The gaming industry experienced a greater impact from the difficult financial conditions for consumers in 2008 than many investors expected. Generally, gaming spend per visit has been affected more than visitation levels, which can be bolstered by promotions. Considering the combined effect of recent declines in gas prices, and reductions in airline capacity and international demand, Fitch believes regional/local markets will fare better than destination markets, such as the Las Vegas Strip.
In its 2008 Outlook, Fitch indicated that it expected the gaming industry to be more economically sensitive than in previous downturns, which was clearly exhibited in the past year. Therefore, Fitch's macro-economic outlook weighs heavily on its 2009 gaming industry outlook. The main themes and questions that will affect gaming credit profiles and ratings in 2009 include:
Credit Markets
Given the capital intensity of the business and refinancing risk, corporate gaming operators are heavily reliant on access to external capital sources. Will the credit markets begin to thaw after the New Year? If so, to what degree? A number of issuers are at increased risk of bumping up against covenants in 2009, and will be approaching credit facility expirations in 2010-2011. Therefore, the bank lending climate will become increasingly important as 2009 progresses. Harrah's and Station attempted to address near-term maturities and/or heavy LBO-related debt loads with debt exchanges, but Station was unsuccessful and Harrah's has yet to complete the transaction. MGM and Ameristar are other issuers with notable refinancing risk that will become more concerning as 2009 progresses, although MGM has recently enhanced its liquidity profile with a secured note issuance and an announced asset sale;
Depth and Length of Recession
Will the U.S. economy begin to recover around mid-year 2009, or will the recession extend into late 2009 or 2010? Will a consumer spending recovery lag the broader economy? As the industry begins to anniversary the 2008 weakness, will pressure on operating results moderate? Or will we see another step down, fueled by the weak employment trends filtering through the economy? With unemployment expected to rise significantly throughout 2009, Fitch believes that a gaming industry recovery is unlikely until 2010, particularly if capital markets remain weak. Continued weak capital markets and rising unemployment would lead to sustained pressure on retiree investment portfolios and consumer confidence, resulting in constrained consumer discretionary spending. Therefore, Fitch's current Outlook incorporates operating declines in 2009 at best similar to 2008 on a same-store basis;
Supply Absorption
How will upcoming new supply be absorbed in Las Vegas amid weak demand? A significant amount of supply is planned to be added to the LV Strip market over the next 12-18 months including Wynn Encore, the Caesars Palace expansion, CityCenter, and Fontainebleau. Regarding the impact of the increase in supply, Fitch believes Wynn is extremely well positioned, but remains cautious on the credit profiles of MGM, LVS, and Harrah's. In addition, the Las Vegas Locals market needs to absorb the Eastside Cannery, Aliante Station, and M Resort supply additions, which will have a notable impact on both Station and Boyd.
2009 Credit Outlook
Fitch believes that a prolonged U.S. recession that extends beyond 2009 and into 2010, coupled with an extremely tight credit environment, will put significant additional pressure on the balance sheets of already stressed corporate gaming operators. There was a significant tick up in high yield (HY) gaming defaults in 2008, with five issuers (French Lick, Tropicana, Greektown, Herbst, and Majestic Star) defaulting on $2.3 billion of HY market principal through November 2008. Three other issuers (Trump, Station, and Harrah's) are on the cusp of defaulting on debt obligations.
The weak fundamental trends combined with generally high leverage and tight liquidity provides the basis for Fitch's negative outlook on corporate gaming operators in terms of both operating fundamentals and credit ratings. While Native American gaming operators are feeling similar pressure on operating trends, the issuers in Fitch's rated portfolio generally maintain more conservative financial profiles relative to rating levels, so those issuers will have somewhat more ability to maintain ratings in 2009. Due to more stable free cash flow profiles, stronger internally generated liquidity positions, a less capital intensive business model, and more conservative balance sheet management, gaming suppliers have the most attractive overall credit profiles and greatest ability to weather the downturn.
