Casino Reinvestment And Expansion

The Proper Care & feeding of the Golden Goose

Under the new paradigm of declining economic conditions across a broad spectrum of consumer

spending, casinos face a unique challenge in addressing how they both maintain profitability while

also remaining competitive. These factors are further complicated within the commercial gaming

sector with increasing tax rates, and within the indian gaming sector by self imposed contributions to

tribal general funds, and/or per capita distributions, in addition to a growing trend in state imposed

fees.

Determining how much to "render unto Caesar," while reserving the requisite funds to maintain

market share, grow market penetration and improve profitability , is a daunting task that must be well

planned and executed.

It is within this context and the author's perspective that includes time and grade hands-on experience

in the development and management of these types of investments, that this article relates ways in

which to plan and prioritize a casino reinvestment strategy.

Cooked Goose

Although it would seem axiomatic not to cook the goose that lays the golden eggs, it is amazing how

little thought is oft times given to its on-going proper care and feeding. With the advent of a new

casino, developers/tribal councils, investors & financiers are rightfully anxious to reap the rewards

and there is a tendency not to allocate a sufficient amount of the profits towards asset maintenance &

enhancement. Thereby begging the question of just how much of the profits should be allocated to

reinvestment, and towards what goals.

Inasmuch as each project has its own particular set of circumstances, there are no hard and fast

rules. For the most part, many of the major commercial casino operators do not distribute net profits

as dividends to their stockholders, but rather reinvest them in improvements to their existing venues

while also seeking new locations. Some of these programs are also funded through additional debt

instruments and/or equity stock offerings. The lowered tax rates on corporate dividends will likely shift

the emphasis of these financing methods, while still maintaining the core business prudence of on-

going reinvestment.

Profit Allocation

As a group, and prior to the current economic conditions , the publicly held companies had a net profit

ratio (earnings before income taxes & depreciation ) that averages 25% of income after deduction of

the gross revenue taxes and interest payments. On average, almost two thirds of the remaining

profits are utilized for reinvestment and asset replacement.

Casino operations in low gross gaming tax rate jurisdictions are more readily able to reinvest in their

properties , thereby further enhancing revenues that will eventually benefit the tax base. New Jersey

is a good example , as it mandates certain reinvestment allocations, as a revenue stimulant. Other

states, such as illinois and Indiana with higher effective rates, run the risk of reducing reinvestment

that may eventually erode the ability of the casinos to grow market demand penetrations, especially

as neighboring states become more competitive. Moreover, effective management can generate

higher available profit for reinvestment, stemming from both efficient operations and favorable

borrowing & equity offerings.

How a casino enterprise decides to allocate its casino profits is a critical element in determining its

long-term viability, and should be an integral aspect of the initial development strategy. While short

term loan amortization/debt prepayment programs may at first seem desirable so as to quickly come

out from under the obligation , they can also sharply reduce the ability to reinvest/expand on a timely

basis. This is also true for any profit distribution, whether to investors or in the case of Indian gaming

projects, distributions to a tribe's general fund for infrastructure/per capita payments.

Moreover, many lenders make the mistake of requiring excessive debt service reserves and place

restrictions on reinvestment or further leverage which can seriously limit a given project's ability to

maintain its competitiveness and/or meet available opportunities.

Whereas we are not advocating that all profits be plowed-back into the operation, we are encouraging

the consideration of an allocation program that takes into account the "real" costs of maintaining the

asset and maximizing its impact.

Establishing Priorities

There are three essential areas of capital allocation that should be considered , as shown below and

in order of priority.

1.Maintenance and Replacement

2.Cost Savings

3.Revenue Enhancement/Growth

The first two priorities are easy enough to appreciate, in that they have a direct affect on maintaining

market positioning and improving profitability, whereas, the third is somewhat problematical in that it

has more of an indirect affect that requires an understanding of the market dynamics and greater

investment risk. All aspects that are herewith further discussed.

Maintenance & Replacement

Maintenance & Replacement provisions should be a regular function of the casino's annual budget,

which represents a fixed reserve based on the projected replacement costs of furniture , fixture,

equipment, building, systems and landscaping. Too often however we see annual wish lists that bear

no relationship to the actual wear & tear of these items. It is therefore important to actually schedule

the replacement cycle, allocating funds that do not necessarily have to actually be incurred in the year

of accrual. During a start-up period it may not seem necessary to spend any money on replacement

of brand new assets, however by accruing amounts to be reserved for their eventual recycling will

avoid having to scurry for the funds when they are most needed.

