By Roger S. Cline
The U.S. gaming industry enjoyed growth without precedent during the past two years as gambling won higher marks for acceptability among many Americans, while continuing to be a significant lure to overseas travelers. Indeed, U.S. gaming is today a $36 billion industry, of which fully 44 percent is attributable to casino gambling. American households with family members visiting a casino in 1994 had almost doubled from just two years before, and visits to casinos were just behind theme parks in entertainment draw. The gaming industry today represents a significant economic force.
Notwithstanding the enthusiasm in late 1993, however, last year yielded significant disappointment for some elements of the gaming industry, while offering success to others. Despite growing support of casino gambling among U.S. households, the majority of initiatives to legalize gambling in new jurisdictions failed. Gambling initiatives in a number of states were rejected in last November's elections, as well as in the recent efforts this year in Vermont, Virginia and West Virginia. The biggest loss was in Florida, where proponents outspent opponents 15 to 1, and still lost by a margin of 62 percent to 38 percent. Clearly, the odds have been stacked in favor of existing jurisdictions and operators, many of whom posted significant growth in revenue and profitability in the past year.
On Wall Street, gaming stocks have had a roller-coaster ride with a big run-up in late 1993, followed by a long slide during 1994, although stock prices picked up in the early months of this year. The hammering of gaming stocks in 1994 was largely attributed to concerns relating to overbuilt markets, high taxes, interest costs and uncertainties in the regulatory environment. Wall Street is likely to be more cautious in the future, with the focus on well-capitalized, well-managed companies.
This mixed profile sets the stage for significant issues confronting the gaming industry in the United States as it responds to the allure of future growth opportunities -- and a simultaneous challenge to further legitimize itself. The hospitality and gaming sectors in the United States have been generally perceived as separate industries, despite the fact that gambling casinos are frequently housed in large-scale hotel properties. Capital availability and operational issues confronting both sectors, however, are not only extremely complex, but also interrelated. Both sectors must continue to redefine themselves in relation to each other -- and within the travel and entertainment industries respectively. Las Vegas, capitalizing on its historic leadership position, carved a new path in marrying casino gambling and family entertainment in a $2 billion bid to attract a broad swath of the American and overseas public. How the gaming industry positions itself in light of these and other events raises a number of future questions as new markets emerge and mature.
The demise of recent gambling initiatives places a spotlight on conflicting attitudes toward gaming as the industry has evolved in the past four decades. The industry's growth following the big success of casino operations in Nevada during the 1950s was moderated by religious opposition and fears of its links with organized crime. These barriers, however, gradually weakened with the success of state lotteries in the 1970s and 1980s, and continued to fall when Congress in 1988 required states to negotiate with Indian tribes to permit gambling on their reservations. Regulatory success in Nevada and New Jersey further allayed fears of crime connections, and many of the industry's largest casino gaming companies are respected, publicly held corporations. More recently, dozens of states with an eye on the tax revenue potential have permitted gambling in a variety of forms. State lotteries alone represented 38 percent of total U.S. gaming last year, generating $14.4 billion in revenues. Lotteries in 36 states and Washington, D.C. are now within easy reach of 86 percent of the U.S. population, while video poker is increasing in a handful of smaller states.
According to the Harrah's/Yankelovich Gaming Survey, 59 percent of Americans find gambling acceptable as a form of entertainment -- up from 55 percent two years ago. This increase is in all likelihood a function of rising exposure to casinos as their numbers grow. The Harrah's survey showed that at least 30 percent of U.S. households had at least one member visit a casino in 1994 -- up dramatically from 17 percent in 1992. A 1994 Survey on Gaming Attitudes by Casino Journal supports these findings. The survey found that 54 percent of Americans favor casino gambling, while 56 percent have themselves gambled in a casino. A third of those surveyed support gaming because of its positive economic impact, while fear of crime and personal beliefs were primary reasons for opposition.
