High-rolling casinos hit a losing streak

The American gaming industry enjoyed an unprecedented run of luck during the late 1990s and the first half of this decade. Las Vegas casino owners built bigger, more luxurious — and wildly expensive — new properties, betting a bundle that the booming economy would keep their casinos full of gamblers and their hotel rooms loaded with tourists. But it all came tumbling down when the collapse of the capital markets began, throwing the U.S. economy, and the economies of most countries in the world, into a tailspin. The gaming industry "has suffered very substantially in the period since then," Gary Loveman told a ballroom full of business leaders attending a recent Economic Club of Phoenix luncheon. Loveman is chairman and CEO of Harrah's Entertainment Inc., the largest casino company in the world.

The American gaming industry enjoyed an unprecedented run of luck during the late 1990s and the first half of this decade. Las Vegas casino owners built bigger, more luxurious — and wildly expensive — new properties, betting a bundle that the booming economy would keep their casinos full of gamblers and their hotel rooms loaded with tourists. Then the industry rolled snake eyes.

"In the 10 years leading up to 2007, the casino industry had the highest performing industry equity index [in America], higher than homebuilders, higher than technology companies, higher than anybody," said Gary Loveman, chairman and CEO of Harrah's Entertainment Inc., the largest casino company in the world. "It had been a very good run."

It all came tumbling down when the collapse of the capital markets began, throwing the U.S. economy, and the economies of most countries in the world, into a tailspin. The gaming industry "has suffered very substantially in the period since then," Loveman told a ballroom full of business leaders attending an Economic Club of Phoenix luncheon February 26.

Harrah's hit by downturn

Las Vegas-based Harrah's, which will report its annual earnings results March 13, posted a net loss of $415 million for the first nine months of 2008, filings with the Securities and Exchange Commission show. The company has laid off 1,600 workers in Las Vegas and told employees recently that it would cut managers' pay and suspend 401(k) contributions during the economic downturn.

Harrah's, which owns or manages 51 casinos, including Harrah's Ak-Chin in Maricopa, Arizona, doubled its debt load when it was taken private in January by private equity firms Apollo Management and TPG Capital. Loveman, a former associate professor at the Harvard University Graduate School of Business Administration, attributed the downfall of his industry, and of the world economy, to the inflation of asset prices driven by leveraging.

The cycle began with a boom in the financial markets, and led to a complicated and somewhat obscure financial structure, he said. "There was a remarkable willingness to enter into highly leveraged transactions at every level of America life, including financial institutions, consumers seeking to finance homes and personal consumption, state and local governments, and corporations," Loveman said.

"There was an unprecedented and remarkable explosion in the use of leverage. You're looking at a guy who had his mouth in the trough on this to a fairly large degree as Harrah's borrowed a total of $24 billion to finance the privatization." The boom cycle went bust with the unwinding of the financial markets, including the bankruptcy of Lehman Brothers and the buyouts of Merrill Lynch and Bear Stearns.

"That led to a massive level of deleveraging, enormous reductions in asset prices and a high degree of fear and reluctance on the part of consumers and businesses to have any confidence in the future of their investments and economic activities," Loveman said.

Most Americans were impacted by the economic downturn through the housing market. Many people paid too much for over-valued houses financed by adjustable-rate mortgages with interest rates that eventually increased. When housing prices began to fall, homeowners found they owed more on their mortgages than their homes were worth, resulting in a wave of foreclosures.

If God built a casino

The gaming industry met a similar fate, but by accumulating vast amounts of debt to build newer and bigger hotel-casino projects. Loveman said gaming companies could raise capital for just about anything.

"We could describe a project almost anywhere in the world, show pictures of beautiful buildings designed by leading architects, and we would have banks lined up at the door prepared to lend money on that basis at something like the government's rate of interest plus 70 basis points," he said.

"There was an extraordinary and indeed unprecedented willingness to take on a risky investment on the part of the financiers in an uncertain business at a very, very low price." One such project under construction in Las Vegas is the $9 billion CityCenter resort complex, which Loveman described as "the sort of casino God would build if he had the money."

