TOP VIEW While the gambling industry in the U.S. remains primarily focused on Las Vegas and Atlantic City, international gaming companies are eyeing opportunities overseas. Macau’s gambling revenues, for example, topped those of Las Vegas in 2006. Investors should closely examine the multinational firms that have comprehensive strategies for expanding into foreign locales, particularly in Asia, where recent regulatory changes invite foreign companies to build huge resorts with casinos at their cores.

The industry has acted like a mature one in recent years, especially in the U.S., pursuing a state of mergers and acquisitions more typical of Big Oil or Big Pharma. After all, one symptom of hardening of the corporate arteries is the growth-through-acquisition strategy, indicating that industry leaders can gain market share only by gobbling existing market share. But large gaming companies are now moving beyond that approach, particularly the ones that are building colossal casino complexes in Asia in an attempt to tap that burgeoning market.

Macau, of course, is the neon-lit mecca that immediately comes to mind. Most industry observers are concerned about how quickly this 8-square-mile cluster of a peninsula and two islands in the South China Sea is, over the next few years, going to be able to produce enough well-trained staff and well-heeled guests to fill some two dozen new "integrated" resorts—the industry term for the high-end complexes of hotels, theaters, stores, restaurants, convention and exhibition spaces, golf courses and centerpiece casinos. These resorts will soon be the mainstay of the former Portuguese colony, which reverted to Chinese control in 1999.

Singapore recently awarded two casino licenses for the development of integrated resorts, scheduled to open in 2009 and 2010 and designed to double the number of visitors and their expenditures. The casino as part of a complete destination venue represents the standard of the gaming industry today. The megaresorts along Las Vegas Boulevard—The Strip—offer so much diverse, family-oriented recreation and entertainment that casino income accounts for less than 50 percent of overall revenue. Even so, the Big Gaming companies are still not that "big" in relative terms. Industry leader Harrah’s Entertainment ranks only 309th on the Fortune 500; MGM Mirage is the only other gaming company on the list.

Why Buy Macau?
At a 2003 London gaming conference focusing on the United Kingdom’s planned expansion of its staid casino industry, panelists from the U.S. discussed the potential role of American casino companies in developing Las Vegas–style resorts in the UK. An American speaker mentioned Harrah’s. The audience—almost entirely British—became puzzled. Did he mean Harrod’s, the legendary British retailer? The confusion was perhaps understandable; both companies even employ a similar font in their logos.

In the short run, Macau is likely to  end up with more high end integrated resorts than it can support.

On a superficial level, such bafflement strikes a blow against the corporate egos of casino firms. More importantly, it indicates how much room these companies have to grow just to establish international name recognition. Since the conference, Harrah’s has captured more than a few storied properties in Las Vegas and Atlantic City through its 2005 purchase of Caesars Entertainment, a global brand that is arguably more recognizable than the Harrah’s name.

But in the long run, the opening of Macau to foreign operators may turn out to be more important than any acquisitions. Gambling has been legal there since the Portuguese introduced it in 1847, but the territory was little more than a collection of sleepy villages until Stanley Ho, the flamboyant entrepreneur from Hong Kong, started opening casinos there in the early 1960s. By the time the colony reverted to China and became a special administrative region, Ho controlled nearly 70 percent of the total economy, operating the racetracks, the jet-foil ferry service and most of the real estate—in addition to 15 casinos. In 2002, however, the post-colonial government, seeking a long-term economic boost, canceled the 40-year monopoly held by Ho’s STDM conglomerate. Las Vegas Sands and Wynn have since opened properties there, and MGM Mirage and Australian gaming company PBL have plans to open resorts there this year in partnership with Melco, which is run by Ho’s son. In addition, the elder Ho is building his own Vegas-style resort.

According to industry statistics released in late January, Macau actually surpassed Las Vegas in gaming revenue in 2006; it is expected to do so again in 2007, fueled by several large resorts that are scheduled to open this year on the Cotai Strip, a parcel of reclaimed land connecting the two islands and peninsula. Foreign and existing operators have pledged investments of more than $20 billion over the next five years, which includes building a replica of the Las Vegas Strip off the Macau peninsula. Clearly, this is Sheldon Adelson’s greatest gamble. His company, Las Vegas Sands, is the largest investor in Macau. The organization plans to build 12 hotels there and has already committed more than $8 billion.

