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Best of Liz Benston

Gaming Guru

Liz Benston

Casinos see private funds as a way to go

6 December 2006

LAS VEGAS, Nevada -- The private offers to purchase Harrah's Entertainment and Station Casinos reflect the evolution of who invests in casinos - from banks in the 1970s to junk bond dealers in the '80s to the stock market in the '90s, and now private, cash-rich equity firms on the hunt for places to invest their money.

Private investment has brought more advantages than drawbacks to casinos, leaving some gaming bosses wondering why they should continue as a publicly traded company, especially because the primary reason for issuing public stock - to generate capital - has diminished.

"When I joined the company in 1998 I felt the only way to the promised land was through a public vehicle," said Jim Murren, president and chief financial officer of MGM Mirage and a former Wall Street banker. "But being public is not as fun as it used to be."

Public financing allows companies to market their business strategy to a wide audience, access significant capital over the long haul and raise lots of cash on demand.

But being public has its challenges. Auditing rules created in the wake of corporate accounting scandals have created millions of dollars of reporting costs - viewed by many executives as unnecessary and distracting.

More important, public companies are under pressure to turn bigger profits every three months when they report their performance to the Securities and Exchange Commission. Falling short of Wall Street profit targets can hurt a company's stock and sabotage its development plans. Gaming companies build expensive casinos every few years or substantially revamp existing ones to drive growth and keep shareholders happy.

For chief executives, the growth treadmill can be exhausting and, in some cases, counterproductive.

By trading public shareholders for a smaller, more focused group of private owners, executives can make unpopular decisions that make sense longer-term, experts say.

"Managers will complain that they can't manage long term because short-term investors like hedge funds will dump the stock if they don't see progress," said Ellis Landau, former chief financial officer of Boyd Gaming. Landau retired in May after more than 15 years with the company he helped take public.

Private equity funds have gained prominence as the new brain trust of the investment world. Not content with 10 percent returns in mutual funds and other run-of-the-mill investments, pension funds, endowments and other institutional investors have flooded into private equity funds for much higher returns.

Flush with billions in newfound wealth, private funds are engineering takeovers and taking companies public again at a higher price.

Funds often hold their investment for five to seven years - enough time to restructure a company - and take it public when the time is right.

The stars are aligned for private equity funds, which thrive when interest rates are low because they can borrow money on the cheap and reap big profits over the longer term by reorganizing undervalued companies.

"What you're seeing is capitalism at its best - the reallocation of dollars to sectors that are under pressure as public companies," said Al Osborne, a senior associate dean at UCLA's Anderson School of Management and a professor of global economics and management. "You can finance (a buyout) attractively by leveraging it, paying tax-deductible interest and not having to worry about earnings for a few years."

Private equity funds are willing to value Strip properties more aggressively than public markets, which appear content to value a casino property on a per-acre basis rather than as a unique piece of real estate, Murren said.

Before turning their attention to casinos, private equity funds were driving up the value of commercial real estate by investing in trophy properties such as New York office buildings, said Scott Butera, who engineered a restructuring of Trump Entertainment Resorts as the company's former president and chief operating officer and now oversees Strip landowner Metroflag Management.

The hurdles involved in getting a casino license initially kept such investors at bay, but that changed when a few private equity funds got licensed by Nevada regulators more comfortable with the new investment vehicle.

The casino industry is an attractive place for private equity money because it has bigger profit margins than most other consumer sectors and generates a lot of cash that can be used to pay down the debt needed to buy out the public shares, experts say.

But that may mean less money left over to pay for new casinos and other projects on the drawing board.

Going it slow by scaling back on spending may be attractive for gaming companies seeking a break from several years in full-bore growth mode, Landau said.

"The long view ¦ that the company will be worth a lot more in five years if I can run the company the way I want - may be better than the short view," he said.

Just how many companies will jump on the going-private bandwagon is unknown. The decision to pull the trigger ultimately depends on each company's business plan rather than what the competition is up to, Butera said.

"Your business objectives should drive your capital structure and not the other way around," he said. "Everyone's looking at who's next, and you may see a couple more (companies go private), but I don't think you're going to see every lodging or gaming stock go private in the next year."

For all of the recent attention from private suitors, deal-making in the gaming industry is but a tiny part of the big picture, Murren said.

"We're a very small fish in the big corporate pond of America," Murren said. "But the spotlight today is intensely bright in the gaming industry - and I see that trend continuing."