As the saying goes, the house always wins. But when investing in casinos and gaming stocks there's more to making money than just owning the house. The location and quality of a resort or casino, as well as the local regulatory environment, have a lot to do with how much money you can make as an investor. However, if you can bet on the right players, the sky is the limit.
What is the casino & gaming industry?
Casino and gaming companies own and operate properties that offer games of chance and sports betting. They can range from small racetracks or gaming halls with a few slot tables or gaming tables to megaresorts that cost billions of dollars, offer world-class dining and entertainment, and define the skylines of some of the world's most famous cities.
Throughout most of the world, gaming is a highly regulated market in which taxes are levied on the house's take and a limited number of casinos are allowed. For those who can navigate this complex environment, the opportunity in gaming is enormous.
How big is the casino & gaming industry?
It's estimated that $160 billion in revenue was generated annually from legal gaming around the world in 2013. When you include hotel rooms, food and drinks, and entertainment, an estimated total of $272 billion was spent at casino and gaming resorts in 2013, growing at a 5% compound rate over the prior five years.
The two best-known gaming regions are the Las Vegas Strip, which generated $6.5 billion in gaming revenue in 2013, and China's Macau, which generated an incredible $45.2 billion in gaming revenue during 2013.
While Macau may dwarf Las Vegas in gaming revenue, it's important to keep in mind that there is more to a resort and casino than the gaming floor. In 2013, more than half of The Las Vegas Strip's revenue was generated from hotel rooms, clubs, restaurants, and retail.
How does the casino & gaming industry work?
The concept of building a casino is simple enough: You build a facility that will attract customers to your hotel rooms, restaurants, shops, clubs, and gaming tables and hopefully generate a good return on that investment.
Resorts and casinos are generally built to attract a certain kind of customer, like the mass market player or VIPs, high rollers who will gamble hundreds of thousands of dollars per trip. VIPs are generally less affected by economic swings than the mass market but are also lower margin because they can demand kickbacks and freebies from the casino.
The distinction between the VIP and mass markets is especially distinct in Macau where junket operators act as a conduit to bring VIPs to casinos, loan them money for gambling, and often operate their own gaming rooms. These arrangements come with financial payments to the junket operators as well as extravagant complimentary services for VIPs. While these costs lower margins, the VIP market is around 70% of the gaming market in Macau so it's a market operators can't ignore.
One thing that's different about resorts and casinos versus other businesses is when cash flow occurs. A large outflow happens when the property is being built. Once the building is completed, gaming and other activities have fairly high cash margins. Investors use earnings before interest, taxes, amortization, and depreciation -- or EBITDA -- as a proxy for the cash flow generated each quarter.
A well-designed resort and casino can generate in excess of 20% of its original cost in EBITDA each year.
What are the drivers of the casino & gaming industry?
The success or failure of a resort or casino comes down to three major factors: location, the regional and macro economy, and the design and operations of the facility. The location of a casino is the first thing investors should look at because this defines the regulatory environment as well as the market opportunity. The regional and macro economy will act as the tide that raises or lowers the overall gaming opportunity for gaming companies. Finally, design and operations are what separate a specific casino in a given location.
As an example of the importance of location, Macau is by far the largest gaming market in the world; with only six concessionaires competing for customers there's plenty of cash to go around. On the other side of the spectrum is Atlantic City, which once had a monopoly on East Coast gaming but is quickly going bankrupt because Pennsylvania, New York, Delaware, and other surrounding states have legalized gaming and given consumers more options.
The economy is clearly a driver and this can be for both the good and bad of the industry. When the economy is booming, companies planning conferences and consumers planning vacations are willing to increase travel and gaming expenses to the benefit of resorts and casinos. But when a recession hits, these are among the first expenses to be eliminated. Las Vegas saw this during the Great Recession, during which a few of the best-known gaming companies in the world nearly went bankrupt.
The design and operation of a resort and casino have everything to do with the kind of clientele a company can attract and how much those people will pay to be there. Resorts trying to attract high rollers willing to spend money both on gaming and non-gaming activities will often be built with grand attractions like the fountains at the Bellagio or the Grand Canal at The Venetian. These iconic features become a calling card for resorts and can boost traffic, spending, and profits for gaming companies. The impact of superior design and operations can be significant. For example, Wynn & Encore Las Vegas were more profitable than neighbors Circus Circus, Monte Carlo, Excalibur, New York-New York, Luxor, and Mirage combined.
Companies that can get these three factors right can create long-term value for shareholders, but getting even part wrong can spell disaster. Casinos and gaming stocks are a risky bet, but at least on the stock market the house is on your side.