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Bear Stearns Bullish on Atlantic City (Part Two)

18 December 2000

We believe that the Atlantic City story is really about two types of gaming market: 1) its current value as a stable generator of cash flows for major casino companies, from a frequent locals-type visitor; and 2) its ambition to go farther to become a regional destination resort with upscale dining, retail, and entertainment amenities similar to those of Las Vegas, as well as a bustling convention business generated by the city's $268 million convention center.

Going forward, we believe that these two characteristics are not necessarily mutually exclusive but that Atlantic City could become a blended market, with a high-frequency component as well as a strong overnight/weekend destination component.

High-frequency, short-stay visitors generate stable, reliable cash flows much like the Boulder Strip or North Las Vegas, while low-frequency, longer-stay visitors generate higher margins through cash room and food and beverage (F&B) sales as well as a higher capture rate on the gaming budget.

With nearly 30 million people within three hours driving distance, we believe that Atlantic City offers substantial unrealized potential as an overnight resort, especially during the summer months with its prime oceanfront real estate.

Location, Location, Location

Atlantic City is located in one of the wealthiest areas of the country, along the New York-Philadelphia-Baltimore/Washington corridor. Average household income within 50 miles of Atlantic City is 10% above the national average.

In the outer rings (50-200 miles), household income is 23%-32% ahead of the national average. In addition, the inner market has a high concentration of retirement communities for people age 55 and above.

As older people have a high propensity to game, more leisure time, as well as more disposable income, we believe the expansion of retirement communities near Atlantic City bodes well for the town and further supports our thesis that Atlantic City has a significant locals component.

At the Jumping-Off Point . . .

We believe that over the next few years, returns on invested capital (ROIC) in Atlantic City will continue to accelerate, as the market has absorbed the supply increases of 1996 and 1997, and fears of cannibalization from Connecticut and Delaware have gone largely unrealized. In addition, we believe that the city could begin to realize its vision of becoming a destination resort, albeit not at the level it once envisioned.

Nevertheless, we believe a number of operators, including Aztar, Harrah's, and Boyd Gaming as well as Park Place, are beginning to examine ways to diversify their revenue base by taking the best of Las Vegas and applying it in a style and scale that is applicable for the Atlantic City market.

We believe these enhancements to entertainment, F&B, and retail will ultimately broaden the market and generate incremental new visitation to the city. Furthermore, we believe that Atlantic City's convention business, anchored by the Atlantic City Convention Center, should begin to accelerate over the next few years, increasing midweek occupancies with cash-paying guests.

Finally, we believe Atlantic City will continue to generate steady mid-single-digit gaming revenue growth for the next few years, while operators should keep their promotional expense in check, allowing margins to expand.

Likewise, with additional hotel rooms, retail, F&B, and entertainment venues, operators should be able to expand their sources of cash flow and reduce their overall dependence on using hotel rooms and F&B as a primary means for stimulating gaming revenues.

Lastly, we believe Atlantic City has finally reached the jumping-off point, where operators must decide whether or not to deploy significant capital in the market to raise it to the next level, i.e., an overnight destination. We believe market leaders, such as Harrah's, Park Place Entertainment, and Aztar, are taking (or will take) the initiative, and along with Boyd Gaming and MGM Mirage, will bring the second wave to the shore.

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