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Rod Smith

Gaming Industry: Betting on a Monopoly

19 July 2004

The recent spate of mergers, merger agreements and rumors about mergers is beginning to turn the real estate on the Strip into a giant Monopoly board with fewer and fewer players who have larger and larger stakes in the game.

Two of the biggest players right now are MGM Mirage Chairman Terry Lanni and the company's controlling shareholder, Kirk Kerkorian. They want to be able to use the giant Mandalay Convention Center their company would get from a pending buyout of Mandalay Resort Group as a cash cow and lure to build demand so they can charge higher rates for the 37,000 hotel rooms their company will control on the Strip after its $7.9 billion merger.

The two newest players in the giant Monopoly game are Harrah's Entertainment Chairman Phil Satre and President Gary Loveman. They want to ring registers with their customer rewards database management system to fill the 17,000 rooms they'll operate after their company picks up Caesars Entertainment for an estimated $9.4 billion.

The strategies are very simple, but together these two mergers create questions no one can answer. Only time will tell.

Wall Street analysts had expected the MGM Mirage-Mandalay merger to fly through regulatory approvals with little difficulty and with no requirement that properties be sold, except in Detroit, where both companies operate casinos and the number of licensees is limited.

However, in a worst-case scenario, some industry experts are now saying the proposed Harrah's-Caesars merger could lead federal antitrust officials to kill both deals.

Steven Newborn, a partner in New York-based Weil Gotshal & Manges who was the former director of litigation at the Federal Trade Commission's Bureau of Competition, said it "is not reckless" to suggest that derailing the MGM Mirage deal may even have been the motivation in proposing the Harrah's-Caesar merger.

Analysts who make just that point cite two 1998 cases involving drug distributors Amerisource and Bergen Brunswig, which had reached merger agreements that were ultimately shot down by the Federal Trade Commission for being harmful to competition. Amerisource planned to merge with McKesson, and would have controlled 32 percent of the drug distribution market.

That merger was initially as well received as the MGM Mirage-Mandalay deal, but Bergen Brunswig quickly reached agreement to merge with Cardinal Health, which would have given it control of 36 percent of the market.

In the end, the FTC decided it had to consider the two mergers at the same time and as one case, and shot them both down.

That case is still making its way through federal courts amid charges of fraud and conspiracy.

Newborn said now the FTC will certainly look at the MGM Mirage and Harrah's merger proposals together, whatever disclaimers it makes about looking at them separately.

He said the McKesson case is not a good precedent because the gaming companies can be compelled to sell off specific, individual properties, unlike the drug distributors.

However, analysts said it will make it very difficult for the FTC to consider the two gaming industry mergers without requiring some divestitures, especially for MGM Mirage, which will control the larger share of rooms, slots and table games on the Strip and in Las Vegas and Nevada.

"The MGM-Mandalay deal is one of the tightest, most restricted mergers ever seen. There was no regulatory risk, not at first," one analyst said.

"The regulatory issues will be much more important on the Harrah's-Caesars front, but Kerkorian's blood pressure must have gone up when this was announced. It won't kill his deal, but it'll probably stall it and it's going to force divestitures which he might have gotten away without otherwise," he said.

Wall Street analysts said if the agency defines the companies' competitive market as just being Las Vegas, it would raise particular concerns because the proposed merger would exceed federal guidelines under the Herfindahl-Hirschman Index, a weighted index that measures an industry's market concentration.

The Federal Trade Commission considers an index under 1,000 to reflect real competition, an index between 1,000 and 1,800 to reflect a moderately concentrated market and an index of more than 1,800 to reflect a highly concentrated, monopolistic, market.

Mergers that increase the HHI by more than 100 points in concentrated markets raise antitrust concerns and are examined more closely by the FTC.

The HHI for the Las Vegas gaming market without the MGM Mirage-Mandalay merger is 1,497, but with the merger, the HHI would rise almost 1,000 points to 2,480, data prepared by Leverage World, a New York-based research service, showed.

