by Eugene Martin Christiansen
Reprinted by permission from Insight — The Journal of the North American Gambling Industry, December 2008.
As the recession deepens the myth that gambling is recession-proof pre-occupies the journalistic mind, which tirelessly recycles it in newspapers reporting casino layoffs in their business pages. Some investors who should know better bought the gambling-is-recession-proof story and presumably are now reflecting on the folly of basing investment decisions on unexamined received wisdom. Thousands of laid-off casino employees are probably reflecting on this too, in bitterness. Economic contraction impacts companies and industries differently: October 08 domestic retail sales shrank by 2.8%-the 4th consecutive monthly decline and the worst on record; General Motors, a 20th century industrial icon, is looking at bankruptcy as high gasoline prices and eroding personal incomes depress automobile sales while Wal-Mart, a discount retailer, reported a 10% increase in 3rd quarter profit. Like the general economy, gambling is diverse. Playing blackjack and buying a lottery ticket have little in common other than their status under the law. One might therefore expect to see differential impacts across the dissimilar industries that attracted $92.7 billion in consumer spending on legal gambling in 2007, before the crash. How are the various components of the economy’s gambling sector faring in the current recession?
The recession’s impact on the casino sector can be summed up in a single word: devastating. Markets around the country exhibit month-over-month declines with monotonous regularity; Las Vegas, once thought “different” by virtue of seemingly inexhaustible global demand for its unique package of gaming and entertainment, now looks like a shiny new rust belt in the desert. Negative indicators multiply like rabbits: air traffic down 13.2% in September 08; room rates down by double digits week in week out; casino stocks off 40% to 90% from their twelve month highs; a negative outlook from Moody’s and other rating agencies; layoffs at properties all over town (and around the world) except Steve Wynn’s; new condominium towers standing empty, vertical ghost towns; business at the Strip’s storied or notorious night clubs off 20% to 25% and “wait until December” when club owners expect things to get really bad. Gross gaming revenue, the engine that built Las Vegas, was down 8.1% in August, 5.4% in September and no relief in sight. But enough about Las Vegas: the malaise is global. September gross gaming revenue in Macau, the world’s biggest casino market, was down 3.5%; in a chilling sign of the times, Las Vegas Sands, struggling to stay in compliance with debt covenants, announced on November 13th that it was suspending projects in Macau and elsewhere and would lay off 11,000 workers, 2,000 of them in Macau and the remainder in Honk Kong, mainland China and other parts of Pacific Asia, this despite the company’s success in raising $2.14 billion in new equity on November 11 that reduced Sheldon Adelson’s ownership from about 69% to 52%.
For casinos, current economic conditions are a perfect storm. Because casino gaming is capital-intensive the freezing of the credit markets had immediate and disastrous consequences. Projects from Atlantic City to Las Vegas to Macau were cancelled or placed on indefinite hold. Construction underway when the crisis hit ran into difficulties: one big one, the Las Vegas Cosmopolitan, entered bankruptcy three months ago. Absent a miracle there will be more. But the credit crisis’s consequences go beyond development. Gaming’s inherently capital-intensiveness means that most casino companies were highly leveraged when the crisis struck. Overnight, casino companies, which two years ago had bankers lined up outside the door offering them money or financing, were spiraling towards default. High gasoline prices and skyrocketing jet fuel made getting to casinos more expensive than at any time in living memory, reducing casino/hotel patronage and invalidating pre-recession pro forma business projections, and as consumer income dwindled the people who did come had less money to spend. Tribes are similarly affected, with layoffs reported at Indian casinos from California to Connecticut. Even IGT, one of the most reliable cash machines in history, is laying people off and reducing its workforce by a reported 10%.
It’s an ill wind that blows nobody good. Companies with strong balance sheets and plenty of cash can now if they choose acquire financially weakened properties or companies at fractions of their pre-crash value. Peter Carlino’s Penn National Gaming, flush with the settlement from its aborted purchase by Fortress Investment Group, James Packer’s Crown Limited, flusher with the proceeds of the sale of PBL Ltd. media assets, and Dan Lee’s Pinnacle Gaming, which astutely shelved its multi-billion dollar Atlantic City development to focus on smaller markets it dominates, are kicking tires but seem to be in no hurry to buy. Steve Wynn, stepping as surely in treacherous times as he has throughout his astonishing career, raised $390 million in an over-subscribed November 13th (2008) stock offering-and promptly offered to re-purchase, at a discount, $650 million of debt before it matures on March 31, 2009. Class tells.
Lotteries are gambling’s second largest sector (after casino gaming) measured by consumer spending and by far the largest source of government gambling revenue. How they fare in recessionary times is thus an important question to State governments and to taxpayers, who, if lottery revenues fall, are likely to be asked to make up the difference. Here the picture is mixed.
Exhibit 1 presents month-over-month percentage changes in ticket-game sales for 13 medium to large lotteries (i.e., instant and online games and monitor games like keno but excluding VLTs). Third quarter sales data for 2007 and 2008 are presented in table format in Exhibit 2.