One area of special consideration is slot machines, whose replacement cycle has been shortening of

late, as newer games & technologies are developing at a much higher rate, and as the competition

dictates.

Cost Savings

Investment in cost savings programs & systems are, by their very nature and if adequately

researched a less risky use of profit allocation funding then almost any other investment. These items

can often take the form of new energy saving systems, labor saving products , more efficient

purchasing intermediation, and interest reductions.

These items have their caveats, one of which is to thoroughly analyze their touted savings against

your own particular application, as often times the product claims are exaggerated. Lease buy-outs

and long term debt prepayments can sometimes be advantageous , especially when the obligations

were entered into during the development stage when equity funds may have been limited. In these

cases it is important to look at this strategy's net effect on the bottom line , in comparison with

alternative uses of the monies for revenue enhancing/growth investments.

One recent trend is the growing popularity of cash-less slot systems, which not only provide labor

savings for fills, counts and hand-pays, but also serve as an aid to patrons who do not like to lug

around those cumbersome coin buckets, while also encouraging multiple game usage.

Revenue Enhancing & Growth

Leveraging is the key catalyst of any revenue enhancing/growth related investment. It includes the

following:

oPatronage Base

oAvailable Funds

oLands

oMarketing clout

oManagement Experience

The principal is to leverage the use of the available asset towards achieving higher revenues &

profitability. Typical examples include increasing average patronage base spending and widening the

effective trading radius, by offering additional products/services, such as retail stores , entertainment

alternatives, recreational/leisure amenities , overnight accommodations, more restaurant choices, and

of course, expanded gaming.

Master Planning

Anticipation of potential growth and expansion should be fully integrated into the project's initial

master planning so as it assure cohesive integration of the possible elements in a phased-in program,

while also allowing for the least amount of operational interruption. Unfortunately, it's not always

possible to anticipate market changes, so expansion alternatives must be carefully considered.

The Big Picture

Before embarking on any type of expansion and/or enhancement program we strongly recommend

first stepping back and assessing the property's present positioning relative to the market and

competitive environment. As we have observed in numerous gaming jurisdictions around the country ,

often casino ventures that have been operating "fat and happy " for a few years, find themselves in a

zero-growth period. Sometimes this is due to competition stemming from either/both new local area

casinos or regional venues that have the affect of reducing patronage from peripheral area markets.

Additionally, the current customer base may become bored with their experience and are seeking

greener pastures. The historical growth of the Las Vegas strip is testament to the success of

continually "reinventing" oneself.

Our approach to these market studies is initially focused on determining the degree to which the

current facility is penetrating the potential market and in relationship to any competitive market

shares. Typically, this represents an analysis of the current patronage base in terms of information

gleaned from the player tracking data base, and mailing lists, coupled with day-part, daily, weekly,

monthly and seasonal revenue trends.

This data is then interfaced with an assessment of the overall market potential to indicate the extent

to which certain market segments are utilizing the facility and the needs it is fulfilling. More importantly

however, is that this type of analysis will indicate those market segments that are not utilizing the

facility more fully , and why.

Occasion Segmentation

As our proprietary studies have indicated , casino markets are segmented by various characteristics

of occasioned-use that also include typical spending & visitation patterns. The traditional methods of

market measurements, including gravity models, usually only weigh the demographic characteristics

of a given population, based on revenues achieved in similar markets. However, an occasion

segmentation market analysis reveals more detailed information as to the reasons precipitating a

casino visit, how they relate to the benefits being sought, and the degree to which the occasion

determines average spending and visitation frequency. This type of data mining is far more helpful

than gravity modeling, in that it can help determine the type of facilities and positioning strategies

necessary to attract each market segment, by measuring their relative contribution to the aggregate

potential. The process has been successfully employed in the restaurant business and other leisure

time service industries, especially amid a widening supply/demand marketplace.

Perhaps even more importantly, looking at the market from an occasioned-use perspective, reveals

the extent and characteristics of the underling competition, that, in many cases not only include other

casinos, but also alternative entertainment and leisure time activities, such as restaurants, clubs ,

theaters, and the like.

