"The industry is going to have to get accustomed to the notion that not every project is a good project -- and $1 billion is a lot of money, after all."
-- Gary Loveman, CEO, Harrah's Entertainment
Last week, members of the gaming industry gathered in Las Vegas for the Global Gaming Expo (G2E) to discuss the state of the industry and showcase new gaming products. The conference highlighted the key issue the gaming industry faces today: a liquidity crisis owing to the tightening of the credit markets.
True, gaming companies are also concerned about a slowdown in consumer spending, but that's a purely short-term problem by comparison. Particularly in a business where recent years' stock values have been largely based on future projects, rather than existing ones, companies are more worried about their inability to raise capital. This credit crunch has devalued the stocks of casino operators across the board, while threatening some of the biggest players in the gaming industry with insolvency.
Some companies -- such as Boyd Gaming (NYSE:BYD), with its Echelon Place in Las Vegas, and Pinnacle Entertainment (NYSE:PNK), with its Atlantic City project -- have plunked money into the ground, only to suspend their projects. Others, such as Harrah's Entertainment in Kansas, have pulled out of projects altogether. And when a project gets canned or suspended, the value attributed to the project is discounted from the company's stock price.
More problematically, we've had companies such as MGM Mirage (NYSE:MGM) and Las Vegas Sands (NYSE:LVS) pile up massive amounts of debt chasing ever-grander visions -- namely MGM's Project CityCenter in Las Vegas, and LVS' Cotai Strip in Macau. While neither company is likely headed toward bankruptcy at this point, given recent financial transactions, the debt loads have had disastrous consequences for both companies in general, and LVS shareholders in particular.
Too much leverage = no leverage
The problem for MGM Mirage and Las Vegas Sands is that it had already put too much capital into the ground to stop. Once you've spent $5 billion on a project, you've probably got to put in the other $2 billion to finish it and generate cash flow. Otherwise, you've just got $5 billion sitting in the ground doing nothing -- except costing you interest.
And the problem with having too much leverage is that, well, you've got no leverage left to tap.
When I first started looking at casino stocks about six years ago, I thought a debt-to-EBITDA ratio around 5 was reasonably high. Today, MGM's debt approaches 7 times EBITDA, while LVS is up near 13 times EBITDA. Meanwhile, Harrah's ratio is approaching double digits as a result of its leveraged buyout.
When a company like Las Vegas Sands desperately needs cash to finish a project just to survive, and it can't raise debt, it ultimately has to sell stock. When you sell stock because you have to, you have no leverage. And when you have no leverage, you wind up with massive share dilution, selling stock and doubling your shareholder base at a price of $5.50 per share -- as Las Vegas Sands did a few weeks ago -- rather than at more than $100, where the stock was this time last year.
MGM didn't escape unscathed, either; a couple of weeks ago, it sold $750 million in 13% debt.
These examples stand in stark contrast to a relatively financially fit company like Wynn Resorts (NASDAQ:WYNN), which isn't desperate for cash, but thought it wise to have some just in case. Wynn was able to sell stock at a relatively favorable price in an oversubscribed share sale earlier this month.
Read 'em and weep
The general lesson here: Raise capital when you can, rather than waiting until you absolutely have to.
It isn't really fair to say that LVS in particular should have seen the depth of the tightening of the credit markets ahead of time. But on the other hand, the company had to know it would need more money to build out the Cotai Strip (a portion of which has been suspended). In that case, the company should either have planned a smaller project to begin with, or thought to raise capital sooner -- namely, before it reached the desperation point.
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