The Valuentum analyst team talks the casino and online gaming industries from the Las Vegas strip to the vast market in Macau. Online poker, sports betting, potential tax breaks, and Churchill Downs’ Kentucky Derby are topics of interest. Remember: In this industry, “the house always wins.” ~14 mins.
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Brian Nelson, CFA:
The gaming industry is a profitable one, but the gaming industry is also particularly sensitive to discretionary consumer and corporate spending and can be impacted by both the ups and downs of the economy. One particular aspect of explaining this dynamic is looking at Nevada’s gaming industry itself, which while gaming sales have (more than) tripled since 1984 according to the Center for Gaming Research at UNLV, it has faced some tough times as of late. In fact, gaming revenue from Nevada hasn’t returned to levels it achieved prior to the Financial Crisis in 2007.
The wealth effect is an important dynamic behind the gaming industry, and right now even though gaming revenue isn’t back to where it was during peak times in 2007 in the Las Vegas, Nevada, market, the stock market being at all-time highs, housing prices being at all-time highs has been a stimulant for gaming activity — and what we’ve seen more recently out of the Macau (China) and Las Vegas markets is somewhat of a resurgence in activity. While this industry continues to be sensitive to the willingness of customers to travel to these destinations in Las Vegas and Macau, what we’ve been witnessing is improvements – and we’re going to be talking about four particular aspects of the gaming market today, the first being online gaming and sports betting, and Mr. Kris Rosemann will discuss that particular aspect in depth.
But I also wanted to mention one underlying factor of a lot of the casino operators that Valuentum tends to be very cautious about, and that is the corresponding debt loads. While they do generate significant property EBITDA, their debt loads, their net debt loads in particular, are very hefty, and for a business model that is very cyclical, having a high debt load in a cyclical end market could potentially be a recipe for disaster during tough economic times. With that being said, let’s get started. Mr. Kris Rosemann, let’s talk online gaming and sports betting.
Kris Rosemann:
Thanks Brian.
One of the troubles that arises in observing the online gaming industry is that there’s no federal law banning online gaming, or online gambling, but it’s kind of left up to the states to determine how they want to structure their state laws, so it’s really hard to get consistent data, or to get a good read on data, but what many observers within the industry have noted in recent years, since 2013 actually, is that we’ve seen an annual decline in online poker traffic in each year, which there’s really no rhyme or reason that they point to for that.
As you’ve said before, the casino or the gaming industry, competes with many other areas, aspects of life, and online gaming in particular competes with leisure activities more so than your destination-themed casinos. Other areas of the online gaming industry include Churchill Downs’ (CHDN) subsidiary Big Fish Games, which is the world’s largest distributor of casual games, and they do a lot of premium games and just regular smartphone games, but they also have a large casual casino segment that generates about half of that segment’s revenue. They compete directly with other leisure activities.
But one thing to note in the online gaming industry that Big Fish Games participates in is it is highly competitive, characterized by frequent product introductions, rapidly-emerging technologies and platforms, and also there are very low barriers to entry for the developers of such games, and the same goes for the online poker rooms that are not very highly regulated in certain parts of the country.
One area that we are seeing high growth, though, in the online gaming market is in sports betting, and the recent merger of DraftKings and FanDuel, two major platforms in the United States for online sports betting, has pushed online sports gambling into the mainstream, and it (the merger) has made those two companies stronger in their negotiations with government entities, which will inevitably push legislation on the topic one way or the other, and many industry observers believe that 2017 will be a year of importance or inflection for that portion of online gambling.
The consolidation of those two major players also gives them incredible scale relative to other competitors, and it also gives them a leg up in new products and marketing, and we think that these online sports gambling companies have really strong business models, but right now it’s kind of hard to see that – first of all, since they’re still private; they’re not publicly-traded entities at this point in time – but they’re just buried under loads and loads of legal and lobbying costs trying to get this industry off the ground as they battle various state legislators. Most notably in New York, there was a high-profile case against both companies.
If they’re able to push their popularity into the face of federal legislators, that might be when we’re going to see an inflection point in this industry, and that might trickle down into other facets of online gambling where federal legislators are forced to make a decision one way or the other.
Brian:
Thanks for that tremendous insight Mr. Rosemann.
The second area we wanted to discuss is the Macau market. For those that don’t know about Macau, the market is the largest gaming market in the world, and in fact, it is the only market in China to offer legalized casino gaming. To provide some perspective about just how big Macau is relative to any other gaming market, Macau’s (gaming) revenue in 2015, even though it fell 34% compared to 2014, it was still more than 4.5 times bigger than the gaming revenue of Las Vegas.