Demand Density

Another important aspect of occasion segmentation is in measuring overall market characteristics by

day-parts, which is revenue density by time of day , day per week, weekly, monthly , and seasonally.

This is especially important data when casino venues are seeking to lessen any higher than normal

fluctuations that may be occurring between a slow Monday morning and a packed Saturday night ; or

that experience severe seasonal variations.

By segmenting markets by their demand patterns , a better understanding can be gained of which

amenities may help bolster the weak demand periods , and those that may only add to the already

maximized peaks.

Many expansion programs often make the mistake of configuring additional amenities such as high-

end restaurants and lodging elements based on the peak demand periods. As a result , the net effect

of costs & expenses for these investments can negate any contribution they may make to increased

gaming revenues. RAther , "fill-in" markets are the most efficient means to increase overall revenues ,

as they utilize existing capacities. Las Vegas has achieved great success in creating strong mid-week

activity through promotion of its extensive conference/convention facilities.

Amenity Driven Markets

Another benefit of utilizing occasion-segmentation is its ability to also indicate the potential impact

certain amenities have on "impelling" visitation. While gravity models examine the casino related

spending characteristics of a given market area, the formulas cannot measure the relative impact of

any non-gaming driven activities that could nonetheless generate casino traffic.

Important data relating to the population's occasioned-use of restaurant, entertainment , and weekend

getaways can often form the basis on which to focus amenities designed to cater to these markets;

and by so doing , increase visitation. Whereas many of these patrons may or may not utilize the

casino , their exposure to the opportunity may hasten their use, while also creating an additional profit

center.

Again, looking to the las vegas paradigm, more and more of the strip properties are now generating

as much , if not more, non-gaming revenues than gaming revenues; as their hotels and restaurants

are less & less subsidized, and along with their growing retail elements , represent strong contributors

to the bottom line.

Program Development

Once equipped with a basic understanding of the market dynamics , both in terms of the existing

facility's current market shares/penetration rates in relationship to the competitive mix , and the

overall occasioned-use of the market, a matrix can be created that sets the demand against the

supply. This function seeks to identify areas of un-met demand opportunities and/or over supply, that

forms the spring-board to the creation of relevant amenities, expansion and upgrade criteria &

strategies.

Impact Criteria

Essentially there are two types of expansion/upgrade strategies: subsidized and profit-centers.

Subsidized elements may include adding and/or improving amenities that will further widen current

gaming market penetration/shares, thusly having a direct impact on growing casino revenues; while

profit centers are designed to further leverage current patronage patterns with additional spending

opportunities, and having an in-direct effect on gaming activity. Although many of the more traditional

amenities , such as restaurants, hotels, retail shops, entertainment venues and recreational facilities

can fall into one or both of these categories, its important to make the distinction, so as to clearly

establish the design/development criteria.

Upgrading/Expansion

As has been previously discussed, Las Vegas continually seeks to reinvent itself as a means to

increase repeat visitation, that in itself creates a snowballing affect as each venue must keep-up with

its neighbor. To some extent upgrading programs, that may include creating a new and fresher look,

is a lot like an insurance policy against slipping revenues, and do not necessarily relate to any

incremental growth per se. Not to be mistaken for replacement programs of worn carpeting and slot

machine recycling, an upgrade program should seek to create new excitement about the facility in

terms of ambiance, quality of finishes , layouts, and overall décor.

Expansion of existing capacity is less a function of market analysis and more a function of "making

hay while the sun shines," based on a thorough understanding of the visitation pattern densities.

Patron back-ups for gaming positions and restaurant tables can be both good and bad, depending on

when they occur and how often. High per position per day net win averages are not always a sign of a

prospering casino, as they could also mean lost opportunity because of an insufficient number of

games. Conversely , additional positions are not always going to generate the same averages.

When initially configuring capacities for a new facility, it is important to fully evaluate the demand

patterns into their respective day-part components that will maximize penetration during the peak

periods while minimizing inefficiency - the point where the costs associated with additional capacity is

exceeded by its net income potential.

Food & beverage Amenities

Within most casino venues , restaurant amenities are "loss leaders," designed to retain & attract

casino patrons with low prices and great value ; yet they have the ability to both widen occasioned-

use of the casino , while also representing potential profit centers.

