Atlantic City's Losing Streak

By all accounts, Atlantic City was not a particularly fun place to visit in the early 1970s. After slowly declining for years, the once-popular vacation spot had been reduced to a city of rampant crime, decaying hotels, boarded-up stores, and a deserted boardwalk. However, that all changed in 1978, when the introduction of casino resorts revitalized the area and began transforming Atlantic City into the vibrant tourist destination that it has become today.

However, the city took a big step backwards at 8:00 Wednesday morning, when a government-mandated casino shutdown went into effect, returning the region to its moribund pre-gaming days. As that state-imposed deadline passed, thousands of players throughout the city were immediately forced to cash in their chips and file for the exits.

For the first time since opening their doors nearly three decades ago, Atlantic City's casinos have watched their gaming activity come to an abrupt halt.

Political squabbling
The unprecedented shutdown is the end result of heated budget negotiations in the state legislature that ended in a stalemate last weekend. New Jersey is currently facing a $4.5 billion budget shortfall, and Governor Jon Corzine has proposed a sharp sales-tax increase as a way to fill the gap. However, his plans have been thwarted thus far by fellow Democrats in the state Assembly and Senate. Many are either opposed to a sales tax hike or favor using the proceeds to help ease the burden of property owners, who pay the nation's highest property-tax rates.

According to the state constitution, the government cannot spend taxpayers' money unless a balanced budget is in place before July 1, the beginning of the new fiscal year. And though several counterproposals have been made, the two sides are reportedly nowhere near reaching common ground.

This annual summertime budget crisis has been all too repetitive in recent years. In fact, the gaming industry faced a similar fate in 2003, until a last-minute agreement was finally reached. Given that history -- and the millions of dollars at stake -- many assumed that the looming collision with a costly government shutdown would again be narrowly averted. But this time, nobody swerved.

So while lawmakers wrangle over the details, roughly 45,000 "non-essential" state personnel have been furloughed -- including the state regulators who are required to monitor casino operations.

Despite pleas to the state appellate court for an exemption, all local gaming companies -- including Trump Entertainment (NASDAQ:TRMP), Harrah's Entertainment (NYSE:HET), and Aztar (NYSE:AZR) -- have been ordered to rope off their casinos until the dispute is resolved.

Write your local congressman
It's amazing what a few well-intentioned politicians can accomplish. Over the years, Atlantic City's casinos have been battered by everything from labor disputes to blizzards to hurricanes -- but they have always remained open.

But now, Atlantic City's critical gaming industry has been temporarily crippled by a government that lacks the funds to pay employees such as casino inspectors -- which is comedically ironic, since the casinos themselves pay these workers' salaries in the first place.

Let me get this straight: New Jersey is a few billion short of making ends meet, so the state must furlough casino regulators -- who are on the casinos' payrolls -- thereby pulling the plug on the one industry that it depends on most. That makes sense.

It won't take long for lost gaming revenues to strain New Jersey's already bone-dry coffers. The state takes an 8% cut of gross gaming revenues, and through May its 12 resorts have won $2.1 billion from players -- a 6% increase from the same period last year.

According to the New Jersey Casino Control Commission, the state will forfeit approximately $1.3 million in lost taxes for every day that Atlantic City's casinos are closed -- to say nothing of potential unemployment benefits payable to thousands of displaced workers. Roughly 15,000 dealers and casino employees are currently out of work, and that number could rise substantially if workers in food and beverage, retail, and other departments -- which are still open but likely to suffer -- are no longer needed.

Atlantic City resurgence
For the gaming companies that operate in Atlantic City, the timing of this shutdown couldn't have been worse. July is peak season for the industry, and last year the market generated more than $16 million in average daily revenues during the month. In all likelihood, that amount would have been even higher this year.

Spurred by gaming competition in neighboring states and emboldened by the success of the Las Vegas business model, casino operators have been pumping billions into property expansions and renovations designed to help Atlantic City evolve from a haven for day-tripping nickel slot players to a complete entertainment destination.

