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Bear Stearns Bullish on Atlantic City

15 December 2000

If there were a slogan for Atlantic City, it might be the words of comedian Rodney Dangerfield: "I don't get no respect." In our opinion, Atlantic City doesn't get the respect it deserves as a major gaming market and a substantial contributor to the cash flow of major gaming companies.

The Big Operators Continue to Widen the Gap

A downturn in the economic health of the Atlantic City gaming market could have significant consequences for Aztar, Park Place Entertainment, and Harrah's, which generate approximately 60%, 30%, and 25%, respectively, of their cash flow in Atlantic City.

Fortunately, these three operators continue to be the market leaders across most measures of success, including revenue and cash flow growth, gross operating margin, cost of promotions, and return on capital. As the market has become increasingly competitive internally, the big guys have prospered, while the smaller properties, like Sands, Claridge, and Resorts, have struggled to remain competitive.

Atlantic City Continues to Struggle with an Identity Crisis

In 1999, Atlantic City's 12 casinos generated $4.2 billion in revenues compared to approximately $4.5 billion for 27 casinos on the Las Vegas Strip. In other words, the average Atlantic City casinos generates 54% more gaming revenue than the average Strip property.

In fact, until last year, which saw the opening of the Venetian, Paris, and Mandalay Bay, the Strip had never generated more gaming revenues than Atlantic City. However, Las Vegas generates significantly more in nongaming revenues, as nearly 50% of Strip revenues come from nongaming, compared to only 19.0% in Atlantic City.

The difference in nongaming revenues highlights the major difference between the two giants of the gaming world. Atlantic City has struggled with an identity crisis, striving to become a convention/destination market like Las Vegas, while not being able to shake its reputation as a day-trip market populated by older bus customers who spend their day strolling the Boardwalk.

To that end, Atlantic City has made significant strides in remaking itself as a destination resort, although, in our opinion, it is still constrained by a lack of hotel rooms, which are needed to increase length of stay as well as support the new convention center that opened in 1997.

The Second Wave Has Finally Come to Shore

The second wave of casino development may finally have come to the shore in Atlantic City, as construction has begun on the 2,010-room Borgata, the first totally new property since the Taj Mahal opened in 1990. In our opinion, this development could mark a turning point for the Atlantic City market, particularly as we believe the market has a significant need for more hotel rooms.

Upon completion in late 2003, the Borgata will be the largest hotel in the market. We believe this property could expand the depth of the Atlantic City market, as many visitors are currently unable to get a room on busy nights. We believe the additional room capacity could also help the market evolve from mostly a day-trip to an overnight market, increasing in length of stay.

In our view, the development of Atlantic City's first Las Vegas-style resort, and the ancillary amenities of the property, could represent a new era for the Atlantic City market, bringing a new dimension of casino/entertainment product.

Atlantic City Has One of the Strongest Locals Components in the Industry

In our opinion, Atlantic City has one of the strongest locals components in the gaming industry, sharing similar characteristics with the Las Vegas locals market that we believe lead to a stable stream of cash flows that isn't as dependent on air traffic, high-end play, and the need to reinvent itself with must-see mega resorts every few years to drive visitation.

In our view, the stability of this locals franchise is undervalued by investors. However, as the market is reliant on the frequent "local" guest (i.e., one who resides within of 150 miles of the city) to generate revenues, targeted marketing promotions often involve comped rooms and food, precluding the ability to generate high-margin leverage from selling hotel rooms as the Las Vegas Strip does.

Likewise, the Atlantic City market maintains a tenuous balance between generating incremental revenues and promotional expenses. Promotional allowances as a percentage of revenues are some of the highest in the industry, and 40% higher than they are on the Strip, as operators must give away rooms, food, and beverage to generate gaming revenues.

Despite the high rate of promotions, our research indicates that win per visitor is accelerating, indicating that operators are allocating their promotional dollars toward more profitable customers.

Part Two appears Monday.

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