In Nevada, which is the only state where detailed historical F&B departmental operating results are

available for casinos , properties with gaming revenues averaging between $20M to $200M showed

food operations having a net departmental loss of 1.5% of sales in 2001, versus almost a 14% loss in

1995.

Much of this major turnaround is due to the growth in the number of food outlets, especially more

upscale/specialty restaurants, which has spurred sales from 20% of gaming revenue in 1995 to

almost 27% in 2001. Moreover, food costs have been reduced sharply from 45% in 1995 to 35% in

'01.

As the previous discussion on occasion-segmentation revealed, a consumer's choice of a casino visit

can sometimes compete with other entertainment/leisure time activities, including dining out. Having a

market relevant restaurant facility within the casino can serve to attract the dining-out destination

market, with the casino benefiting from its proximity. Therefore when market conditions indicate

changes in a casino's restaurant configuration , the questions to be addressed are how can they be

designed to satisfy the current patronage base, widen occasioned-use, and improve profitability.

Lodging Elements

With turnkey hotel development costs ranging between $75K to $350K per available room , a market

positioning strategy had better be well studied. Yet we see many such projects undertaken with little

understanding of the market dynamics and economic impact.

Nationwide, according to our most recent survey, there are 724 casinos around the country;

comprised of 442 commercial operations, about half of which are located in Nevada, and 282 Indian

gaming venues , of which 209 offer most , if not all, of Las Vegas type (Class III) games. Roundly

58% of casinos in the commercial gaming sector have co-located hotels, compared with 37% of Class

III Indian gaming venues, despite their containing a similar average number of games.

The high preponderance of hotels within the commercial sector owes to some gaming jurisdictions

requiring them; including nevada (for an unrestricted license) and New Jersey. Moreover, much of the

Nevada market demand stems from beyond a daytrip radius , making overnight accommodations

necessary in order to gain market share. When extrapolating these states from the total, the

percentage of all commercial casinos with hotels drops to 50%, with an average of 312 rooms &

1,183 games.

The obvious advantages of casino lodging units is their ability to attract gaming markets from beyond

the typical day trip radius , while also having a somewhat "captured " market (Casinos with hotels ).

Moreover, guest rooms can be another perk-use for player club points. Hotels also widen a casino's

occasioned-use by offering non-gaming leisure activities & amenities, augmented by the ready

availability of gaming, while also representing another profit center (Hotels with Casinos). Additionally

, within a traditional lodging setting , a casino/hotel has a competitive advantage by virtue of its added

entertainment features.

Among the major Las Vegas properties there are more hotel rooms than games, as the city transits

from a gaming destination to more of a resort & convention destination. In so doing these properties

increased their hotel profitability and investment returns by not having to offer low rates to attract

gamers. Whereas , some areas such as Laughlin and Reno, which do not enjoy the critical mass of a

las vegas , still find it necessary to supplement their hotel investment with casino revenue, due to low

room rates and large seasonal visitation fluctuations

In configuring a casino hotel development it is therefore important to understand the market and

financial dynamics and their impact on overall gaming revenue and profits. Within the free-standing

(non-casino) hotel industry, financing terms are usually over a 15 to 20 year amortization schedule

with a ten year balloon/refinance, and have a break even point that approaches 65% to 70%

occupancy. Typical casino based lodging elements enjoy high occupancy levels on the weekends,

but low levels weekday. It is therefore incumbent not to "build a church for Easter sunday ," keeping

in mind the overall efficient use of the asset.

Moreover, if the intent is to attract additional casino patronage from a wider market radius, it is

important to evaluate the cost of any hotel subsidy versus the potential increase in gaming profits. A

new 200 room hotel at a casino already generating 20,000 weekend visitors , may only be adding 2%

to 4% more players , while exposing itself to higher costs. In regards to occasioned-use, especially

among tourists and weekenders, casino hotels may also be competing with alternative resorts in the

region.

Ideally, these types of facilities, when not situated in markets with insufficient local/day-trip markets

(e.g. Laughlin), should be configured on the basis of their non-gaming related and off-peak period

support so as to maintain relevant room rates and adequate levels of profitability. They should also

include those amenities these markets are seeking, including, where applicable: conference and

convention facilities, and indoor/outdoor recreational elements.

