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Gambling Stocks Still Look Like Good Bet

Investors recently doubled down on gambling stocks despite a yearlong
winning streak, wagering that expansion will spur growth and bettors will
keep spending even as the economy softens. The Dow Jones U.S. Gambling Index
has surged more than 35 percent since the start of the year, easily
outpacing the broader market as represented by the Standard & Poor’s 500
index, which has added about 12 percent. The gambling index, comprising 67
stocks weighted primarily toward large hotel-casino operators such as
Harrah’s Entertainment and MGM Mirage, has generally tracked sentiment about
the overall economy. After rising through April, the index gave back most of
the gain amid worries consumers would be cash-strapped as oil prices climbed
steadily ahead of the summer months. “Those concerns didn’t come to
fruition,” said Robert LaFleur, a gaming, lodging and leisure industry
analyst with Susquehanna Financial Group. “Expectations were that higher gas
prices and a softening housing market would pressure the industry, but
visitation has remained strong.” Part of the reason is that casino
performance does not necessarily track consumer spending, despite investor
reaction. “The Las Vegas strip market is driven more by overall economic
growth,” said Morningstar equities analyst Sumit Desai. “The stocks are more
cyclical than the underlying business,” he said. And gamblers don’t
necessarily curb spending in economic slowdowns, anyhow. “The high-roller
business is always going to be strong because these guys don’t worry about
short-term factors,” LaFleur said.

Either way, there was more good news Monday when a leading economic
indicator edged higher, suggesting the recent housing slump was not enough
to offset lower gas prices and a rising stock market.

Another boost for the sector, said Frank Fahrenkopf, head of industry trade
group American Gaming Association, is casino operators’ expansion into other
businesses.

“The industry has moved to the total entertainment package,” he said.
“People come to destination resorts _ they come to shop, to see shows and to
play golf.”

That trend in Las Vegas, which attracts more families and couples to what
was long considered a bachelor’s paradise, has turned off some of the city’s
more committed gamblers, but it has benefited the operators.

“It used to be that a casino’s bottom line was about 65 percent gaming
revenue,” Fahrenkopf said. That’s down to around 40 percent now at some
companies, even as gaming revenue surged past $30 billion for the first time
last year, according to the AGA.

And casino operators are boosting investment into additional entertainment
venues. There are $20 billion worth of projects in Las Vegas alone that will
be completed by 2010, said Desai.

“They want to offer a resort experience instead of just gambling,” he said.

The danger is that new casinos and hotels could lead to excess supply. “That
could be a hiccup for the industry, especially if it coincides with an
economic slowdown,” he said. “But generally the industry does a great job at
managing growth.”

Driving that growth _ in Las Vegas and Atlantic City, N.J., and also in the
numerous other states that license American Indian casinos _ is increased
social acceptance of gambling, Fahrenkopf said. The lobbyist traced the
start of public softening toward gambling back to the reintroduction of
lotteries in 1963 in New Hampshire. Now 48 states have some form of
legalized gambling, from lotteries to horse racing to casinos.

But the surge that benefited casinos most came as poker soared in
popularity, first through Internet sites and then, starting in 2002,
televised tournaments. The Poker Players Alliance, a player-based lobbying
group, estimates there are more than 70 million Americans who play poker.
The number of poker tables in Las Vegas has risen to 405 in 2005 from 142 in
2003.

“Poker clearly helps,” said LaFleur. “It’s a tough game for casinos to make
money on, but it attracts gamblers.”

Harrah’s, the country’s largest casino operator, has turned the game’s
popularity into a major revenue source with its annual World Series of
Poker. The company is currently being courted by private-equity groups with
a $15 billion buyout offer, excluding debt assumption.

The offer, which would be about a 25 percent premium, helped bolster the
sector, LaFleur said, because it sets a mark by which to determine the value
of other companies in the sector. “The stocks often trade up in anticipation
of other deals,” he said.

The news helped Harrah’s stock recover after it stumbled earlier this year
on investor concerns about its lack of a presence in Asia.

Las Vegas Sands Corp., run by billionaire Sheldon Adelson, and Wynn Resorts
Ltd., run by Steve Wynn, have licenses to operate in Macau, China _ the
former Portuguese colony on the Chinese mainland that is now considered the
next gambling paradise.

The expansion overseas marks the first time U.S. casinos have ventured
abroad, lured by a strong gambling culture in Asia and the Chinese
government’s desire to attract foreign direct investment.

“The market trends are very strong in Asia and there are no indigenous
companies with the experience to operate on the scale they want in Macau,”
LaFleur said, adding that Singapore is also a growing market for U.S.
casinos.

The attraction of new markets is clear, but Desai warns that intense capital
spending could hamstring some companies. “A lot of times investors think you
can’t lose with these stocks, but Trump went bankrupt two years ago.

“The problem is they require a lot of investment to keep them fresh and new
and they have a ton of debt on the balance sheets. They are inherently risky
investments,” he said.