Gambling on debt

It’s no secret that casino companies are more debt-encumbered now than they’ve ever been. In 1990, the average big Las Vegas Strip casino (those earning more than $72 million a year in gaming revenue), had $7.8 million in long-term debt attached to it. By 1999, that number had soared to $171.5 million. And as of 2009, the total stood at $860 million. That’s a lot of borrowing.

And yet casinos continue to borrow money—last month MGM Resorts International sold nearly $500 million in bonds that it plans to use to pay loans that are coming due in 2011. And Boyd Gaming is preparing a similarly sized bond offering for much the same purpose.

Taking on debt to pay off debt is the ability to put off paying for today what we didn’t have money for yesterday. To those of us paying our bills each month, this seems too good to be true. Yet, in the corporate world, issuing debt to pay for debt is a common practice and one that can be a viable strategy.

“Taking on more debt to pay for current debt can work, provided that the free cash coming in rises sufficiently to service the increased indebtedness,” says Christiansen Capital Associates CEO Eugene Christiansen, a veteran casino analyst who has performed numerous studies of casino operations throughout the world.

Christiansen uses an analogy to explain the risk and potential rewards of the process. “For the chief executive officer of a highly leveraged casino company, selling new debt that increases corporate leverage to pay for old debt is exactly like a legislator or elected official putting off a difficult vote or decision as long as possible,” he says. “It gives the CEO (or legislator or elected official) another year (or two years) in office, another $1 million or more in annual salary and perks, and, who knows? Maybe the company won’t default.

“But unless the company’s performance, as reflected in occupancy rates, gaming and resort revenues and the like improves significantly, the company will default eventually, and when it does the default will be worse. Dead man walking, in other words.”

But while there’s life, there’s hope, and casino companies have fended off default in the face of long odds.

“Take Las Vegas Sands,” Christiansen says, pointing to a company whose share price has battled back from lows below the $2 mark in March 2009 to nearly $50 a share, and which compares favorably to another Las Vegas casino powerhouse, Station Casinos.

“When the credit markets shut in August 2007, LVS had immediate problems in servicing its very high levels of debt, just as Station did, albeit for different reasons,” he says. “On the numbers, default appeared to be inevitable for both companies. LVS stock collapsed.

“Circumstances, however, differed in ways that an Excel spreadsheet couldn’t capture. Station was 100 percent invested in Clark County, and Clark County market metrics got worse and worse. Station defaulted.

“LVS, on the other hand, was operating in Macau in addition to Las Vegas, and would soon be operating in Singapore. The Macau market recovered rapidly, and the Singapore market is exceeding all expectations. LVS’s Strip investment, had it been the company’s only source of income, would have put LVS in Station’s box—the default box.

But LVS’s properties in Macau and Singapore generated so much cash that LVS skated away from the precipice—although it might not have if Adelson had not dipped into his own pocket to keep the company out of default.”

So sometimes it is possible for casinos to reverse what seems an inevitable slide toward bankruptcy, and borrowing money at the right time can be a part of the solution.

Yet there should still be some concern about increasing levels of debt. The return on invested capital has fallen precipitously for big Las Vegas Strip casinos in the past 20 years; from a stellar 16.4 percent in 1990, to a merely good 10.8 percent in 1999 at the tail end of the 1990s boom, to an abysmal -4.3 percent in fiscal 2009.

According to Christiansen, this means the casino industry will be less attractive for new capital construction for a long time. We could be seeing “unrefreshed properties aging into obsolescence—and half-finished investments like Fountainbleau” in our future.

So while taking on new debt can give casinos a chance to fight another day, the more that is piled on, the greater the chance it will come toppling down.

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