurrence,' the analysts said in a January report. 'Given the economic slowdown that started to grip the United States in the spring of 2000, coupled with the repercussions from the terrorist attacks, we believe that the groundwork has been laid for somewhat of a repeat of the proliferation of gaming that occurred in the early 1990s.'

Riverboat gambling in states abutting the Mississippi River became legal as a result of the economic troubles beginning in 1991, the analysts said, noting that there are some 90 riverboat casinos today where there were none in 1990. Differences in the economic conditions existing then versus those now 'will likely result in the legalization of a slightly different form of gaming,' the analysts said. They believe, however, that 'the spread of gaming will again be positive for equipment suppliers as well as shrewd casino operators.'

Today's state legislators, however, are much more gaming-savvy and have at hand a decade's worth of statistics on revenue generated by various types of gaming. Anders and Di Pietro believe 'there is greater likelihood that the gaming that is legalized will be taxed more onerously than it has been in the past, which could have a major impact on the economics of a new casino project,' possibly making new projects more risky.

Since residents of non-gaming states travel across state lines to gamble, the Merrill Lynch analysts invoke a form of the domino theory as another factor inducing the expansion of gaming. Non-gaming states may not want to lose the money gambled out-of-state by their residents and are thus more likely to enact pro-gaming legislation to keep these funds within their states. Ohio, Maryland, Kentucky, Pennsylvania, New York and Kansas, all of which 'border existing gaming jurisdictions and have undoubtedly incurred significant lost revenue,' are likely candidates for expanded gaming, according to the report.

On April 3, however, Dow Jones News Service and the AP reported that the Kentucky legislature ended its session without legalizing slots at the state's racetracks, which Anders said would not bode well for similar legislation in Kansas and Pennsylvania. Legislators in Maryland, Florida and Indiana also recently voted down proposed pro-gaming legislation, the news services said.

In a March 21 report, a trio of gaming analysts at Bear Stearns & Co., led by Jason N. Ader, reached conclusions similar to those of the Merrill analysts.

'We continue to believe several [gaming] markets could revisit regulatory changes over the next several months, as income tax revenues diminish and state legislatures look for ways to plug holes in the state budget,' said the Bear Stearns analysts. They added that the industry's 'fundamentals remain solid in the regional markets, and we expect solid trends to continue into 2002, driven by a modestly improving economic outlook, lower gasoline and utility costs, and the likelihood of easing restrictions or expansion of gaming in many markets.'

Ader and his team are wary of increased gaming taxes and new forms of gambling, particularly slot machines at racetracks, that could create competition with existing casinos at home and in neighboring states. They remain, however, largely upbeat on the industry as a whole.

'With limited new supply in existing markets, the opportunity for new gaming jurisdictions, the potential for further relaxing of gaming regulations, and substantial free cash flow generation, the gaming industry still exhibits some of the strongest fundamentals' among their covered companies, they said.

Lawrence A. Klatzkin, gaming and leisure analyst with Jefferies & Co. has an interesting take on slot machine gamblers. In a January report, Klatzkin argues that the convenience of gambling at regional casinos makes them a 'highly competitive' form of entertainment when compared with 'a fancy dinner, a movie [or] a sporting event.'

'One might argue that in weak economic times, the significance of a large progressive slot jackpot goes up in value,' Klatzkin concluded. 'Hence, slot gamblers actually might gamble more than in good times. Unless the local economy of the casino tanks, we continue to expect regional casinos to perform well.'

In a more recent report, dated Feb. 20, Merrill Lynch's Anders and Di Pietro pointed to another set of factors that bode well for the gaming sector. Both the collapse of technology stocks and Enron debacle will likely cause investors to focus 'on companies that are transparent, simple and maintain a high level of management integrity.' They say that casino operators fit the bill.

Within the gaming industry, the analysts point out that 'off-balance sheet items are few,' that 'gaming executives do a reasonably good job' of disclosing financial information, and that 'government officials pay close attention to the casinos' top line' as gaming taxes are calculated from casino revenues.

'In every jurisdiction, gaming properties are closely monitored and well regulated by established gaming control boards,' the analysts said. 'The bottom line is that gaming is very highly regulated by dedicated government bodies in each state.'

At a recent conference at Haskell Indian Nations University, some participants were not so upbeat on the future of gaming at Indian-owned facilities. According to an AP report, Montie R. Deer, chairman of the National Indian Gaming Commission, cautioned tribes against becoming too dependent upon gaming revenue.

'As states become desperate for revenue, many are likely to turn to expanded forms of gambling. That's sure to hurt the tribal casinos,' Deer told the AP, adding that tribes need to diversify their economic bases. 'We need to make sure this prosperity lasts.'

In the end, what might all this mean for Indian gaming? It may have considerable effect upon compact negotiations between states and newly recognized tribes or upon compact renegotiations between states and established gaming tribes. How? Under new compact agreements, tribes may be forced to accept less favorable terms than those currently in place; states facing fiscal shortfalls may demand a greater slice of a tribe's gaming take, and such a larger slice of the pie in states' coffers could conceivably serve to placate anti-gambling activists.

The fact that many states are in need of fiscal resources, however, bodes well for gaming tribes, if they play their cards right (pun intended!). Competition for prime locations and favorable compact deals is sure to remain heated for the foreseeable future.