The arguments supporting gaming often revolve around the economic benefits associated with employment creation, the multiplier effects of tourism and ancillary development. The offsets are frequently described as negative "externalities," such as compulsive gambling, increased public sector costs for infrastructure and negative impact on existing businesses. Some of the most vocal opposition has come from religious groups, suggesting that gaming initiatives in certain markets will be difficult to pursue. Notwithstanding these issues, people concerned about negative influences generally become less so as they meet the public companies in the industry and understand the regulatory process. There is no evidence to suggest that casinos attract any more crime than other business, but these operations do draw high volumes of people in relatively concentrated areas -- inevitably resulting in social and economic impacts.
Without question, recent defeats of gambling initiatives combined with growing acceptability of gaming deliver a mixed message to the industry. Were the campaigns on behalf of gaming advocates not well conceived? Or is the pace of gaming's acceptance slowing down? The answers undoubtedly vary from state to state, and among specific markets. What is abundantly clear is that gaming has attracted a great deal of attention, and the industry must address problems early in this wave of growth to demonstrate its contributions to economic development. The chairman of the Small Business Committee in the House of Representatives, for example, introduced a bill last September to establish a national commission to study the impact of gambling -- sparking a fear that a national policy could lead to federal regulation of the entire industry. In addition, the Federal Gaming Excise Tax initiative early last year fell to the wayside after a furious outcry from the industry. But it is not clear whether the industry has seen the last of such initiatives as legislators seek new sources of revenue.
Casino gaming as a business venture is no recipe for success as new entrants to the industry have discovered, but rather is subject to intense competitive pressures as the industry grows rapidly. Industry revenue measured as "net win" by casino operators in 1990 was at $8.5 billion, of which two-thirds came from operations in Nevada, and the remainder in New Jersey. In the ensuing five years, the make-up of the industry altered dramatically as revenues almost doubled to $16.6 billion.
While revenue generated by operations in Nevada and New Jersey continued to grow steadily, these states dropped as a proportion of total revenues nationally. Two new market segments emerged, commanding a significant share of the industry virtually overnight -- riverboat casinos at 20 percent of total revenues and operations on Indian reservations at 18 percent.
Nevada. As gaming has captured attention around the world, Nevada and its casino hotel operations have worked hard to develop new markets and attractions -- consistently staying well ahead of the curve. Six years ago, Las Vegas had eight of the 10 largest hotels in the world; it now has 12 of the largest 13. Nevada continues to set worldwide standards, and
that leadership has paid off handsomely. When the last big wave of expansion occurred in Las Vegas in late 1993, occupancy levels soared to nearly 90 percent. Some $2 billion in properties opened that year with MGM Grand, Treasure Island and Luxor joining other casino hotels to form a critical mass of family entertainment attractions and commercial games unequaled in scale and diversity anywhere in the world. With this, the "Strip" became a multi-billion product in the toughest market of all -- the general entertainment and family destination travel market.
Nevada has consistently dominated in part because gaming, entertainment and tourism are the state's basic industries, and they are conducted in partnership between the state and private enterprise. Infrastructure, roads and airports are well-planned and coordinated in support of these core industries. The state, as a result, has experienced a compound growth in visitor travel of 8 percent during the last 30 years -- with 29 million visitors the latest annual record. Moreover, Las Vegas is the seventh most popular U.S. destination for overseas visitors, attracting 1.4 million annually. The growth of new gaming jurisdictions around the country does not appear to represent any threat to this mature market.
New Jersey. Despite the growth of new gaming jurisdictions, it is clear that Atlantic City will continue to evolve as one of the world's leading mature markets, although recent growth has been slower. Casino revenues had reached $3 billion in 1990 for Atlantic City operations. During 1991, the first recession year, gaming revenues remained flat before an upturn generated $3.4 billion in revenues in 1994. As a result of slower growth, the state has become increasingly responsive to casino operator concerns regarding competition from new Indian and riverboat gaming destinations. Legislation approved since 1993 opened the door to two new forms of gaming, simulcast off-track betting and poker. To support these new forms of gaming and encourage overall growth, the state also has allowed casinos to increase gaming area. As a result, several casinos have expanded casino floor areas, adding table games and slot machines, in addition to off-track betting facilities in 1994 and 1995.
