The Passed Seven
by Paul Larson (TMF Parlay)

MARKET CLOSE            5/23/97  5/30/97
Nasdaq Composite:       1389.72  1400.32 (+0.76%)
S&P 500 (SPX):           847.03   848.28 (+0.15%)
CBOE Gaming Index (GAX): 217.64   215.19 (-1.13%)

Chicago, IL (May 31, 1997) -- For the second week in a row the markets inched forward while the Chicago Board Options Exchange Gaming Index (GAX) fell. Gaming stocks now have the dubious distinction of being the absolute worst performing sector the past year. I looked in three different printed publications that rank performances of sectors and gaming was the absolute bottom on all three tables I scanned. El stinko! While there has been a raging bull market elsewhere, a big fat bear has been sitting on the gaming stocks.

I have also noticed that there has been significant price to earnings contraction in the sector the past several months. Where nine months ago the average P/E in the gaming sector was roughly 20; it is now treading slightly above 17. Comparing average P/E multiples over time tells us where Wall Street is valuing the sector since stock prices are directly related to the P/E multiple. Assuming that earnings have been flat in the sector, this contraction tells us that the market is valuing the average gaming company 15% less than a few months ago.

Some of the P/E contraction has been warranted, however. Since the GAX index is off 36% from its high and 33% from a year ago, this tells us that the gaming companies have been falling short on the earnings front. Remember, a stock's price is simply its P/E ratio multiplied by its trailing earnings. If the average P/E ratio has dropped 15% and the average stock has dropped by twice that value, it means that earnings have also dropped. This relationship may be a simple algebraic formula, but it goes a long way to explain much of the sector weakness we have seen.

Consistent with this trend, CIRCUS CIRCUS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CIR)") else Response.Write("(NYSE: CIR)") end if %> this week announced earnings of $0.40 versus year ago earnings of $0.42. Since last year's first quarter included approximately $0.08 in one-time write offs, earnings are actually down roughly 20% from year ago levels. Blame weakness in just about all of its Nevada megaresorts. The unit level performances are roughly unchanged from what we have seen the past few quarters in that all of the company's units have slightly downward trending operational cash flow with the exception of two of its joint ventures, the Monte Carlo on the Las Vegas strip and the Grand Victoria in Elgin, Illinois. It is unfortunate for Circus that both these units are only half owned by the company since each is showing an annual cash on cash return on investment north of 35%. This means that for every dollar spent constructing these casinos, the units are showing an operational cash flow of 35 cents per year. If Circus could attain those numbers at its wholly owned casinos, they would be sitting pretty.

Apparently some of the analysts on the street didn't like what they saw under the big tent. Both Oppenheimer and Merrill Lynch downgraded the stock this week. The forward profit estimates have also been trending down the past few weeks. Given Circus' anemic base of operations in Nevada and its aggressive (debt incurring) expansion, this Fool thinks that some of the caution the analysts are showing is warranted.

Speaking of expansion, Circus let it be known this week that it is actively seeking one of the three land-based casino licenses available in Detroit by joining with the Atwater group. Atwater is a group comprised 70 local Motown businesses that are largely responsible for the passage of the casino-expansion proposal passed by the state of Michigan in last November's elections. The way the law is written, whoever partners with Atwater is essentially guaranteed one of the licenses. It should come as little surprise that Circus was looking to get of the licenses since the company recently pulled out of its casino management contract across the river in Windsor, Canada. Almost all of the "major" companies in the industry are seeking the remaining licenses, but most I have talked to seem to think that HARRAH'S <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HET)") else Response.Write("(NYSE: HET)") end if %>, MGM GRAND <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MGG)") else Response.Write("(NYSE: MGG)") end if %>, and MIRAGE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MIR)") else Response.Write("(NYSE: MIR)") end if %> seem to have the best odds at also landing in Detroit.

The "Guess the Merger" Game

For all those that wrote me to submit your guesses for our Foolish "Guess the Merger" game, thank you for your thoughts. The number of people thinking that ITT is the most likely to pick up a gaming company over the summer has jumped to nearly half of those responding. However, the most likely takeover candidate numbers have remained relatively unchanged with Harrah's, AZTAR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AZR)") else Response.Write("(NYSE: AZR)") end if %>, and TRUMP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DJT)") else Response.Write("(NYSE: DJT)") end if %> all having roughly the same number of "votes."

The response to the game has been good, to say the least. Since there have been so many respondents, the likeliness of a tie has gone through the roof. To deal with this problem, I am going to raise the stakes and add two more products from Foolmart into the prize kitty. In case of a tie, I will then randomly choose from the correct guesses for the whole prize package.

To play our game, simply email me the merger combination you think most likely to happen over the summer. "None" is a guess and the game ends on Labor Day or when someone wins, whichever first. Join in with your thoughts and have a little Foolish fun!

