How to Care for and Feed the Golden Goose
Casinos face unique challenges in order to maintain profitability and remain competitive under the new paradigm of falling economic conditions. These factors are made more difficult in the commercial gaming sector due to rising tax rates and in the Indian gaming sector due to self-imposed tribal general fund contributions and/or per capita distributions. There is also a growing trend towards state-imposed fees.
It is difficult to determine how much to “render to Caesar” while keeping the funds available to grow market penetration, maintain market share and improve profitability. This must be done well.
This article discusses how to plan and prioritize casino reinvestment strategies.
The Cooked Goose
It would seem obvious not to cook the goose who lays golden eggs. However, it is surprising how little attention is given to its ongoing proper care and feeding. Developers/tribal councils, financiers and investors are all eager to reap the benefits of a casino. There is also a tendency to not allocate sufficient profits to asset maintenance & enhancement. This raises the question of how much profit should be reinvested and for what purposes.
There are no set rules because each project is unique. Most of the big commercial casino operators don’t distribute net profits to stockholders as dividends. Instead, they reinvest the funds in improving their existing venues and seeking out new ones. These programs may also be funded by additional debt instruments or equity stock offering. These financing options will be more prominent due to the lower tax rates for corporate dividends. However, the core business must maintain its prudence and continue to reinvest.
Profit Allocation
The net profit ratio, which is earnings before income taxes & deductions, for publicly-held companies was 25%. This average figure includes gross revenue taxes, interest payments, and group income. On average, nearly two-thirds of remaining profits are used for asset replacement and reinvestment.
Low-tax jurisdictions that allow casinos to reinvest in properties are more likely to have them. This will increase revenues and eventually help the tax base. New Jersey is an example of this, since it requires certain reinvestment allocations as a revenue stimulant. Illinois and Indiana, which have higher effective rates, are at risk of having their reinvestment reduced, which could eventually reduce the casino’s ability to increase market penetrations. This is especially true as the competition in neighboring states increases. A combination of efficient operations and equity offering can result in higher profits available for reinvestment.
The way a casino company allocates its casino profits is crucial to its long-term viability. This should be a key part of its initial development strategy. Although short-term loan amortization/debt repayment programs might seem attractive to get out of an obligation quickly, they can severely limit the ability to reinvest/expand in a timely manner. This applies to any profit distribution to investors, or, in the case Indian gaming projects, to tribes’ general fund for infrastructure/per-capita payments.
Many lenders also make the error of requiring large amounts of debt service reserves. They place restrictions on reinvestment and further leverage, which can severely limit a project’s ability maintain its competitiveness and/or take advantage of available opportunities.
While we don’t advocate that profits be reinvested in the operation, it is important to consider an allocation program that accounts for the “real” costs associated with maintaining the asset and maximising its impact.
Establishing Priorities
Three areas are essential for capital allocation, and they should be considered.
- Maintenance and replacement
2. Cost Savings
3. Revenue Enhancement/Growth
These first two priorities are simple to understand. They have a direct effect on market positioning and profitability. The third, however, is more complex. It has a greater indirect effect that requires a deeper understanding of market dynamics and higher investment risk. These are just a few of the many aspects we will be discussing.
Maintenance and Replacement
Maintenance and Replacement provisions should be part of the casino’s annual budget. This is a fixed reserve that is based on projected replacement costs for furniture, fixtures, equipment, buildings, systems, and landscaping. We see too often that annual wish lists are not proportional to actual wear and tear. It is important to plan the replacement cycle and allocate funds that don’t necessarily need to be spent during the year of accrual. It may not be necessary to replace brand-new assets during a start-up, but by accumulating amounts for eventual recycling it will save you from having to scramble for funds when you need them.
Slot machines are a special area that deserves attention. The replacement cycle for these machines has been shorter recently as newer technologies and games are being developed at a faster rate than the competition.
Cost Savings
Cost savings programs and systems are by their very nature, and if properly researched, a safer way to allocate profit allocation funding than almost any other investment. These items may include new energy-saving systems, labor saving products and more efficient purchasing intermediation.
There are some caveats to these items. One is to carefully compare their claimed savings with your application. Many times, the product claims can be exaggerated. Long term debt prepayments and lease buy-outs can be beneficial, especially if the obligations were made during development when equity funds might have been limited. It is important to evaluate the net impact of this strategy on the bottom line in these situations, and compare it with other revenue-enhancing/growth investments.
Recent trends include the increasing popularity of cashless slots systems. These not only save labor for fills and counts, but also help patrons who don’t like to carry around heavy coin buckets. They also encourage multiple game use.
Revenue Enhancing & Growth
Leveraging is the main catalyst for any revenue enhancing/growth-related investment. It includes the following:
Patronage Base
o Funds Available
o Lands
Marketing Clout
Management Experience
It is important to make the most of every asset available in order to increase revenues and profitability. Examples include increasing patronage base spending, widening effective trading radius and offering additional products/services such as entertainment options, retail stores, recreational/leisure amenities and overnight accommodations.
Master Planning
In order to ensure cohesive integration of all elements of a phased-in plan, it is important that you include potential expansion and growth into your initial master planning. This will allow for minimal operational disruption. It’s impossible to predict market changes. Therefore, expansion options must be carefully considered.
The Big Picture
We recommend that you first assess the current position of the property relative to its market and the competitive environment before embarking on any expansion or enhancement program. We have seen this in many gaming jurisdictions across the country. Many casino ventures that have been “fat and happy” for several years find themselves in a period of zero growth. This can sometimes be due to increased competition from new casinos in the area or regional venues, which have the effect of decreasing patronage from those markets. Customers may also become dissatisfied with their current experience and seek out new opportunities. Las Vegas’ history is a testament to the importance of constantly “reinventing yourself”.
These market studies are first focused on the extent to which current facilities are reaching the potential market, and how it compares to other market shares. This is typically an analysis of current patronage based on information gleaned via player tracking data and mailing lists. It also includes day-part, daily and monthly revenue trends.