Albeit more of a niche market, RV Park facilities are a less intensive investment in overnight lodging

facilities that can nonetheless offer some of the same benefits. According to the latest data, there are

more than 9 million households in the United States that own RVs, and represent one of every ten

vehicle owning households. Many of these households include the 55 & over age groups, who have a

higher than average gaming propensity and annual income.

RV park development costs are well below those for hotels, but usually have a high seasonal use ,

peaking during the summer months in temperate resort environs and in the winter months in the

"snowbird" areas.

Retail/Outlet Shops

Retail/Outlet shopping is gaining a major foothold at casino venues across the country. First

represented by casino logo shops and a few high-roller/jackpot-winner positioned boutiques, these

stores have now grown into major malls and entertainment centers. The Forum Shops at Caesar's

Palace in las vegas enjoys the highest per square foot sales of all retail malls in the U.S., and the

growth in retail sales in the city is significantly outpacing that of gaming revenue. The presence of

these shops serves as both an activity to the area's 35 million annual visitors, who are now spending

less than 4 hours per day actually gaming , as well as a major profit center that leverages the

visitation base.

In less resort destination type markets, outlet malls are strong traffic generators from which a casino

facility can draw patronage. On a smaller scale, casinos can widen their occasioned-use by offering

unique and indigenous shopping that is especially positioned to attract the "adjunctive" daytripper

market. The extent and characteristics of these stores should be scaled to the potential market,

current visitation trends, and any local ambiance.

Entertainment

Although entertainment is a mainstay in casino environments , stemming from the Rat pack days in

Las Vegas, to today's imposing concert/arena venues and specialty shows; their market dynamics are

much misunderstood. They are at once, diversions, attractions , profit centers, and public relation

tools. They can however , also generate major losses , and therefore should be well studied to

determine their appropriate configuration.

With most major entertainment events occurring during the weekend periods the attracted audiences

may not have any significant impact on a likely already busy period. Therefore it in incumbent that the

specific event be structured so as to at least break even or turn a small profit. While this is somewhat

self evident, the more central issue is the entertainment venue's ability to also amortize its initial

development cost investment. Outdoor facilities can sharply reduce construction costs, but also are

prone to weather vagaries and seasonal use. Moreover, party tents and temporary structures usually

do not have the cache of a fixed venue that is an integral part of the casino facility.

Recreational Facilities

There is a lot of attention these days being given to the development of recreational facilities at

casino venues, especially those associated with resort projects. Golf courses are a common adjunct

to many resorts, and many indian communities enjoy the advantage of having access to the ample

land areas and water rights these types of undertakings require.

As with all of the other revenue enhancing reinvestment alternatives discussed herein, recreational

facility development should be considered within the context of its ability to generate additional casino

patrons and/or serve as a profit center. Whereas golfers traditionally have a high gaming proclivity the

association of golf with a casino is not exactly in sync, given the length of time required for a typical

round. Moreover, even under the highest utilization rates, a typical 18 hole golf course will only

accommodate about 140 players per day , while the national average in year round environments is

about 100 rounds per day. This is not a lot of additional players for the casino , even if all of them

gambled, and especially considering the cost of an average course , excluding land, ranging between

$5M to $15M.

However, golf course development as part of a resort package and/or to fill a local market demand

can have many non-gaming related benefits. From a resort development standpoint, a golf course as

well as other recreational elements can add to the facility's competitive positioning, to the point where

its development/operating costs can be recaptured through higher room rates/green fees. Many

traditional golf courses also "pencil-out" when incorporating fairway home sites, which have a

particularly higher value than non-golf course sites. Given the trust status of Indian lands , this may

be somewhat problematical on reservation lands, unless some sort of long term land leases could be

negotiated for the home owners.

Planning/Financing & Implementation

Once all of the salient market factors have been considered and weighted against their cost vs.

Benefits, a comprehensive reinvestment & expansion program can begin to take shape. A design &

construction team should be assembled that can help further interpret the program in terms of

creative and value engineering input , while also maintaining its established market positioning and

financial strategies.

Importantly, the program should illustrate how each element will be coordinated into the overall facility

fabric and the manner in which it will be financed. Some funding can stem from reserved profit

allocations, while others independently funded with additional debt , whose amortization has been

factored into the overall project's feasibility analysis. CSO