The political front

Quite a bit of news from the political front this week. First, California's state Senate passed a bill that would set up a California Gaming Control Board to oversee the legal gaming establishments operating in the state. The card rooms and tribal casinos in the state had been operating with little to no regulation up to this point and adding this regulatory body will help legitimize (and hopefully further legalize) gaming in the state.

Gambling for charities ended in Maryland this week. For the past 19 years there has been charitable casinos in the state whose proceeds went towards funding such things as boys clubs and fire departments. The 16 small casinos in the state grossed nearly $20 million last year.

There has been rumbling in the Illinois legislature for an increase in the state tax on casinos coupled with expansion and concessions for the industry. Cook and Dupage County, where the majority of the Chicago metro area live, have no casinos. The current deal in the works would raise the tax rate, eliminate the "cruising requirement" the casinos have now, bring riverboats to Chicago and suburbs, and also allow slot machines at the suffering horse tracks around the state. The governor, who has been solidly in the current casinos' camp in the past, has said he would veto the bill.

Missouri's attorney general won a major case against internet gaming this week. Pennsylvania based INTERACTIVE GAMING AND COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SBET)") else Response.Write("(Nasdaq: SBET)") end if %> was fined $66,000 for illegally offering gambling over the Internet. The company was ordered by the court to halt promoting and offering gaming in the state. In addition, the company was told to post a message on its home page that Missouri residents cannot to register to gamble on the site. Typical of the defiant attitude many of the Internet gaming companies have shown, the company has not paid its fine yet. The stock, which had been as high as $3 5/8 in February, closed at $1 on Friday.

Last but certainly not least, there have been more stories of corruption down in Louisiana. If any state has shown how NOT to do casino gambling, it has been Louisiana. This time, its word that the former governor is under investigation for possibly taking bribes in connection with the awarding of casino licenses in the early 90's. Between mob infiltration, to political scandals, to the New Orleans debacle, Louisiana's regulation of the industry has been a train wreck. Hopefully they'll get it right sometime in the near future.

Whoops! I made a mistake...

When speaking of SHUFFLE MASTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SHFL)") else Response.Write("(Nasdaq: SHFL)") end if %> last week I goofed when I said, "(the company) came out with earnings Thursday that met the First Call mean analyst estimate of $0.14 per share." Shuffle actually came out with earnings of $0.13 per share versus the $0.14 in 1996's first quarter. In reality, it looks like the company actually came in a penny shy of the First Call mean estimate. However, the company said in its press release that, "Analysts had estimated that the company would report earnings per share in a range of $0.09 to $0.11." I guess the issue of whether or not the company actually beat or missed estimates is up for debate. Regardless, the company reported EPS of $0.13 and not $0.14 for 1997's first quarter.

And lawyers wonder why no one likes them...

The following is a true story. Early this week the New York Stock Exchange made it known that they are seeking upwards of $200 million from the New York New York casino and hotel for "mutilating and bastardizing'' the appearance of the NYSE's trademarks and has "tarnished, blurred, diluted and disparaged" its reputation and goodwill. The casino has a facade that mimics the columns of the actual NYSE in the resort that has tried to replicate Manhattan as its theme. The NYSE wants the facade as well as several signs that say "New York $lot Exchange" taken down.

As any good Fool, I'm all for the separation of gambling and investing in the public's mind. However, I think the NYSE needs to relax and invest in some sense of humor. I don't think people are going to be mistaking blackjack tables for Bloomberg machines and slot change people for brokers any time soon. Exactly how many lawyers does it take to rain on a parade? (Answer next week... after I consult counsel.)

Winners and Losers

This is a new feature where we will look at the previous week's big movers in the industry. The elves here at Fool Labs are busy working on many other analytical tools for the gaming industry that will be debuting in the coming weeks. As we say, stay tuned!

Top percentage movers (stocks over $1)

Winners                     Closing Price  Weekly Move
Lady Luck (LUCK)            $1 7/8           +20.0%
Stuart Entertainment (STUA) $3 1/4           +18.2%
Intl. Lottery
 and Totalizer (ITSI)       $1 15/32         +17.5%
Casino Magic (CMAG)         $1 13/32         +15.4%

Losers                      Closing Price  Weekly Move
Virtual Gaming (VGTI)       $2 3/4           -26.7%
Multimedia Games (MGAM)     $9 1/8           -24.0%
Sands Regent (SNDS)         $2 1/8           -19.1%
Casino Data Systems (CSDS)  $4 1/4           -15.0%

Earnings Summary

                      1997        1996
Circus Circus (CIR)  $0.40       $0.42

Did You Know. . .
It is estimated that 65,000 people a day use pedestrian bridge between MGM Grand and New York, New York over Las Vegas Boulevard?

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