The orientation of Atlantic City gaming has shifted significantly during the last five years. In 1990, table gaming accounted for 35 percent of total market "drop." As interest moved towards slot gaming, casino operators have replaced casino area dedicated to table games. By 1994, table gaming accounted for less than 21 percent of total market drop. This trend is likely to continue for the next several years.
With the addition of a 500,000 square foot convention center, expansion of area airports and future funding dedicated for tourism development, Atlantic City is repositioning itself as a resort and convention destination, rather than a casino day-trip destination. Casino operators will need to aggressively market the destination as a full-service gaming and entertainment experience.
Riverboat Gambling. Riverboats and dockside casinos are newcomers to the gaming industry, having only been launched in 1991. Nevertheless, revenue from riverboat casinos reached approximately $3.2 billion in 1994, with the two largest markets in Mississippi and Illinois, followed by Louisiana, Missouri and Iowa. Voters tend to approve riverboat gaming more easily than land-based initiatives, in part because they isolate and limit the perceived negative externalities associated with gaming. Five states -- Iowa, Illinois, Mississippi, Louisiana and Missouri -- have approximately 65 boats in operation, with admissions in 1994 at about 55 million. Mississippi and Illinois operators now generate well in excess of $l billion in revenue annually.
Market performance, however, has not been entirely positive with some jurisdictions encountering decidedly rocky shoals. Riverboat gaming as an industry has bifurcated into two markets -- a financially successful segment in locations where regulations limit capacity (Illinois and Louisiana), and a saturated market with declining returns in areas lacking regulatory limits. In Mississippi, free-market regulators let demand determine supply, and have thus licensed in excess of one million square feet of casino floor space.
While riverboat gaming has been the target of some criticism, it has spurred economic development benefits, at least where they can be measured in smaller communities in which employment data and town center improvements can be seen. The jury is out, however, on the overall impact and benefit of the riverboat gaming phenomenon. It is likely that there will be continued consolidation and restructuring in this industry segment. Limited-license states will be most likely to attract further investment as savvy operators avoid the pitfalls of oversupplied and saturated markets in unlimited-license states.
Indian Reservations. As riverboat gambling was introduced, there has been a tidal wave of new casino operations on Indian reservations. Revenues from these casinos rose dramatically from $1.5 billion in 1992 to $3.0 billion in 1994, and the National Indian Gaming Association now consists of 133 member tribes. The Foxwoods casino, located in Ledyard, Connecticut, has been an astounding success -- reportedly the most profitable casino in the Western Hemisphere. As the only casino in a six-state region since 1992, Foxwood attracts an average 39,000 visitors daily and features the largest gaming space in the Western world. Notwithstanding its success in generating close to $800 million in annual revenue, New England voters failed to approve gambling in Massachusetts, Connecticut and Rhode Island in recent initiatives.
The benefits of casino gaming on Indian reservations range from increased local economic activity and stimulation of new businesses to increased tourism. There is no question, however, that growth has also encouraged considerable debate about regulation. Regulation of Class II gaming (primarily bingo) on Indian reservations falls to the Indian tribes in concert with the National Indian Gaming Commission (NIGC). The NIGC approves gaming ordinances and management agreements between the tribes and third parties. In Class III gaming (casinos), the tribal-state compact is the basis for regulation and jurisdiction. Some states have adopted strict licensing procedures, while others have almost none. An amendment to the Indian Gaming Regulatory Act -- under review by the U.S. Supreme Court -- has been proposed by Senator Daniel Inouye to establish minimum regulatory requirements, allow direct federal intervention in the negotiation process, specify types of gambling, broaden authority for the NIGC and set federal guidelines. It has been strongly opposed by the tribal community.
