Foolish gaming analyst Nathan Slaughter is in the hot seat this week. He shares his thoughts on the past year in gaming and gives us some stock ideas for 2007.
Joey Khattab: 2006 was a wild year for casino stocks. Nathan, what's been the biggest surprise for you?
: The first event that caught me off guard was Wynn Resorts'
Second, this year's private equity buying binge has been equally surprising. Since Colony Capital purchased Lake Tahoe's Harvey's Casino for $420 million in 1998, private equity has done little more than dip its toes into the gaming pool over the past decade. Apparently, though, the water is more to its liking now. Instead of select properties, entire companies have suddenly been targeted, and Kerzner International, Aztar, and Station Casinos
This shakeup will have a profound impact for players and investors alike, and the wave of leveraged buyouts could continue to wash over the gaming sector over the next couple years.
Joey Khattab: Casino stocks saw some weakness in the summer, but have since rebounded. What do you make of it?
: The summer swoon was short, but brutal, as many casino-related stocks surrendered all of their year-to-date gains and then some in just a few weeks. From the beginning of July through the middle of August, Harrah's, MGM Mirage
Some of that hostility was company-specific. Harrah's, for example, had already been stung by its failure to lock up Singapore's first casino license (which was awarded to Las Vegas Sands), and a $0.07-per-share shortfall in second-quarter earnings didn't help. Boyd Gaming
For the most part, though, I think the entire group pulled back when many investors bought into the notion that rising gas prices would discourage travel and pinch the discretionary bankrolls of casino patrons. Generally speaking, gaming companies have been more insulated from these macroeconomic concerns than other businesses. (That proved to be the case again this time, particularly at the high end of the market.)
Nevertheless, those accustomed to seeing blowout earnings reports and upward guidance revisions felt that a slowdown was on the horizon -- a feeling reinforced by soft earnings forecasts from heavy hitters like MGM.
Joey Khattab: If you had to pick one casino stock that's a good investment for 2007, what would it be?
Nathan Slaughter: That's the $64,000 question, isn't it?
Over the past year, almost any gaming stock would have made you money, and the reverse may prove true in 2007.
Driven higher by this recent private equity feeding frenzy, the average casino stock has rallied almost 30% over the past three months -- the best-performing group of nearly 130 industries in Morningstar's database. Not surprisingly, that advance has made valuations much less appealing.
That said, the fundamentals that have underpinned this prolonged advance remain in place, and many gaming stocks could easily outperform the S&P500 over the long haul.
I think a case can still be made for Boyd, a stock I own and have written about several times over the past year. Buyout rumors aside, the company has a solid portfolio, an ambitious development pipeline, and trades at just nine times cash flows.
But for those with no exposure to the industry who want an opportunity to participate in the global expansion of gaming, I would take a hard look at MGM -- which is well-positioned to shower shareholders with riches dug up in the world's most promising markets.
The company owns three of the top EBITDA generators on the Las Vegas strip (Bellagio, MGM Grand, and Mandalay Bay), the premier resort on the Gulf Coast (Beau Rivage), and also the runaway leader in Atlantic City (Borgata). Furthermore, MGM will also be well-represented in Macau, with a lavish $975 million waterfront property, and it's far more affordable than exorbitantly priced neighbors like Wynn and Las Vegas Sands.
From another perspective, we sometimes forget that investing at its core is still a function of supply and demand. As the popularity of gaming continues to spread around the world, demand for the companies involved will also expand. Yet because of recent consolidation, the supply of available gaming stocks has suddenly dwindled to just a handful.
With Harrah's likely departure to the private realm, MGM will suddenly become the world's largest publicly traded gaming company.
Joey Khattab: 2007 looks like a big year for slot makers IGT
Nathan Slaughter: It's no secret that slots generate the lion's share of a casino's revenues, and thus command the majority of the floor space. In Atlantic City, for example, gamblers lost $416 million during the month of October, and $309 million of that total was generated by the slots.
Though this past year was a lull for the slot makers on the product side, the future remains promising. The proliferation of racinos and tribal casinos have provided new outlets, previously untapped markets from Pennsylvania to Singapore could be major growth drivers, and rebuilding efforts on the Mississippi Gulf Coast should lead to a flow of new orders.
The introduction of Las Vegas-style class III slots in Broward County, Florida will also provide a boost, though voters in Miami rejected a similar ballot initiative.
Even without any catalysts, IGT still managed to ship more than 100,000 units worldwide in 2006, so it's easy to be optimistic that product revenues will soar when server-based and multi-player technologies fuel the next upgrade cycle.
In the meantime, the sale of parts, gaming systems, and other "non-machine" products have been rising at a healthy double-digit clip, and steady, recurring revenues generated by the firms' gaming operations should help pick up the slack and level out the choppy nature of product shipments.
To echo the comments of my Foolish colleague Jeff Hwang, I think either of these companies would be attractive at the right price.
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