The last time the market crashed it was a bloodbath for gaming stocks. Weak companies like Stations Casinos and Trump Entertainment Resorts filed for bankruptcy and a number of major developments on the Las Vegas Strip were abandoned mid-construction.
Even companies like Las Vegas Sands (LVS -0.55%), MGM Resorts (MGM -1.57%), and Caesars Entertainment (CZR), which operate some of the most iconic casinos in the world, were lucky just to survive. Las Vegas Sands needed a bailout from majority owner Sheldon Adelson to stay afloat, MGM had to sell assets like Treasure Island in Las Vegas, while Caesars did financial gymnastics to keep out of bankruptcy. Even Wynn Resorts (WYNN -1.88%), who is one of the most conservative operators in the business, plunged on the stock market and had to IPO its Macau operations.
In the five years since the crash the gaming market has changed a lot, but there are still a lot of companies that couldn't handle a market crash if one came in the next year or two. Here's a look at where risk lies in the gaming industry.
Las Vegas was built on debt, which can be dangerous for investors who don't know the risk their taking. Image is in public domain.
Leverage kills
Companies that are forced to file for bankruptcy don't do so because revenue falls or they begin losing money. Some companies operate with massive financial losses for years. Bankruptcy is forced when companies run out of cash for operations or investors stop funding them.
That's why in the gaming industry, surviving a market crash has more to do with keeping debt at a manageable level and appeasing to your creditors if times get tough. Problems arise because debt that funds massive casinos around the world also comes with covenants that require a certain amount of cash flow -- EBITDA is used as a proxy for property cash flow -- or debt holders can call their bonds and make a company insolvent.
For example, Las Vegas Sands had to be rescued when it was approaching debt covenants requiring less than 7.5 times leverage on EBITDA in late 2008. Luckily, Sheldon Adelson stepped in with an equity and preferred stock offering that staved off bankruptcy.
If there's another crash in the market and tourists stop going to gaming resorts this scenario could play out again. The companies at the most risk are those who highly leveraged with debt and few options out if bondholders decide they aren't going to continue funding operations. Below is the net debt/EBITDA ratio for the largest publicly traded gaming stocks in the U.S.
|
Net Debt (mrq) |
EBITDA (ttm) |
Net Debt/EBITDA | |
|---|---|---|---|
|
Las Vegas Sands |
$6.79 billion |
$5.29 billion |
1.3 |
|
Wynn Resorts |
$4.20 billion |
$1.90 billion |
2.2 |
|
Melco Crown |
-$26 million |
$1.39 billion |
n/a |
|
MGM Resorts |
$11.56 billion |
$1.90 billion |
6.1 |
|
Caesars Entertainment |
$20.84 billion |
$1.89 billion |
11.0 |
|
Boyd Gaming |
$4.17 billion |
$591.8 million |
7.0 |
|
Pinnacle Entertainment |
$3.94 billion |
$536.8 million |
7.3 |
Source: Company earnings releases.
Based on this table, it's easy to see why Caesars Entertainment is by far the greatest risk among gaming companies. I think it would be easy to argue that it's already insolvent based on its current balance sheet and some bondholders are making this argument in recent lawsuits.
In the next group would be Pinnacle Entertainment, Boyd Gaming, and MGM Resorts, who have a significant amount of debt compared to current EBITDA. They all survived the last downturn but it was dicey and asset sales wouldn't be out of the question if the market crashes again.
Boyd Gaming's abandoned project on the Las Vegas Strip shows that even the most experienced operators can fail. Image source: Bobak Ha'Eri via Wikimedia.
The least risky companies in Las Vegas are Las Vegas Sands and Wynn Resorts, who both have significant exposure to Macau. Melco Crown, who generates 100% of its revenue in Macau, could actually pay off all of its debt if it wanted to, highlighting where the industry's strength is.
The reason these companies are in good shape is that Macau has been so profitable over the last five years they've been able to increase cash, pay down debt, fund expansions, and even pay dividends with the cash being generated by Macau's casinos. I'd be comfortable owning all three in a market downturn for their balance sheets alone.
Customer sensitivity
The other thing investors need to consider if the market crashes is which customers will stop seeking out gambling and entertainment first. The players who have traditionally been at risk first have been regional gamblers. A weekend trip to the casino would likely be one of the first discretionary expenses cut if the economy goes south, and with increased competition regional casinos can quickly become money losers if customers do decide to stay home.
Las Vegas and Macau would also see a decline in revenue, no doubt, but they're destinations for vacations and still rely heavily on high rollers -- who are less affected by market swings -- for revenue. That's where I would rather be invested in a down market than regional gaming.
Stack gaming stock odds in your favor
Sometimes it's enticing to chase the high risk, high reward gaming stock, but like a table game in Las Vegas it's all about putting the odds in your favor.
In today's gaming market, not only does Asia present the greatest growth opportunity for gaming stocks, they're also the companies most likely to survive a market crash. Las Vegas Sands and Wynn Resorts are the two Las Vegas companies that would survive a crash and ironically it's casinos an ocean away who would save the day.
