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Rod Smith

Bank Foresees Downturn for Gaming

24 May 2005

International investment banking giant Merrill Lynch is projecting that the casino industry's rate of return on investments will fall, citing development issues that it said make the industry's financial prospects challenging.

Gaming companies on average enjoyed improved returns on investment in 2004, but returns are expected to start falling this year, owing to industry consolidation and the need to market down to the level of acquired properties, Merrill Lynch Vice President David Anders said in a Thursday report to investors.

Overall, the return on investment for large-cap companies has dropped from 9 percent in 1996 to 7.3 percent in 2004. It is expected to increase briefly to 7.6 percent this year and fall again to 7.1 percent in 2006, Anders said in the report.

Las Vegas Sands Corp., owner of The Venetian, is expected to lead the pack with rates of return of 18.1 percent in 2005 and 12.2 percent in 2006.

Caesars Entertainment, which is being sold to Harrah's Entertainment, is projected to trail competitors with rates of 4.4 percent in 2005 and 2006, along with Wynn Resorts Ltd., which is expected to bring in returns of 1.6 percent in 2005 and 4.6 percent in 2006.

Merrill Lynch found that the limited supply growth that has pressured room and other prices to record levels has been key to holding up recent rates of return.

The significant supply expected to come on line in 2007 and 2008 is expected to bring added competitive pressures on prices and drag down rates of return on investment, Merrill Lynch found.

Other analysts took issue with the gloomy prognosis for the gaming industry, particularly in Las Vegas.

"When we look at the history of growth of room inventory and demand, supply has not kept pace in the short run, and we expect supply to generate more demand, net, than the number of rooms built," said Brian Gordon, a partner in Applied Analysis, a Las Vegas-based financial consulting firm.

Deutsche Bank analyst Andrew Zarnett said that in the short run, room inventory increased 0.8 percent last year while demand surged 5.2 percent.

"In the longer run, the supply coming on line isn't even catching up and does not go nearly far enough to keep up with demand as baby boomers age and have more time and money to spend on gaming," Zarnett said.

"Also, there are a lot of announced projects, but there aren't that many in the ground. As the cost of capital and interest rates increase, it'll get harder to get financing. And some projects now discussed will not be built," he said.

Besides gaming operators, rates of return for gaming equipment makers also are expected to decline in 2005.

Merrill Lynch found that increased competition, a slowing replacement cycle, limited proliferation to new jurisdictions and the possibility of a slowdown in consumer spending could negatively affect manufacturers, Anders said.

Merrill Lynch found that maintaining returns on investment in the gaming industry could prove more challenging than in recent years.

Anders cited access to capital enjoyed by Las Vegas Sands and Wynn Resorts, which will finance additional megaresorts in Las Vegas and Macau in 2007 and 2008.

Also, thanks to appreciating home prices, Las Vegas is experiencing a surge in plans to build condo-hotels, he said.

Ultimately, condo-hotel units are likely to compete with traditional resorts and drive down room rates, Anders said.

Gordon challenged Merrill Lynch's analysis of the condominium market.

"We've found very negligible if any impact. Some properties along the Strip allow condo units to enter the hotel pool, but the units are located close to hotel-casinos and generally generate more business rather than taking business away," he said.

Both Merrill Lynch and Goldman Sachs released critical reports last week.

Merrill Lynch's compliance office did not clear Anders to discuss his findings Thursday.