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Rod Smith

Analysis Warns of Gaming's Future

17 May 2005

Merrill Lynch is warning that prospects for the gaming industry may be dimming, saying Wall Street recently may have been caught up in a general, but misleading, euphoria about casinos and Las Vegas.

"While it is easy to get caught up in the euphoria surrounding gaming, which has been robust over the past few years, we believe investors need to take a step back and revisit the proliferation of riverboats in the early 1990s -- the last expansion period," Merrill Lynch gaming analyst David Anders said in an investor advisory Thursday.

Although riverboat gaming revenues grew at an average rate of 79 percent between 1991 and 1999, stocks in gaming companies peaked in 1993 and did not recover until 1998-2000, he said.

Anders also cited unrealistic expectations for the recently-opened Wynn Las Vegas and the tepid first-quarter performance of gaming in Macau as key factors in the reappraisal of gaming's prospects.

In comparing Wynn Las Vegas to other high-end Strip properties, he said Wall Street had made unrealistically aggressive performance estimates.

Anders said Wall Street generally has estimated the same level of cash flow, or earnings before interest, taxes, depreciation and amortization, from Wynn Las Vegas as other high-end resorts despite the 2,700-room Wynn property having 30 percent fewer rooms than comparable megaresorts.

Anders also questioned Wynn Resort Ltd.'s management under Steve Wynn. He explained that cash flow from the Bellagio was $269 million in the four quarters before MGM Grand bought out Mirage Resorts, but increased to $345 million in the four months after the buyout.

Macau, where Wynn is already building a second hotel-casino, could dilute the table win for Wynn Resorts.

Estimates for Wynn Macau, which Wynn plans to open in late 2006, are roughly 80 percent above the current performance at Sands Macau, a casino owned by developer and Venetian owner Sheldon Adelson.

"This could prove aggressive given the significant amount of supply coming on in 2006 to 2008," Anders said.

Merrill Lynch is the second international investment bank to sound a warning about Las Vegas. Early last week, Goldman Sachs Group named gaming its least-favorite industry and recommended caution in investing in most casino companies, especially Wynn Resorts, which the investment bank downgraded to "in line" from "outperform."

However, other investment banks disagreed with the gloomy advisories.

Susquehanna Financial Group gaming analyst Eric Hausler said: "Overall, Las Vegas is doing fine. The fundamentals are strong, although inevitably when you have a long (period of growth), you run into tough comparisons with the previous year."

In addition, first-quarter performances for some companies were below expectations and that is tugging Wall Street back to a more realistic evaluation of Las Vegas and the gaming industry, he said.

Still, Deutsche Bank analyst Andrew Zarnett said gaming companies are "hitting on all cylinders" and should continue to reap the benefits of the tourist boom going on in Las Vegas in the short run.

"In the long run, as baby boomers age and free up time and money, they like to spend it on leisure travel, and Las Vegas is one of the great beneficiaries of that trend," he said. "In addition, Macau, where Wynn, Adelson and MGM Mirage are all building casinos, is one of the greatest gaming markets we've ever seen. With a billion Chinese next door, with increased wealth for each one of them, travel restrictions freeing up from mainland China to Macau and with the appeal for other Asians, it will become one of the biggest gaming markets in the world."

Zarnett attributed some of the recent skepticism to Adelson's initial return on investment of 100 percent, following the opening of the first American casino in Macau a year ago.

"We all knew that type of return doesn't last forever," he said.

Moreover, Zarnett said, Wynn announced at his annual meeting at the end of April that by all measures -- room rates, casino play, retail sales and food and beverage -- Wynn Las Vegas was outperforming the Bellagio at comparable periods of time.

"And we all know it takes a few months to get the new properties operating optimally," he said.

Nevertheless, Merrill Lynch cut its earnings estimates for Wynn for 2005 by one-third to 16 cents per share from 24 cents per share because of increased costs in the first quarter.

Still, it increased its earnings estimates for 2006 to $1.27 a share from $1.11 a share.

Wynn Resorts shares rose 75 cents, or 1.71 percent, Monday to close at $44.57 on volume of 3.3 million shares.