In fact, he said, just about every hotel built in Las Vegas in recent years has been a luxury project with four- and five-star rooms, "reflecting a tendency in our country over the last several years to build everything upscale, whether it is luxury retail products in malls, whether it's luxury automobiles, whether it's luxury accommodations in hotels, or luxury cruise ships."

Loveman said the Bellagio hotel and casino, which opened in 1998 on the Las Vegas Strip, cost $1.8 billion to build, or about $330,000 a room, considered a huge price tag at the time. By comparison, the Encore at Wynn Las Vegas, which opened in December, cost $1.4 million per room, he said. The problem is these high-end properties are opening at a time when people are losing their jobs and houses and either have stopped traveling or are seeking out the best hotel deals they can find.

Vegas means value

"Everyone is flocking to value," Lovemen said, noting that Saks Fifth Avenue discounted everything in its New York department store by 70 percent in November. "There are big questions about whether the pricing structure of luxury retail will ever recover from people thinking they can get 70 percent off at the cosmetic counter in November." That mindset also can be seen in a big way in Las Vegas, where several multimillion-dollar projects have been canceled and hotel deals abound.

"So having spent years convincing you that Las Vegas is the place to go to be naughty and let your hair down — what happens in Vegas stays in Vegas — all of a sudden, Vegas has become the value capital of the world," Loveman said. The gaming industry will have to react by building more economical projects for guests who are perfectly happy if their hotel room is clean, appealing, comfortable — and inexpensive, he said.

That, he said, was the way Las Vegas operated several years ago, "when you could stay cheap, and eat like a maniac at the $3 buffet. Then we managed to run all the way up to the constant pursuit of luxury, and now even with beautiful places like the Mirage we're in the business of selling them to you very inexpensively."

Burning down the houses

Commenting on the overall economy, Loveman said we are not experiencing a recession, but a "fundamental restructuring of the system of financial interaction that we have grown accustomed to over a very long period of time. And it's not at all clear yet where that's going to go." Two months ago, he said he expected a recovery to begin later this year.

"My guess today, as a result of the worsening condition of the central entity in this story, the financial sector in our country and abroad, my hunch is this will take a little bit longer, perhaps well into 2010." He said a potential impediment to a recovery is the overhang of an abundance of devalued assets, especially commercial and residential properties. He noted that years ago, an abundance of agricultural products prompted farmers to burn their corn crops.

"This sounds like a silly notion," Loveman said, "but there is a sense that what we ought to do is go burn down all the foreclosed houses that are all written off, and then they'd be off the market, the builders would have to rebuild them and there would be a whole new dynamic in the country."

He added that the challenge facing federal regulators is to time the revitalization of demand with the contraction of the money supply. "We are printing money like drunken sailors because there is such weak demand in the system that there is really no fear of inflation in the short term," he said.

"In fact, we have a significant fear of deflation in the near term as prices of just about everything, including my poor hotel rooms, are falling dramatically. When the economy gets a little momentum, they are going to have to start applying the brakes. And while that will be the prudent approach, it certainly will have the effect of slowing down the recovery. And that's going to be the balance that these poor folks are going to have to try to maintain."

Driving business away

Loveman said the Las Vegas economy isn't being helped by the recent criticism of companies, especially financial institutions, planning to hold conferences and other events in the Nevada gambling Mecca. "All of a sudden, from President Obama to others, people are wagging their fingers at anybody who thinks they can hold a meeting, and particularly if that meeting happens to be in Las Vegas."

He said that attitude hurts people working in the hospitality industry. "These are not corporate fat cats. These are folks who are trying to make a decent living like everybody else."

Loveman said Las Vegas officials have mounted a campaign to remind the public, politicians and meeting planners that even though the city "has an edge," the hotel workers there are as deserving of their business as they are in other cities. And, he added, "lately, you're not going to have a meeting in a more economical setting, I regret to tell you, than you will have in Las Vegas."