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Analysts: Tough Times Ahead for Gaming Companies

9 January 2003

by Rod Smith

LAS VEGAS--The continuing national economic slump has finally caught up with leisure travelers and the Las Vegas gaming industry.

On a day that Wall Street investment houses downgraded major casino company stocks and gaming shares tumbled more than 12 percent, analysts were predicting tougher times likely lie ahead.

"We are at a stage in the economy where traditional casino customers are unwilling to wager as aggressively as they have over the past few years," said J.P. Morgan analyst Harry Curtis.

The trend, analysts agreed, is reminiscent of 1998 when Asian economic conditions had a similar impact on high-end gaming as many high rollers stopped coming to Las Vegas and others cut the size of their play at baccarat.

And analysts warned that casino spending will only worsen if public anxiety over travel safety increases in the next several months.

Las Vegas hotels already have been discounting rates steeply, attracting visitors looking for cheap rooms and wagering limited amounts in the casinos.

Through November, analysts thought consumer spending was adequate to sustain recent economic improvements.

Room availability in Las Vegas during New Year's, however, indicated retrenching demand and an increasingly cautious consumer, Curtis said.

"This year, casinos struggled to fill (their rooms), rates were lower, occupancy was in the low 90 percent range, and domestic casino volumes were poor. ... We believe this trend could continue," Curtis said.

Much of the local room demand is being driven by conventions, and analysts are concerned that when the convention calendar is less full, weaker leisure demand will drag casino business and the Las Vegas economy down.

The biggest problem facing casinos, however, is that customers are wagering one-half of what they historically have in recent years, Curtis said.

Also, "with a decrease in casino wagering, earnings growth rates will lag the broader market so portfolio managers will be looking at other sectors for investment opportunities," he said.

The sluggish economy, weak high-end play, low business from independent travelers and a weak performance over New Year's conspired to cause the downgrading, said Deutsche Bank Securities analyst Marc Falcone.

"The economy is catching up with the gaming industry," he said.

That leaves Las Vegas-based stocks pretty much "dead money" for the foreseeable future, Falcone said.

Based on rapidly deteriorating casino business, J.P. Morgan Securities Inc. Wednesday downgraded its ratings of stock in Harrah's Entertainment Inc., MGM Mirage and Park Place Entertainment Corp., and maintained its neutral rating on Mandalay Resort Group.

Credit Lyonnais, Gerard Klauer Mattison & Co. and CIBC World Markets also downgraded Mandalay and Jefferies & Co. downgraded Aztar Corp., owner of the Tropicana in Las Vegas.

The downgrading of stock recommendations followed pre-announcements that fourth-quarter earnings would fall short of company and Wall Street predictions. Companies making pre-announcements included Mandalay, MGM Mirage, Harrah's and WMS Gaming.

The downgrading and earnings warnings sent many gaming stocks down Wednesday.

MGM Mirage, the second-biggest owner of casinos, dropped $3.73 to $28.89 in New York Stock Exchange composite trading, while Mandalay Resort Group slid $3.78 to $27.01. Park Place Entertainment Corp., the No. 1 casino company, fell 74 cents to $7.65.

Mandalay Tuesday night pre-announced worse than expected fourth-quarter results, the first of the major gaming companies to do so.

J.P. Morgan attributed the disappointing earnings primarily too a low hold percentage.

"Other issues of concern in 2003, which limit upside in the group, include higher labor costs contracted by the Culinary union," Curtis said.

"We also believe that if there is growth in new gaming jurisdictions, especially racinos in 2003, most of the economic benefit will accrue to state governments and not to public casino companies," he said.

MGM Mirage was the second of the Las Vegas gaming companies to pre-announce a worse than expected fourth-quarter performance.

"We had a disappointing end to the fourth quarter. That's why we came in shy of our estimates and those of the Street," said MGM President and Chief Financial Officer Jim Murren.

"It was understandable we'd downgrade. We haven't missed a mark since 1998. When we miss, people stand up and take notice since we don't do it as often as others," he said.

"We are a consumer dependent industry and company. The consumer is stressed and stretched. That's true wherever you look. And that has finally found its way to the gaming industry although we're still more resilient than most industries," Murren said.

"We had a tremendous year in '02, even though we had a disappointing end to the year. And no one can tell you how long this is going to last," he said.

The biggest problem for MGM, Murren said, is with the gaming tables.

"Slot business is actually up. We've been through this before. Usually, it will last for a quarter or two, and then you can start seeing improvements," he said.

Harrah's and Park Place Entertainment did not pre-announce earnings shortfalls, although their stocks also were downgraded on the basis of the expected industry performance in 2003.

Still, J.P. Morgan reduced its projected earnings for Harrah's by 6 percent from to $0.56 pre share from $0.59 per share and for Park Place by 40 percent to $0.03 from $0.05 per share.

Mandalay reduced its fourth-quarter earnings per share estimate 50 percent to $0.12 from $0.24 and MGM reduced its projections 35 percent to $0.25 from $0.39.

At Bear, Stearns & Co., Jason Ader predicted the Strip would remain sluggish overall in 2003.

"Meanwhile, operators in riverboat markets face very difficult comparisons throughout most of 2003 and are likely to post mid-single digit growth rates in 2003," he said.

Equipment manufacturers should benefit from any gaming expansion and the transition to cashless slots, Ader said.

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