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Gaming Industry Bonds Outperform Casino Stocks

NEW YORK -- Gaming industry bonds are outperforming casino stocks so far this year, bouncing back from a sharp downturn toward the end of 2002, a gaming analyst said.

Investments in gaming industry bonds on the average outperformed stock, returning 0.68 percent in the first three weeks of 2003, compared with gaming stocks in the Dow Jones casino index, which tumbled more than 3 percent in value. Standard and Poor's 500 index was down more than 4 percent in the same period.

Gaming industry bonds, however, are underperforming the broad bond market with comparably rated Treasury issues returning investors an average of 2.72 percent, Deutsche Bank analyst Andrew Zarnett said.

"The entire high yield bond market snapped back last year as the market began to see significant fund inflows," Zarnett said.

The influx of new money came primarily from mutual fund managers, he said, following the early summer lulls.

"Gaming continues to do well, although it's trailing the overall high yield index so far this year. The value of the broader index in many sectors is more attractive than gaming because they're playing partial catch up (following a record year for gaming bonds in 2002)," Zarnett said.

"For the rest of the year, I think gaming (bonds) will perform in line with the broader (bond) market. Given the strong performance in 2002, it is unlikely they will outperform the broader market," he said.

Deutsche Bank projects that in 2003, gaming companies that have publicly traded debt (or bond financing) will generate $2.7 billion of free cash flow before new capital investments.

"The fundamentals of gaming will continue to be strong. The strongest single fundamental of gaming is that it generates significant cash flow (compared with other industries)," Zarnett said.

"The second strength (of the gaming industry) is its huge geographic diversification. Its cash flow comes from a wide base across the country," he said.

Still, Deutsche Bank remains cautious, expecting bonds for companies with significant dependence on Las Vegas to be adversely affected "as investors deal with a slowing economy and marginally difficult fourth-quarter results."

Despite "management disorder" in 2002, ending with the departure of Tom Gallagher as CEO, Deutsche projects strong performance from Park Place Entertainment in 2003 based on its geographic diversification, strong brand names and continued commitment to debt reduction.

"Further, we believe (CEO) Wally Barr, a seasoned gaming executive, already has made a significant impact on strategy and employee morale," Zarnett said.

Also, "improved performance at Park Place's properties in Las Vegas during the second half of 2003 should mitigate the cannibalization that we believe will occur on the Atlantic City Boardwalk following he opening of the Borgata in the summer of 2003," he said.

Deutsche Bank is also bullish on Mandalay Resort Group, largely because of its stock repurchase program and likely gains from its recently opened convention center, and MGM Mirage's 8.5 percent senior notes because of the company's "premier assets and triple-A locations."

"Lastly, the great size of these companies and their ability to generate cash flow should insulate their credit positions, even with the somewhat lower volumes we expect Las Vegas will experience through the first half of 2003," Zarnett said.

A recently Deutsche Bank analysis found that while occupancy, gaming revenue and room rates have experienced a steady recovery from their low levels following Sept. 11, 2001, they are still "modestly" below previous levels.

"Overall, we expect continued improvement in visitation in room rates for Las Vegas during 2003, although this improvement will be gradual as indications are that January remains soft on the room rate side," Zarnett said.

Investment advisers say bonds are generally better investments when their yields are high compared to stock yields. However, analysts say bond yields can be expected to eventually drop back toward more "normal" levels relative to the stock yields. Thus, bonds can be considered a relatively good value when bond yields are judged as "being too rich and poised to drop."

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