Continued Focus On Liquidity
Given the rapid deterioration of demand and highly leveraged balance sheets, the liquidity profiles of corporate gaming operators will remain a focus until credit markets ease and the economy stabilizes. Over the course of 2008, numerous gaming operators increasingly pulled back on planned expansion projects, reducing expected capital expenditures in an effort to improve free cash flow profiles. As the credit crisis worsened, some companies went further and slashed upcoming maintenance capex budgets and reduced labor forces. While cutting maintenance capex levels provides some short-term liquidity relief, if sustained too long, it will be detrimental to longer-term credit profiles by compromising asset quality.
The bank lending environment will be a key factor as 2009 progresses, as a number of issuers are in danger of bumping up against credit facility covenants. In addition, a number of corporate gaming credit facilities expire in the late 2010-2011 time frame. Those companies will want to avoid those liabilities becoming current, which means that a number of new agreements are likely to be entered into by the end of 2009/early 2010. It is clear the terms will be much more costly than those of the existing agreements that were entered into during a more accommodating credit environment. In addition, Fitch believes there may be downward pressure on the size of the commitments as investment banks seek to limit their own balance sheet exposure, as was the case in Mohegan's credit facility amendment on Dec. 10. Downsized commitments will contribute to a slower growth rate for the industry over the next three-to-five years.
Fitch published a sector liquidity overview in a report on Oct. 23 (Liquidity Focus: U.S. Gaming & Lodging) and follow-up comment on Nov. 14 (Fitch Provides Update on Recent Gaming Liquidity Trends). Of the seven issuers that were noted with weak or weak-to-moderate liquidity profiles, three companies (Trump, Station, and Harrah's) are now on the cusp of defaulting on their obligations. Two others, LVS and MGM, announced significant capital raising transactions since Fitch's initial report. LVS completed a highly dilutive $2.1 billion equity sale, while MGM issued a $750 million secured note sale priced to yield 15%, and also announced a $775 million asset sale. The remaining two issuers, Ameristar and Pinnacle, have less immediate needs and minimal upcoming bond maturities, but will likely need to address potential covenant violations with their banks in 2009.
Distressed Transactions
Given the pressure on operating cash flow, current depressed debt prices, and limited refinancing options, distressed transactions are likely to continue. Harrah's and Station have been negotiating with bondholders regarding the terms of distressed debt exchanges (DDEs), which is one of three definitions of default according to Fitch's published criteria (the other two include failure to make an interest/principal payment, or a bankruptcy filing or liquidation). Station announced on Dec. 15 that conditions of the exchange would not be met, so it terminated the exchange offer. Harrah's exchange offer expires on Dec. 19, 2008.
Although Native American issuers maintain generally more conservative financial profiles than corporate gaming operators, their credit profiles have also come under pressure due to the macro economic environment. To date, Fitch is unaware of a distressed workout situation occurring in relation to the bonds of a Native American gaming issuer, and believes that a DDE would be the most likely outcome of a workout scenario.
To the extent that credit markets remain tight, Fitch believes there will be increasing pressure for companies to engage in both casino and non-operating asset sales in 2009. However, Fitch believes potential buyers are limited and credit markets conditions would make it difficult to complete a transaction. Despite that, MGM announced on Dec. 15, 2008, that it is selling Treasure Island to Phil Ruffin, who previously sold the New Frontier site and is able to provide largely cash financing for the transaction. The $775 million purchase price will consist of $500 million in cash at closing and $275 million in secured notes. Penn National and Boyd Gaming, with their relatively more attractive balance sheets, may be able to consider operating asset purchases early in the credit stabilization cycle. Wynn also maintains an attractive liquidity profile and clearly has the balance sheet to be a buyer. However, Fitch believes that the company may be more inclined to purchase attractive real estate for future development, rather than operating assets that are not a strategic fit with its brand.
Market Outlook
Same-store gaming revenues in many large jurisdictions are down in the mid-to-high single-digit range so far in 2008, and due to operating leverage, property same-store cash flow declines can be greater. The declines since September are notably worse than year-to-date figures and Fitch believes that gaming operating trends are likely to remain weak well into 2009. Fitch believes it is clear that there will be significant operating pressure in the first half of 2009. Although year-over-year comparisons will get easier in the second-half of 2009, Fitch does not believe there will be a meaningful gaming recovery until 2010. Specifically, Fitch's current Outlook incorporates operating declines in 2009 at best similar to 2008 on a same-store basis.
