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Analysts Ponder Earnings Warning from Mandalay Resorts

1 November 2000

by David Strow

An earnings warning started a sell-off in shares of Mandalay Resort Group of Las Vegas this morning, though analysts were mixed on whether the bad news was a blip or a symptom of a greater problem.

After markets closed Tuesday, Mandalay said its third quarter earnings would be close to the year-ago result of 37 cents per share. Analysts had expected 50 cents per share.

Though Mandalay said cash flow at all of its Las Vegas properties was "up significantly," the company said it was hurt by declining performances at its properties in Tunica, Mississippi, and in three Nevada markets: Reno, Laughlin and Jean. A lower-than-normal hold percentage at Mandalay Bay's tables on the Las Vegas Strip also hurt earnings, the company said.

Mandalay President and Chief Financial Officer Glenn Schaeffer declined to elaborate beyond the company press release, saying the results would be discussed in more detail in the company's quarterly earnings call Nov. 21.

Brokerage firms Bear Stearns and Morgan Stanley Dean Witter responded by dropping their ratings on Mandalay -- Bear Stearns from attractive to neutral, Morgan Stanley from outperform to neutral.

This morning, investors punished Mandalay's shares, which fell more than 13 percent in early trading. By midday, Mandalay had recovered some of those losses, though the stock was still off $1.19 to $19.63.

But the big debate this morning was whether Mandalay's earnings warning spelled the end of a long boom cycle for gaming companies, or was merely a bump in the road for one company.

Those concerns were apparently spilling over to other companies today; Harrah's Entertainment Inc. fell $1.56 to $27.06, MGM Mirage was off $1.63 to $32.94 and Park Place Entertainment Corp. declined 25 cents to $12.50.

This concern about coming weakness triggered Hibernia Southcoast Capital gaming analyst Daniel Davila to downgrade the entire gaming sector several weeks ago.

"Who knows whether these are Mandalay-specific problems," Davila said. "Time will tell. Without the benefit of a crystal ball, it's hard to say whether there will be residual effects for Harrah's, Park Place or MGM.

"What I have seen, and I don't expect anyone to agree with me, is an environment where growth slows, the record (room) pricing starts to flatten, and some of the returns start to shrink."

Other analysts, however, were just as quick to say that Las Vegas was as strong as ever.

"This is definitely not a Las Vegas going to zero (growth) situation," said J. Cogan, analyst with Banc of America Securities. "The month of September was soft for the company, and for the industry as a whole. September will turn out to be a blip.

"We're hearing that October was a great month. New Year's will be better (than last year), and the first quarter looks quite good."

PaineWebber gaming analyst Robin Farley echoed this position in a report this morning, though she lowered her Mandalay price target from $26 to $23, and her 2001 earnings estimate to $1.57 from $1.79.

"While this pre-release may look like the first crack in gaming trends, we would beg to differ," Farley's report said. "Mandalay's October quarter results do not reflect weakness in Las Vegas trends. Park Place and MGM Mirage continue to see positive demand trends in Las Vegas in the quarter ahead, following solid (third quarter) results."

Analysts are generally projecting that Mandalay's cash flow will be $15 million to $17 million below initial expectations. At least half of that shortfall is thought to come from weakness in markets other than Las Vegas, with the rest coming from low hold at Mandalay -- something that analysts generally consider a short-term issue that isn't cause for great concern.

The company also said it was hurt by having only four weekends in October 2000, as opposed to five in October 1999.

"Tunica is easy to understand, because it's become a more competitive market," Cogan said. "I'm confused about Laughlin and Reno."

But Mandalay's bullish statement about performance in Las Vegas helped create optimism.

"The company is obviously a big play in Las Vegas, and they're generating significant cash flow (from Las Vegas)," Cogan said. "Assuming the economy hangs in there, Vegas will do as well as everyone expects."

But one thing is clear -- Mandalay's aggressive stock buyback program helped magnify the effect of a shortfall in cash flow.

"Given that (the company) has created so much leverage on the EPS line through share repurchases, a minimal (cash flow) blip will be exaggerated on the bottom line," Davila said. "That's one of the interesting effects of share buybacks."

And even if Las Vegas remains strong, Davila pointed out that the markets that hurt Mandalay in the October quarter are markets that other gaming operators also rely on.

"It's hard to say what's happened in those particular markets -- which are clearly not Mandalay specific, are systemic," Davila said. "We won't know for another quarter or two.

"In the past, this type of indication generally led to something more systemic that we could look at and draw cause for concern. But going forward, because pricing has been so robust, we're really dealing with an unknown here."

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