Gaming expansion is clearly fraught with a number of challenges that span economic, social and regulatory factors. Since New Jersey gave the nod to casino gambling in 1976, state approval of land-based casinos has been relatively minimal. Land-based casinos represent $10.4 billion of the total revenue generated -- split primarily between Nevada and Atlantic City. Limited stakes gambling is permitted in South Dakota and Colorado. Louisiana has approved casino gambling, and a major new land-based casino in New Orleans -- Harrah's Jazz Casino project -- is slated to open in temporary quarters in mid-1995, while a permanent facility under construction is expected to open in spring, 1996.
Despite limitations and the slow expansion into new jurisdictions, the gaming industry is not immune to overbuilding, nor to the high costs and scarcity of capital. Many ventures in new jurisdictions have been marginal as a result of these costs as well as taxes. Gaming taxes, which range from 7 to 25 percent of revenues, differ substantially from one market to the next, and the regulatory environment also varies in terms of the approaches taken to limiting supply through licensing. Some gaming businesses have failed altogether to produce profits as a result of too much competition in markets with no licensing limits. Since high tax rates and unfettered competition produce uneconomic oversupply, the gaming industry faces a difficult dilemma in its quest to persuade public officialdom of the need for a balanced approach to taxation and regulation.
In addition, certain new gaming markets have relied heavily on demand from neighboring states where gaming is prohibited. This is a risky marketing proposition as has been realized by Iowa following the legalization of riverboat gaming in neighboring Illinois. As examples, Louisiana could be vulnerable to Texas, Nevada to California and New Jersey to Pennsylvania if casino gambling were legalized in these states.
Gaming tends to become more acceptable and respected when it is presented as part of a total entertainment experience. Nevertheless, the need to position gaming properties as entertainment venues may place even greater financial burdens on many owners. A number of the early gaming operations in new markets have offered little but gaming. When the initial novelty and enthusiasm wears off, these operators may be under pressure to finance and rationalize heavy new investments required to broaden their product's appeal. In under-supplied, quasi-monopolistic markets, it is likely there will be continued support for casinos focusing exclusively on table and machine games. These opportunities, however, will be more limited in the future as the industry continues to redefine itself as part of the larger entertainment business.
A number of entrants to the casino business in new markets have been inexperienced and poorly capitalized -- with some gaming projects suffering from substantial cost overruns as unanticipated expenses (both hard and soft) show up during the development process. Many of these early entrants had little operating experience, and with more competition, their margins deteriorated. Colorado is a good example of what happens when local markets are oversupplied with tables and machines. Some weaker operators are forced out of business, and there is consolidation as stronger players pick up the pieces. Mississippi is also a case in point. The state is saturated with stand-alone casinos, which are dependent on an inadequate infrastructure. The conventional wisdom holds that investors will from now on focus on large, well-capitalized companies with plenty of operational and development experience in this industry.
Two other questions of key importance to operations have surfaced. The trend toward redefining gaming as entertainment has greatly expanded the market potential. At the same time, some experienced casino owners have questioned whether the move to broaden market appeal is a distraction from the core business, with the effect of diluting returns on the casino floor. Does the "family entertainment" moniker being given to the Las Vegas mega-resort operations attract the wrong type of business -- guests that don't gamble? Some critics contend that new themed attractions may result in lower per capita returns in the casino. Others, however, believe this entertainment focus bodes well for the industry generally, and for Las Vegas specifically. They contend that consumers -- once introduced to gaming in new jurisdictions -- will be much more likely to plan visits to experience the entertainment offerings of the "Strip."
In addition, there continues to be much faster growth in slot machine
revenue as compared to table games, driven by the orientation of much of
the new capacity around the country to mid-market gamblers. The win-per-table
in Nevada has remained flat, as it has in Atlantic City, while slot inventory
is up significantly with such expansions as the mega operations added in
Las Vegas. These trends not only influence revenue potential, but casino
design and the markets they will attract in the future. In addition to
expansion into new geographic areas, the industry also is keeping an eye
on a more distant, long-term prospect -- gaming in the home. This will
be greatly facilitated by interactive communications applications, similar
to home shopping. Nevertheless, the legal obstacles standing in the way
of intrastate gaming may be significant, given the recent demise of state
gaming initiatives placed before the public.