The largest commercial markets, Las Vegas and Atlantic City, are experiencing some of the most significant demand pressure, which Fitch expects to continue into 2009. Las Vegas Strip revenues have declined 8.7% year-to-date through October, while Atlantic City revenues have declined 6.7% year-to-date through November. In addition to the consumer-driven demand pressures, those markets are facing additional challenges from competitive supply increases.
The largest Native American markets of California and Connecticut are also experiencing significant demand pressure. In addition, some Californian Native American operators are struggling to offset increased fees associated with amended state Class III gaming compacts signed in 2008 that allowed additional supply.
Certain regions have held up better, such as the mid-south, where high energy prices for much of the year supported that regional economy. However, the recent pullback in energy prices may pressure the region in upcoming months. Other less mature markets in the northeast, specifically Pennsylvania, New York, and Rhode Island, continued to grow in 2008, resulting in notable competitive pressure on the more mature markets of Atlantic City and Connecticut.
Internationally, growth in Macau will moderate in 2009, following several years of extremely high growth that enabled it to surpass the Las Vegas Strip as the world's largest market. The government has recently implemented visa restrictions and LVS has pulled back on Cotai Strip development plans. In addition, the opening of the Singapore market in 2009-2010 will likely have an impact on Macau. In terms of the operating environment, Singapore has a lower tax rate and much more limited competition than Macau, which provides incentive for LVS to market its Singapore property more heavily than Macau to its regional customers.
Regulatory Environment In 2009
State budgets are likely to be increasingly under pressure in the next few years, which historically has provided governments with incentive to consider gaming as a revenue source for budget shortfalls. However, legislators are likely to be less optimistic regarding gaming taxes as a lucrative revenue stream. Gaming tax revenues have not met expectations in a number of jurisdictions that recently legalized or expanded gaming. In addition, with unfavorable credit markets and struggling corporate operators, there is likely to be limited appetite for funding new developments. Investment appetite will be further dampened if governments continue to seek extremely high tax rates of 50%+, which has been the case in the states that most recently legalized gaming such as Maryland, New York and Pennsylvania.
For example, there has been very limited recent interest from major corporate gaming operators for Atlantic City's Bader Field development and Illinois' 10th gaming license. Kansas passed gaming legislation in 2007 and opened the bidding process for commercial casino developments, but the ensuing economic turmoil contributed to a number of developers withdrawing their bids. The state is now likely to rebid some licenses with more liberal rules.
Native American expansion opportunities may be more likely than commercial expansion, as recently implemented revenue sharing rates under Class III gaming compacts have generally been more reasonable than commercial gaming tax rates for new jurisdictions. In addition, Fitch believes that gaming expansions may be more likely a result of relaxed gaming regulations.
In 2009, regulatory changes in certain markets will provide some credit support to certain issuers. Regional operators such as Ameristar, Isle of Capri, Pinnacle and Penn National will benefit from the recent easing of gaming restrictions in Missouri and Colorado. Missouri recently eliminated the $500 loss limit in exchange for a 1% point increase in the tax rate. Colorado raised its betting limit to $100 from $5 and increased daily hours of operation to 24 from 18. The Seminole Tribe of Florida continues to implement table games at its properties pursuant to the Class III compact it signed in 2007, which has helped offset demand pressure. However, the Florida state legislature has yet to approve the terms of the compact.
Smoking bans remain a secular challenge for the industry, as political pressure mounts in states across the nation. In 2008, gaming revenues in Illinois, Colorado, and New Jersey were affected by smoking bans. Gaming operators received a temporary reprieve in New Jersey, where a full ban was recently delayed by a year in lieu of maintaining a partial ban. Although pressure has increased to enact similar restrictions at Native American casinos, those operators maintain more flexibility due to their sovereign status under U.S. law.