And Newborn said, depending on how it is calculated, the Harrah's-Caesars merger will likely raise the HHI for Las Vegas by a couple of hundred additional points.

MGM Mirage officials who asked not to be named disagreed and said they had always expected the FTC to give their company's merger 100 percent attention, and that there is no such thing as 110 percent.

"Nothing changes. The competitive landscape for gaming companies is all 50 states whether they do or don't have gaming. I've never known the FTC to be wildly unreasonable and that is what is going on in the marketplace," one of the officials said.

MGM Mirage spokesman Alan Feldman said his company, in fact, has no problem with the proposed Harrah's-Caesars merger and does not expect it to have any impact on the sale of Mandalay.

Analysts are not quite sure what Harrah's is buying or what it will end up with, but it's a given the company will have to sell off some assets and will probably want to sell others.

Joe Greff, gaming analyst at Fulcrum Global Partners, an independent Wall Street investment research firm, said Harrah's was driven to increase its presence on the Strip.

After the deal is done, it will own Caesars Palace, the Flamingo, Bally's and Paris Las Vegas, all on the Strip clustered around Flamingo Road.

However, by expanding on the Strip through a Caesars deal, it increases the company's exposure to antitrust issues, especially in Atlantic City, Mississippi, Indiana and Northern Nevada, Greff said.

"For Harrah's, there are still more questions than answers," he said.

The main problem, Greff said, is because it will end up being a "forced seller," there is no way Harrah's will be able to command the same multiple of price to cash flow for individual properties that it is paying for all of Caesars.

That makes each sale a likely losing proposition.

Eric Hausler, gaming analyst for Susquehanna Financial Group, agreed that Harrah's is buying Caesars for the increased exposure in Las Vegas.

He said Las Vegas is particularly attractive to Harrah's because of the high rates of return it is producing on investments and because of Nevada's friendly regulatory and tax environment.

However, Hausler said the question is how much exposure does Harrah's want and how much will regulators let it have in other markets.

Deutsche Bank analyst Marc Falcone said Harrah's will have to sell off, at a minimum, significant properties in Atlantic City, Lake Tahoe and Indiana, where it is limited by the number of gaming licenses the state allows.

"In order for a transaction to be consummated, it will require significant divestitures in my view. The question is what is Harrah's looking to get," he said.

Analysts said the biggest question for Las Vegas, however, involves what properties MGM Mirage may be forced or may choose to sell off.

The most bandied about suggestions are MGM Mirage may sell Treasure Island and The Mirage on the north end of the Strip or New York-New York and Excalibur on the south end of the Strip.

Industry sources have also been saying there is tremendous industry interest in buying and redeveloping the Tropicana on the south end of the Strip and the New Frontier, the Riviera, the Sahara, Wet 'n Wild and possibly the Stardust at the north end of the Strip.

With Wall Street primed to invest in the gaming industry because of its yields, especially in Las Vegas, any sales by MGM Mirage or by the owners of the other properties would open opportunities for major investors including Las Vegas developers.

Some who have been rumored to be interested in picking up some new properties include Sheldon Adelson and Steve Wynn, Jack Binion, who recently sold Horseshoe Gaming Holding Corp. for $1.45 billion, Stratosphere owner Carl Icahn, Palms owner George Maloof, Station Casinos owners Frank Fertitta III and Lorenzo Fertitta or Colony Capital, the new owner of the Las Vegas Hilton.

MARKET SHARE Strip - Clark Co. - Nevada

Slots - 40 - 23 - 19

Table games - 44 - 32 - 27

Percentage of markets that would be controlled by Harrah's Entertainment and

Caesars Entertainment combined.

Strip - Clark Co. - Nevada

Slots - 19 - 10 - 12

Table games - 22 - 16 - 19

Rooms - 23 - 14 - 16