In the Casino Business, Neutral Is the New Positive

The U.S. casino gaming market is finally improving, according to a report published Tuesday by Moody's Investor Services. After more than two years of giving negative outlooks to the business, Moody's has changed its view to neutral and recognizes "signs [that the] industry has bottomed out."

While gaming entities have been saying that very thing for a number of months, Keith Foley, a senior vice president at Moody's and author of the report, explains that the numbers are only now beginning to show it.

"We track monthly gaming revenues and they appear to have flattened," says Foley. "Giving that a large majority of casino revenue comes from gaming, we see that as a leading indicator. We think the industry has hit bottom. Profitability will be flat instead of declining."

Foley points out, though, that flat may not be good enough in an industry where room-rates remain low and debt-loads are back-breakingly high.

"It's a problem [particularly on the deeply leveraged Vegas Strip] when you have $400 rooms that you need to rent for $300 to make a return on your investment, but you can get only $99 for those rooms," says Foley. "For 10 years, Vegas defied gravity and made the argument that if you build it, they will come. The flip side is that if you don't build it" -- a reality of the current environment, save for the Cosmopolitan, due to open later this year -- "will they still come?"

That said, Foley acknowledges the potential for improvements sooner than "neutral" might indicate: "If the economy chugs along or improves a little bit, and that translates to a favorable response in gaming revenue, there is potential for a positive outlook. Companies have trimmed expenses, and that could help."

Apparently, that's a view shared by John Paulson. Last month, his hedge fund, Paulson & Co., which made $15 billion by betting the right way on the sub-prime mortgage meltdown in 2007, revealed that it had purchased 40 million shares of MGM Resorts International (MGM) and 4 million shares of Boyd Gaming (BYD). With the MGM purchase, Paulson has 9.06% of the gaming giant's outstanding shares. Earlier this month, according to BusinessWeek, Paulson exchanged $710 million of debt in Harrah's Entertainment for a 9.9% equity stake in that casino company. A spokesman for Paulson declined to comment on the acquisitions.

According to Larry Klatzkin, gaming analyst with Chapdelaine Credit Partners, "It's always encouraging to have someone like Moody's say that the industry is out of major decline. But we have been moving in that direction for a while now. I think it's already priced in and will not affect the market."