Nevertheless, the gaming companies with strong balance sheets, high cash reserves and solid cash flows seem to have little difficulty in financing. Large-scale projects proposed for Las Vegas involve investments on the order of $500 to $700 million. Indeed, Las Vegas casinos in elaborate theme park settings may galvanize another $3 billion in investment before the century ends in what industry experts call the second "big bang" wave of development. The success of developments in the first "big bang" -- the opening of three mega-resorts in 1993 -- resulted in occupancies actually climbing, rather than falling, as new product hit the market. The several new mega-resorts planned for the next five years may be absorbed just as effectively.
At the same time, joint ventures are increasingly the norm to spread risk and generate sufficient capital. Caesars, Circus and Hilton Hotels have joined forces in a major casino gambling development in Windsor, Ontario. In Las Vegas, MGM and Primadonna, and Mirage and Gold Strike, have formed partnerships. In addition, ITT's acquisition of Caesars Palace was a momentous move in the industry, potentially auguring the entrance of other large newcomers. Some of Wall Street's confidence also seems to have returned with a pick-up in stock prices during the first half of 1995.
Recent experience in the gaming industry parallels some recent experiences in the hotel sector, most particularly the challenge of raising money and the evolving nature of third-party management and franchising. Consolidation, an issue in the hotel industry for a number of years, is now clearly a prominent feature of the gaming business, as small under-capitalized companies face a capital shortage and the industry at large deals with high interest costs.
The implications of consolidation, however, are not clear. The expansion of the gaming industry into new jurisdictions may tend to produce a more fragmented industry, raising questions about whether these destinations will have the chance to mature as readily as those in Nevada and Atlantic City, which benefited from an earlier period of essential monopoly. At the same time, capital constraints -- combined with the extensive skills required to develop and operate large-scale casino projects -- strongly influence a trend toward consolidation in the hands of a relatively few major companies.
With stock prices substantially lower than the highs of a year ago, there have been some attractive acquisition opportunities that have contributed to consolidation. In addition, marketing economies of scale may force the consolidation of the gaming industry into several brand names that will dominate. For these companies, jurisdictional diversification additionally helps to spread risk and supports brand identification. Consolidation also has the potential to foster enhanced financial flexibility and access to capital, as well as the ability to create a higher comfort level to offset local regulatory concerns. In highly regulated environments, deals need to be friendly.
It would appear that casino gaming is undersupplied in the United States relative to potential consumer demand. Americans have demonstrated that they are willing and eager to spend a portion of their income on gaming, and the industry is a potent and growing economic force. Given the economic benefits of creating new jobs and tax revenues, this role in the national economy should continue to expand. With elected officials reluctant to raise taxes, gaming does offer an opportunity of avoiding direct taxation while creating employment. In turn, the scope of the gaming industry's expansion is having an effect on the hospitality industry at large, creating new development and investment opportunities for hotel projects. If gaming enterprises are to embrace a total entertainment concept -- as they seem destined to do in many places -- they will need to create operational structures designed to deliver an economically viable product.
Given the unfavorable vote in Florida last year, the industry also may need to carefully weigh the jurisdictions in which it hopes to expand and how it plans to do so. If recent initiatives placed before voters are any indication, expansion into new jurisdictions will be slower than anticipated earlier. Public referendums on the question of legalizing gaming seem to be the preferred route, as opposed to a legislated approach. Since public officials have a habit of being rotated out of office, broad citizen support is clearly a safer bet for gaming over the long-term.
Gaming as an industry, as a result, may need to focus on strengthening its depth, rather than its reach, and establish itself as a permanent and positive component of local culture and economies. In this way, the industry commits to building permanent tourism infrastructure -- in the process countering the negative image that casino operators are motivated exclusively by self-interest and assuring the maturing of the industry. Public policy makers, in turn, need to understand and plan for the gaming industry as an integral part of tourism and entertainment, while creating a solid and stable legal foundation that is accepted by society.
(Roger S. Cline is Worldwide Director of Arthur Andersen¹s Hospitality Consulting Services. He is based in New York.)