Aztar, for example, spent more than $225 million in 2004 to upgrade its Tropicana resort by constructing The Quarter -- a 200,000-square-foot Havana-themed promenade featuring nearly two dozen restaurants and 30 retail outlets.

More recently, Harrah's unveiled the Pier at Caesars last month. The $200 million complex, built by the same developers who created the highly successful Forum Shoppes in Las Vegas, will be a shoppers' paradise on the boardwalk, featuring 90 middling to high-end retailers spread throughout four levels.

And just last week, the Borgata -- jointly owned by Boyd Gaming (NYSE:BYD) and MGM Mirage (NYSE:MGM) -- put the finishing touches on the first phase of a $525 million expansion project. Atlantic City's hottest property now offers a spacious 85-table poker room, along with a brand-new nightclub, three upscale restaurants, and an additional 36,000 square feet of much-needed gaming space.

All of this spending has begun to pay off in spades. For example, revenues at the Tropicana surged 27% last year to $490 million, from just $385 million the year before. Meanwhile, the Borgata has singlehandedly given Atlantic City an image makeover. The trendy resort attracts a younger, more affluent crowd; remains the runaway leader in per-unit table and slot wins; and raked in $56 million in non-gaming revenues last quarter alone.

All of this makes the unexpected disruption in Atlantic City -- until now one of the most stable regulatory jurisdictions -- all the more painful.

Don't crunch the numbers just yet
At this point, it is virtually impossible to determine how big of a bottom-line bite this shutdown will take. Naturally, Trump Entertainment, which generates virtually all of its earnings from its three AC resorts, stands to lose the most, while more diversified companies such as MGM Mirage will feel a much smaller impact.

The chart below shows the percentage of last quarter's revenues and EBITDA that the four publicly traded players with a stake in the AC market earned there.

There is little sense in trying to pin a per-share damage bill on this shutdown -- let the analysts worry about that. Suffice it to say that until the slots are spinning again, it will be painful, though not as harsh as it would have been five or 10 years ago, before visitors began spending more freely on attractions outside the casino. Still, if traffic falls significantly, which is likely, considering that up to 70% of the hotel rooms at some properties are comped, I wouldn't expect the other departments to hold the line.

If this issue is quickly settled and the casinos are back in business within a few days, then the stoppage will ultimately amount to little more than a footnote in a future 10-Q filing. However, if it drags on into the weekend, or even longer, then earnings revisions will be forthcoming and the shares of those involved could be headed for a steep sell-off.

In that event, patient investors might consider taking advantage of any panic selling. If a single quarter's results have little bearing on a company's fair value, then a one-time two- or three-cent hit should be inconsequential to a long-term investor. Plus, as we saw in the aftermath of Hurricane Katrina, most gaming companies typically carry business interruption insurance to cover a protracted decline.

The bigger picture
There will be plenty of time to tally up the lost chips when this matter has been resolved. Of far more concern is the potential fallout from the shutdown if it lingers longer than expected.

Some unhappy visitors would think twice before booking a reservation this time next year, and companies like Harrah's might stop pouring money into the Atlantic City market -- particularly if gaming taxes are hiked, which some legislators have already proposed.

Certainly, New Jersey lawmakers are under enormous pressure from lobbyists, workers, voters, and just about everyone else to reach an acceptable compromise as soon as possible. However, after more than 100 days of arguing, the issue is still up in the air, and steadfast (some might say stubborn) politicians aren't known for wrapping up debates quickly.

Like the ebb and flow of the nearby Atlantic, this shutdown has sucked visitors out of Atlantic City by the busload. For the sake of both the shareholders and the employees whose lives have been put on hold, let's hope the tide flows back in soon.

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Fool contributor Nathan Slaughter owns shares of Boyd Gaming but no shares of the other companies mentioned. The Fool has a disclosure policy.