So when we think about the size and opportunity for casino operators, and for gaming companies, China is a huge market and a huge opportunity. The Chinese market is an interesting market because the government has to grant concessions and subconcessions to operators there, and these often have to be renewed at certain points in the future, so there’s a risk dynamic with respect to the government oversight in China. A couple companies that have their hands in this oligopolistic type of environment are Wynn Resorts (WYNN), Las Vegas Sands (LVS), and MGM (MGM) –they’re kind of the bigger three in terms of exposure to the Macau market.
When we think about some of the history of Macau, things really exploded following the opening up of the market to foreign players, but over the past several years, things have been not going so well. Part of that has been due to a crackdown on corruption, which has impacted visitors and a lot of high rollers to casinos, and tightening of rules of money moving out of mainland China, a crackdown of junket operators that have been the marketing arms to pulling in some of the VIP gamblers. Really what this has generated is the depths of Macau revenue in 2015, and it’s been kind of a perfect storm to really hurt gaming revenues out of that market.
But more recently, what we’ve seen is that Macau gaming revenue rose 9% in October 2016, which is the largest increase in two years, and I think part of this goes back to that wealth-effect dynamic, where we’re starting to see global markets breathe a sigh of relief following the collapse in crude oil prices, and the general optimism of economies across the globe is probably the best that it’s been two years. I think this has created a wealth effect, bringing in more gaming activity into Macau, and then of course, the easier year-over-year comparisons from really a tough five-year period that had been just plaguing Macau gaming revenue through 2015.
The third facet of the casino gaming industry is the Las Vegas market, and it, too, has seen a little blip of activity improvement over the past several months through October of 2016 with the four-month fiscal year-to-date revenue improving roughly 5%. The Las Vegas market is an ultra-competitive market, and that’s part of the reason why revenues, gaming revenues I think, have been under pressure. Infrastructure, new casinos and improvements continue to fill the voids of some of the older ones that have kind of run their course in that market, but Mr. Chris Araos has an interesting take as to why some of these casino operators in the US, and those operating in several different markets across the US, may find a new Donald Trump administration as a sigh of relief.
Chris Araos:
There is currently optimism due to Trump’s previous history in Atlantic City operating the casinos in that location. There is a belief that Trump will restrain federal agencies from interacting with gambling operations specifically in the range of taxation at the federal level and allowing more state control over those gambling operations.
Brian:
So if I understand correctly, a Trump administration, because of Trump’s personal experience in this industry, may lend itself to a better understanding of the business-operator side of things, and in terms of some of the restraints and some of the difficulties of operating as a gaming company these days, and that particular understanding and experience may translate into an improvement not only on the regulatory side but also in the tax code to benefit some of these US operators. That’s a very unique insight to share. Thank you for that Mr. Araos.
Kris:
Another aspect in the gambling industry in the United States is thoroughbred horse racing, and that’s been on kind of a decline for the past two decades. We’ve seen the number of races in the United States drop from over 73,000 to about 39,000 in just that 25-year span, so a nearly halving of the races. The US foal crop, which is really, ultimately a huge driver behind the races — that has also been halved during that same time period. Meanwhile, wagering has gone down drastically over the past decade, falling from almost 15 billion to just over 10 billion in the past 10 years since 2005.
A lot of what has been pushing this has been easier and more legalized forms of gambling such as we mentioned earlier online gambling and a proliferation of regional (local) casinos — those are also providing competition across the entire industry — and what many racing tracks and racing venues are trying to do to combat this is turning to technology. The New York Racing Association, specifically, is launching a technology called VenueNext, which ultimately enables their guests to use their mobile devices to buy tickets, to wager, and to order food and drinks for delivery to their table or wherever they may be seated at the venue — it also allows them to see different angles of the races. So they’re really trying to ramp up their technological capacity in hopes of bringing in that new consumer, which they have had very little success to this point.
Chris:
Those are interesting points Kris, but I’m kind of curious about the Kentucky Derby’s attendance numbers. For the past two years, they’ve been getting more than 165,000 people in attendance, which is a very impressive number.
Brian:
To add on that, too, the Kentucky Derby week, which includes the Kentucky Oaks and a number of festivities in Louisville, Kentucky, according to Churchill Downs, it delivered its seventh consecutive year of record adjusted EBITDA, and the Derby week attendance and Derby Week all-sources wagering, which were pretty impressive at over 375,000 in attendance and over $265 million in wagering, were also record numbers for the second consecutive year.
So while the thoroughbred industry continues to face pressure internally as it competes with other sources of gambling, the Kentucky Derby itself continues to be a huge winner for Churchill Downs, and its racetrack is an iconic asset that just cannot be replaced. This is Brian Nelson from Valuentum Securities. Thank you for joining us.