Exhibit 1: Month-over-Month Percentage Change Selected State Lottery Sales July, August, and September 2007 and 2008
Source: State lottery agencies
Ticket sales in all but one of these lotteries fell in August (Texas, with essentially flat sales, was the sole exception); in most of these States sales fell sharply. But sales rebounded in September (except in Texas, where they fell). While the pattern is clear the data aren’t extensive enough to constitute a basis for projecting the future of domestic lottery ticket sales-and hence the future of government’s lottery revenue. For the 3rd quarter ticket game sales in all but two of these 13 lotteries declined, mostly by single digits but by double digits in Indiana and New Jersey; for the group 3rd quarter ticket game sales were down 2.8%. While this isn’t good news it is nowhere near as bad as the impacts casinos are experiencing.
Exhibit 2: Third Quarter 2007 vs. 2008 Lottery Sales in Selected States, $M
Source: State lottery agencies
What is clear from the data in these exhibits, however, is that lotteries haven’t been hit as hard by the recession as casinos, at least not so far. This isn’t surprising. Buying a lottery ticket and spending an evening at a casino, or a weekend in Las Vegas, are fundamentally different kinds of consumption. Lottery ticket purchases are incidental to daily activities and take very little time; for many people they are regular, and even habitual, transactions, regular players buying the same tickets to the same games week in week out. Moreover, lottery tickets don’t cost much: depending on the game, $1, $5, $10 or $20 covers the purchase. Casino gaming, in sharp contrast, takes more time and more money-perhaps much more. Casinos are gambling’s equivalent of big-ticket consumer purchases like cars: the time and money costs are large enough to make people considering either in recessionary times think twice.
There is an interesting parallel with consumer spending on movie tickets, a leisure activity that in the past has indeed been recession-resistant. Like casino companies, the big studio-distributors were immediately impacted by the credit crisis (Variety October 20-26, 2008). Projects in development, even ones in advanced stages of production, were cancelled or placed in turnaround; the release of finished negatives was postponed, to save on cash outlays for marketing as formerly available prints and advertising (P&A) financing dried up; there have been wholesale layoffs up and down corporate ladders. But like consumption of lottery tickets consumer spending at the domestic box office has so far been largely unaffected, though DVD sales are down modestly (4%) through 3rdQ08 and (to no one’s surprise) music sales continue the slide precipitated by the advent of Internet file sharing, falling 12% in the same period. On the other hand, spending on video games is up by 26%, reflecting enthusiasm for the Nintendo Wii and new hit games like Guitar Hero and Grand Theft Auto IV. Consumption of these forms of entertainment doesn’t seem to be correlated with the economic cycle. That might turn out to be the case with lotteries. Unless, that is, the current recession turns into a genuine depression, a real possibility for the first time since the ending of World War II. Economic contraction on the scale of the Great Depression of the 1930s, when unemployment reached 25%, would reduce all forms of consumption, including lotteries. This hasn’t happened yet, of course, but it might.
Handle on U.S. and Canadian Thoroughbred racing declined by nearly 10% (9.85% to be precise) in the 3rd quarter of 2008, continuing a trend that started earlier in the year (The Blood-Horse, October 18, 2008). Purses were down 2.37% in the same period. Ominously, yearling prices collapsed. Gross revenue from the first seven days of Keeneland’s bellwether November (2008) breeding stock sale in Lexington plummeted 46.3%, from $302.2 million a year earlier to $162.3 million (The Blood-Horse November 15, 2008). All the numbers are bad: 1,397 horses sold, compared to 1,623 a year ago (-14.2%); average price 37.4% lower ($116,192 this year vs. $185,598 last year); median price off 31% ($60,000 vs. $87,000). Given the credit crisis and the carnage on Wall Street horsemen going into the sale expected declines but no one expected them to be as severe as they turned out to be. Race-horse breeding has been somewhat insulated from the unfavorable long-term trends in pari-mutuel wagering by the tremendous increase in personal wealth created in the U.S. and abroad by economic expansion since the end of the Second World War.
This might be changing. There is global demand for horses sold at Keeneland and the shock administered to equine breeding in the first seven days of the November sale says a sea change in global wealth may be underway. It is a troubling possibility. The recessions that have occurred since World War II were localized and transitory, primarily affecting single national economies and lasting a year or two. None did permanent damage in the sense of reversing long-term global economic growth. This one appears to be different. Every country in the world is experiencing economic contraction, exactly what happened in the 1930s and hasn’t happened since.
Shipping, a good proxy for the global economy, is sending panicky SOS signals. According to The Economist (March 6, 2008) last Spring may have been an inflection point, when the unprecedented shipping boom that reached its peak in 2007 ended and a continuing decline in freight rates and asset values for all classes of vessels began. The contraction has now become general, affecting transportation of all kinds-shipping, rail and trucking (The Wall Street Journal, October 24, 2008). The increase in the volume of transported goods that normally occurs in the autumn pre-holiday months hasn’t happened this year. Much of the distress is caused by the slowing global economy but weakening consumer spending is also a factor: United Parcel Service (UPS) reported “precipitous declines” in October 2008 next-day deliveries. Fedex, railroads, trucking companies, dry bulk shipping companies, container ships, tankers-no matter where one looks transportation is bad and getting worse. Falling passenger counts at McCarran (down 13.1% in September) are bad enough considered in a casino industry context. In the context of global shrinkage in transportation of every kind they are frightening. Far from recession-proof, casino gaming, and perhaps gambling in general, appears to be a leading indicator of economic decline.
Eugene Martin Christiansen is Chairman of Christiansen Capital Advisors, LLC, 250 West 57th Street, Suite 432, New York, New York 10107.
Copyright © Insight (Vol. 6 Issue 9) December 2008.