Debt Matters

It’s the dark matter of the Las Vegas casino business: there, but not readily apparent to the naked eye. You can spy reflections of it in deferred maintenance and longer check-in lines on the Strip. It’s casino debt, and it could remake the Strip over the several next years. Or not.

Like other businesses, casino operators borrow money for a variety of reasons: to cover start-up costs, to expand and to keep up appearances. When revenues keep pace with borrowing, that’s not a problem.

But unless you’ve been under a rock for the past four years, you know that the recession meant that revenues fell off a cliff starting in late 2007—the same time that casinos’ debts started to pile up. From 1999 to 2004, the total liabilities—including current and long-term debt and mortgages—of Nevada casinos fluctuated between $12 and $15 billion. In the same year, total revenues grew from $15 billion a year to nearly $20 billion.

As companies borrowed money—both to go private (Harrah’s and Station Casinos) and to expand (MGM Resorts), total liabilities soared to $22 billion in 2006. That didn’t seem like such a bad thing—revenues had continued to gallop ahead of borrowing.

That led to a borrowing binge, as total debts nearly doubled to $44 billion by 2008, while revenues grew only slightly. Once revenues started shrinking in 2009, that debt suddenly seemed much bigger. With no increase in the money coming in, paying it off would be difficult, if at all possible.

Then things got worse: Casinos started losing money. An industry that posted $2.3 billion in net income before taxes in 2007 lost nearly $4 billion in 2011.

Clearly, this is not the road to financial security, either for the companies involved or the state as a whole. That’s why, as Moody Investor Services analyst Peggy Holloway has warned, large debt structures might represent trouble for some of the biggest casino operators in Las Vegas, as well as operators in Atlantic City and even the formerly bulletproof Foxwoods Indian casino in Connecticut.

But maybe it isn’t such a problem.

Those who speak for casino operators will tell you that debt isn’t quite the albatross Holloway and others make it out to be; that they’ve trimmed budgets, reduced amounts currently due, and extended maturities. It’s possible, then, that debt isn’t going to sink the gaming industry.

But let’s not take the industry’s word for it. Eugene Christiansen, CEO of New York’s Christiansen Capital Advisors, knows a thing or two about casino financials. In the early 1990s, when several Atlantic City casinos declared bankruptcy due in part to over-extended debt burdens, he wrote the state’s financial suitability guidelines designed to stave off a recurrence.

In retrospect, Christiansen believes the massive increase in industry indebtedness was “singularly ill-timed.” But that doesn’t mean that the Strip has hit a point of no return. He sees two possibilities. “As long as credit markets remain open,” Christiansen says, “diversified debtors probably have options like selling assets or buying their own debt back. But if credit markets freeze, as they did in mid-2007, this can tip over into default or bankruptcy.”

This keeps everyone up at night. “People who think high casino leverage does not link this industry’s outlook to larger events in the global economy are wrong,” Christiansen says. “Larger events in the global economy like, God forbid, a euro meltdown that freezes credit markets as Lehman’s collapse froze credit markets in 2007 would have immediate consequences for Nevada’s biggest industry.”

That puts casino operators in the uncomfortable position of gambling. If the overall economy improves, revenues will rise and, taking advantages of leaner budgets, casinos can pay off debts as they mature. But if the ball falls into another slot, another wave of bankruptcies could hit the gaming industry.

In the meantime, Las Vegas casino operators are decidedly more cautious. With interest expenses as a share of overall revenues nearly doubling to 14 percent, the easy-money hangover has taken a bite out of operating budgets. That’s why, even after visitation and revenues have begun to pick up, many casinos still have lower staffing levels. But that caution is also going to constrain new supply as those who want to build new hotel rooms on the Strip find it difficult to borrow. That will stabilize the market, and may give existing operators enough breathing room to make it through the worst of the debt storm.

Cosmologists say that dark matter, which has never actually been seen, most likely holds much of the universe together. Similarly, for the next few years, debt is going to be the invisible mass that gives the industry its shape, for better or for worse.