The state of our engine

Strip building boom, buyouts were ill-timed, and many see more pain in ’09

Last year, Las Vegas gaming revenue fell to 2005 levels.

On the Strip, which generates more than half of the state’s gaming revenue, gamblers lost USD 6.1 billion last year. That’s about what they lost in 2005 — a boom year with revenue soaring 13 percent from a year earlier.

No industry wants to go backward. But considering the stock market has plunged to 1997 levels and homes may take decades to return to their peak values of a couple of years ago, three years of gaming growth seems like a small hit in this economy.

What has the casino business reeling — with several industry giants close to bankruptcy and resorts slashing prices to levels not seen in decades to fill rooms — is that the worst pullback in consumer spending in half a century came at the worst possible moment.

During the boom, gaming’s economic engine was strong but financially vulnerable, clogged with debt accumulated immediately before the economy took a nose dive.

Las Vegas’ largest casino companies took on billions of debt to finance takeovers. Those that didn’t go private built more and bigger properties — MGM Mirage, Nevada’s largest employer, began the country’s most expensive commercial construction job in 2006.

Their buying and building spree snowballed into 2007, as the subprime mortgage crisis began to take its toll on the investment banking system.

Had these companies not taken this aggressive route, they wouldn’t be in such bad shape.

Had the housing slump not hit until a couple of years later, some casino companies might have paid down debt and ramped up performance at newer properties, gathering strength for the coming storm.

Now, analysts are struggling to figure out where the economy will bottom out and what the eventual recovery will bring for gaming.

Was the growth Las Vegas experienced over the past several years, fueled in part by cheap capital and inflated assets, an aberration? If there is a return to “normal” growth levels, what will normal look like?

Casino companies used past experience and positive trendlines to justify their spending. Las Vegas, after all, had bounced back from previous downturns. And new resorts appeared to create their own demand. The modern resort era in Las Vegas, barely 20 years old, was still a young enterprise, without a lengthy track record. Still, the longer and stronger the growth trend, the more indestructible, even inevitable, it seemed.

As casino operators discovered, that growth wasn’t entirely generated by the allure of Las Vegas. It depended on a third factor outside the industry’s control: an appetite to spend that has waned with the housing slump.

Home values not only account for a significant chunk of consumer wealth, they also underlie consumer confidence. The evaporation of trillions of dollars in home equity, according to recent estimates, has undermined the desire to spend.

“When the tide goes out, all boats sink,” said Keith Schwer, director of UNLV’s Center for Business and Economic Research.

Financial experts now understand a concept that, in hindsight, seems obvious: The country’s economic growth was generated more by paper wealth — investment appreciation and inflated housing prices, for example — than by real wealth such as job and wage growth. When the economy began to slow, the downward cycle coincided with the blowup of the housing market — a spectacular blast that has staggered the world economy.

During the boom, people used their homes as ATMs, taking out home equity loans for luxuries. That spending may never return, Schwer said.

Unfortunately for Las Vegas casinos, especially those patronized by locals, extracting money from inflated home values fueled a lot of off-Strip gaming growth, according to CB Richard Ellis. Declining suburban casino revenue can be partly explained by the many homes that are worth less than their mortgages and the unavailability of such loans today, said Jacob Oberman, director of gaming research and analysis for CB Richard Ellis.

“The value of your home … was a safety net,” Oberman said. “Now people don’t have that safety net. And people are concerned about their jobs. So everyone is tightening their belts.”

The consumer downturn has dire implications for a city built on discretionary spending.

By mid-2008, many Las Vegas insiders thought there would be a turnaround year and 2009 would bring recovery, followed by a return to a normal growth in 2010.

After Wall Street’s collapse last year some revised their opinions. They said the first half of 2009 would be flat at best, with the latter half up from the depressed year-ago period.

These days, many say 2009 will be just as bad as or worse than 2008. A turnaround is possible in 2010 but not guaranteed, the experts say. Others are saving their recovery predictions for cocktail parties rather than public statements.

Bond rating agencies, which assess bankruptcy risk, are keeping their predictions open-ended.

Standard & Poor’s expects earnings declines for Strip casino operators “similar to those observed in recent quarters” through at least mid-2009 and a modest recovery in 2010. Moody’s, which has had a bearish outlook on the gaming industry since 2007, says 2009 will be another bad year for gaming. Moody’s isn’t forecasting a recovery because of accelerated declines in some markets, including Las Vegas, with no sign of stabilization.

The complexity and depth of this recession makes it hard to determine cause and effect relationships, said Jeremy Aguero, a partner with Applied Analysis in Las Vegas.

“We can figure out what creates growth but it tends to collapse for different reasons,” he said. “There’s no model that can explain how slot machine (wagering) declined by a billion dollars” in a year’s time.

Many Las Vegans find it hard to accept that slower growth is more realistic, and might be more healthy, Las Vegas economic analyst John Restrepo said. Many moved here during the economic boom, from the late 1990s to the early 2000s, and didn’t witness the slow decade before the Mirage opened in 1989, spurring Strip development, Restrepo said.

Added Schwer: “We have a lot of people in our town making money by saying things are going to go back to where they were before the decline. We’re not going to fall off the face of the earth. But we’re not going to see 5 percent population growth like we’ve grown accustomed to in the past.”

More stabilization, or bottoming out, is needed before analysts can begin to make accurate assumptions about the future, Restrepo said. With gaming revenue and visitor volume continuing to fall, that hasn’t happened.

“It’s like we’re driving forward in a fog,” Schwer said.

But we do have the recent past. And the numbers — so the saying goes — don’t lie.