Gaming Strategy
Featured Stories
Legal News Financial News Casino Opening and Remodeling News Gaming Industry Executives Search News Subscribe
Newsletter Signup
Stay informed with the
NEW Casino City Times newsletter!
Search Our Archive of Gaming Articles 

Accounting Reforms Threaten Gaming Company Earnings

24 April 2002

by David Strow

LAS VEGAS -- Gaming companies could see their earnings cut by a notable margin if officials begin requiring companies to expense stock options, a gaming analyst says.

The hardest hit would be MGM Mirage, Park Place Entertainment Corp. and Station Casinos Inc., which would have seen their earnings reduced by more than 13 percent in 2001 by such a rule, wrote gaming analyst Joyce Minor of Lehman Bros.

Since the collapse of Enron Corp., there has been rising pressure for accounting reforms, and one target in particular has been stock options. Options are currently not treated as an expense by the vast majority of American companies, but several congressional leaders have called for a bill that would force companies to expense them.

Lehman Bros. is predicting that the Securities and Exchange Commission and the Financial Accounting Standards Board -- a private organization that sets the nation's accounting standards -- would act before Congress could.

"In the much more conservative accounting environment today, we think that the stock options expensing rule will go forward," wrote Lehman Bros. analysts Jeffrey Applegate and Rohit Mathur. The FASB could propose the rule this spring, and it could take effect next year, they said.

A stock option is a right to acquire a share of a company's stock at a predetermined price, called a "strike price." If the market value of the stock rises above the strike price, an option holder can make an instant profit by exercising the option to acquire the share at the strike price, then immediately selling the share at market value. In recent years, options have become a critical component of executive compensation packages.

Options have no associated cash expense, but they do dilute the stock held by other shareholders, since new shares are often issued when options are exercised. They also represent potential lost profit for the company, since the company is giving up additional funds that could have been raised, had the shares been sold at market price rather than strike price. As a result, a company can deduct this difference from its income for tax purposes when the option is exercised.

The story is different when a company reports its earnings to investors. Earnings per share are often used to value a stock -- yet most companies do not deduct option expense in their reported earnings, a move that would reduce EPS. They do, however, include footnotes in their annual reports that estimate how much earnings would be reduced if options had to be treated as a compensation expense. These estimates use a complicated formula called Black-Scholes, which uses a number of factors to estimate the potential value of options. The estimated expense of the option is spread out over the life of the option.

Using those footnote estimates, Lehman Bros. estimated the earnings of the companies of the S&P 500 would have been reduced by an average of 7.5 percent in 2000, had they been required to expense options in their earnings reports. In 1998 this average was just 3.5 percent.

Most aggressive with options were information technology companies, which would have seen 28.5 percent of their earnings wiped out, on average, by option expenses in 2000.

In the "consumer discretionary" category -- which includes gaming companies -- the option expense average was 6.3 percent in 2000, up from 3 percent in 1998.

Three major gaming companies would have exceeded these averages. The largest hit would have been taken by MGM Mirage, which would have seen a 14.6 percent reduction, Minor wrote. Closely following were Station (down 14.3 percent) and Park Place (down 12.9 percent). MGM Mirage was up from 6.8 percent in 1998, and Station rose from 9.1 percent that year. Park Place, however, was down from 13.3 percent in 1998.

On the opposite side were Harrah's Entertainment Inc. and Mandalay Resort Group, which ran below the S&P 500 average. Harrah's would have seen earnings reduced by just 3.4 percent, while Mandalay would have taken a 4.1 percent reduction. Both companies have reduced option expenses since 1998 -- Harrah's was at 7.9 percent that year, while Mandalay was at 6.7 percent.

Even if the option expensing rule comes to fruition, Minor doubts it will make much of a difference to investors.

"This is not a significant concern for gaming and lodging stocks, particularly as most will continue to be valued on (cash flow) multiples, which will be unaffected by the proposed change," Minor wrote.

< Gaming News