With Richard McCaffery (TMF Gibson)
April 17, 2000

Station Casinos (NYSE: STN) has made fast-progress since founder Frank Fertitta opened a 5,000-square-foot bingo parlor on the West side of Las Vegas in 1976. He wanted to attract local gamblers by building casinos closer to their homes, near major highways and with lots of parking. The company now has an established lead in a profitable niche, operates four major properties in Las Vegas and has expanded its locals strategy to Missouri.

Glenn Christenson, Station's CFO, talked to The Motley Fool about the local gaming niche, the company's super-profitable operating model, and growth opportunities.

TMF: What's the advantage to targeting the local gaming market?

"We operate in a completely different market than the Las Vegas Strip operators.... We cater primarily to locals."

Christenson: The locals market in Las Vegas is the third-largest gaming market in the country after Las Vegas and Atlantic City. We think it's about a $1.6 billion market comprised of major off-strip properties like Station Casinos, some smaller off-strip properties, and slot routes.

TMF: How fast is the Las Vegas local market growing?

Christenson: It's been growing at an incredible rate. If you look at the population, Las Vegas has been the fastest growing community in the country for many years and has probably grown from about 5% to 7% annually for the last 10 or 12 years. Our gaming revenues have grown at a compound annual growth rate of about 30% for the last five years. If you look at the competition over the last five years, it's been growing around 7% so it's a very healthy market. I don't see anything that's going to slow down the Las Vegas locals market over the next three-to-five years.

TMF: What sets the local gaming market apart as an attractive niche?

Christenson: We operate in a completely different market than the Las Vegas Strip operators. Many people think that all gaming operators are homogenous. For one thing, our customer base and their visitation patterns are completely different. We cater primarily to locals. They typically live within a three-to-five mile radius and come to at least one of our properties from seven to eight times a month. That gives us the opportunity to really develop customer loyalties. Contrast that with the Strip, where they're catering primarily to tourists. They may see their customers once every few years.

Location and convenience are a major concern for us. Our properties are located off interstates and major thoroughfares here in Las Vegas, have great visibility, terrific ingress and egress and very convenient parking.

TMF: People not from Las Vegas may not understand it's a bit of an undertaking to get to the Strip.

Christenson: That's exactly right. Those convenience factors aren't nearly so important for the Strip. Also, the product mix is completely different. If you walk around any of our casino floors, you'll see that about 80% of our machines are video poker machines, only 20% are real machines. Contrast that with the Strip where those percentages are reversed. The reason for that is that our customer base is probably the most sophisticated in the country because many of them work in the gaming industry and know which games have the best odds. When they walk up to a video poker machine, because the pay out table is right on it, they can make a conscious consumer decision, do I want to play this machine or the one next to it, or do I want to go down the street? On the Strip, the tourists are very content to put dollars into the machine, pull the handle, and they're willing to accept potluck. They don't know if the machine is set on 99% payback or 29% payback.

Most importantly, we generate revenues and profits from completely different sources than Strip companies. Eighty-eight percent of our cash flows come from slot operations and only about 6% come from the hotel. Slot operations are very stable, very predictable, and they have high margins. Now, a typical Strip operator gets 35% of cash flows from slots, and 50% come from very volatile sources like hotels. (At the typical operation, about 36% of cash flows come from hotel rooms.) That's great as long as room rates and occupancy is high. That wasn't the case in 1998. We had a much better year in 1999, and the Strip has done very well.

The Strip operators also have about 13% of cash flows coming from table games. When you layer high-end table games onto that, Strip operators end up with a much more volatile cash-flow stream than what we have.

TMF: Give me a sense what the margins are for slot machines.

Christenson: If you look at the typical slot operation, about 75% to 80% of revenues go to the bottom line. I'll give you a real life example. There's so much operating leverage in our model that, in the first quarter of this year, $0.73 of every dollar we increased revenues went right to the bottom line.

TMF: Has that number been growing or staying pat?

Christenson: Growing. Last quarter we had 36% EBITDA [earnings before interest, taxes, depreciation, and amortization] margins. A lot of that has to do with the economies of scale we enjoy from our four properties here, and from our business model.

TMF: Do you offer table gaming and other games?

"[Our customers] come to at least one of our properties from seven to eight times a month. Contrast that with the Strip, where they're catering primarily to tourists. They may see their customers once every few years."

Christenson: We offer a complete product. We probably have as much sports betting as any operator on the Strip. We offer table games, Keno, everything.

TMF: You have additional land in Las Vegas and properties in Missouri. Where do you see growth coming from in the next two or three years?

Christenson: I think there are very few if any companies that have the pipeline of low-risk, high-return projects we have. We think we can grow cash flows at least four ways. With same-store growth, we think we can grow it 4% to 6% annually. We can also grow through master-planned expansion at all six of our properties. We've demonstrated in the past that these expansions generally have low risk and high return. For example, the return on investment is generally in the 25% to 75% range.

TMF: Because you have an established customer base at those properties?

Christenson: The additions that are made to the properties are all revenue-generating. I don't need any more back-of-the-house operations, purchasing, receiving, or anything like that. It's all revenue driven.

We can also develop new properties and grow through acquisition. Virtually all of our efforts and focus on new properties is here in the Las Vegas market. Your readers may not know that we generate about a 31% return on investment here in the Las Vegas locals market with our four properties, so you can see why we focus on it.

TMF: Can Station maintain its competitive edge in the locals market? What's to keep MGM Grand (NYSE: MGG) and Mandalay Resort (NYSE: MBG) from stepping in?

Christenson: Again, people think these are homogenous businesses and they really aren't. What Kirk Kerkorian and Steve Wynn do on the Las Vegas Strip is completely different from what we do. I think there are more barriers to entry in the locals market. For example, Senate Bill 208 was passed a few years ago, which creates some very significant hurdles for operators to develop properties off-Strip. That bill will have a lot of teeth going forward. Also we've seen the Clark County Commission start to talk about limiting where operators can go in the future. Our view is that there's going to be less supply and growing demand as the population keeps growing.

Today we own 448 acres of gaming-entitled property in Las Vegas. We have another 66 acres under option that we can develop at any time. No other gaming operator has as much property as we have in Las Vegas. We own a good bit of whatever property can be developed in the future. We currently have a $55 million master-planned expansion going on at Texas Station. We expect to open it up in the fourth quarter or early first quarter next year. We're adding a 16-lane bowling alley, 40,000-square feet of meeting and banquet space, and additional casino space for another 350 machines.

We just broke ground on a new project in the southern part of Las Vegas called Green Valley Ranch. We'll be contributing $40 million in equity to the joint venture. [Our partners] will contribute the land and cash to equal that amount, and the total cost will be about $270 million and $280 million. We'll operate it and receive a management fee. We expect to open in Q4 2001. We've also acquired three new properties in the last month.

TMF: What numbers should Station investors track?

Christenson: Well, we're bottom-line guys, so investors should watch cash flow, earnings per share, and free cash flow. We think this year we can generate about $120 million in free cash flow, which is about $2.85 in free cash flow per share. I'd also look at the leverage ratio. Our debt-to-cash flow ratio on a trailing basis is about 3.6 times.

TMF: You paid down a lot of debt last year, but your levels are still high. Are you comfortable where it's at?

Christenson: We think all of our expansion -- Green Valley, Texas Station, and the three new properties -- can be funded through free cash flow. We won't have to re-lever the company. The point is we have a lot of flexibility in our capital structure because of our cash flow.

TMF: Thanks very much

Christenson: You're welcome.