New gaming entrants are gambling on whether a continuous stream of visitors from the Chinese mainland will pour into Macau. The opening of this market coincided with China’s decision to waive restrictions on travel out of the mainland, as well as a crackdown on illegal casinos within China’s own borders. So far, Macau has seen an influx of mainland Chinese visitors, particularly from the affluent southern region of the country. Large casino operators maintain databases of well-to-do gamblers, known as "whales," on every continent save Antarctica. Well aware that betting is a popular pastime among the Chinese, the casinos are locked in frenzied marketing campaigns aimed at the country’s growing legions of urban elites.

In the short run, Macau is likely to end up with more high-end integrated resorts than it can support. The casino operators will have to scramble to find qualified staff, as well as accommodations to house their employees. But Las Vegas and Atlantic City had their gold rushes and shakeouts too, and, over the long term, many gaming companies will win. For now, the U.S. operators have an advantage—or perhaps a disadvantage, depending on the caliber of customer—in that they have to comply with the terms of their Nevada or New Jersey licenses, even overseas. Macau’s regulatory structure is still evolving. For example, it is just now implementing antimoney-laundering laws in the casinos. The Chinese government encourages such laws to crack down on corruption from within its own ranks; Macau was, until recently, a place where officials might invest ill-gotten gains in secret underground banks and gaming ventures.

The gambling industry’s long-term agenda is to continue evolving toward mainstream entertainment.

Generally, a solid regulatory environment lays the foundation for a successful gambling industry. Macau is something of an exception, but investors must remember that Nevada spent 50 years developing its regulatory structure. Operators in Macau will emulate the family-oriented entertainment complexes that have swept into Las Vegas in recent decades.

Other parts of Asia are also opening up and developing not just a few casinos, but a swath of luxury entertainment complexes. Singapore legalized gambling just last year. (Spectrum Gaming Group performed background investigations on behalf of the Singapore government.) Genting International, a large Malaysian gaming company, and South Africa–based Kerzner International are among the international players that have already endured grueling license applications, investigations and hearings in the new Asian markets. Over the next five years, gaming companies will invest $27 billion in new properties in Macau and Singapore alone. Japan is rumored to be considering the legalization of casino gaming, and other jurisdictions, such as the UK, are modernizing their gaming laws to encourage new investment.

As gaming becomes more global, foreign companies grow more and more comfortable with American-style licensing processes. The rigorous application scheme in Singapore has proved to foreign companies that they can withstand such intense scrutiny. This should increase the comfort level—not to mention the licensability—of international companies, which could in turn lead to their potential entry into the domestic U.S. market.

Striking a Devil’s Bargain
The United States has not seen many foreign casino operators, but that could change as global players begin to notice that the country holds some tantalizing growth opportunities. The annual Harrah’s survey, which paints a portrait of the state of the U.S. gambler, indicates that about 25 percent of American adults visited a casino at least once in 2005, the most recent period surveyed. In markets where adults enjoy close proximity to casinos, such as Nevada, that 25 percent penetration rate rarely exceeds 40 percent.

The greatest threat that could derail the American casino industry’s bright future is not economic, but political. In state after state, the tax rates that politicians impose on casinos seem to inevitably settle at roughly 50 percent. (These are, of course, the "effective" tax rates. When a casino must pay 10 percent or more of its revenue to the racing industry to supplement purses, technically that is not a tax, but it has the same effect.)

The casino industry has struck a devil’s bargain in the states in which it hopes to expand. Political leadership in these states invariably views casinos as a new and "free" revenue source. Not surprisingly, casino legalization tends to accompany economic downturns. The explosion of riverboat casinos, for example, followed the recession of the early 1990s. Adelson’s Sands plans to build a $600 million hotel, mall and casino on a vacant ore field at what was once the Bethlehem Steel Works in Pennsylvania.

Politicians are deaf to any arguments that gaming tax rates should be lowered to more reasonable levels. They choose not to listen to any notion that lower tax rates would result in more capital investment in their states, thus creating more jobs, attracting more visitors and ultimately generating more revenue. The result is that casinos will inevitably expand into more states, but these high tax rates will discourage casino operators from building integrated resorts. Instead, the industry is developing what can be best described as a hub-and-spoke model. The entertainment destinations serve as the hubs, while the high-tax franchises function as the spokes. Naturally, the hubs are the markets in which casinos have attained some level of critical mass, such as Las Vegas, Atlantic City and the Gulf Coast of Mississippi.

The industry’s long-term agenda is to continue evolving toward mainstream entertainment, which would allow it to penetrate even deeper into the adult demographics. This strategy does not translate into turning nongamblers into gamblers, but instead aims to develop new attractions to draw in new customers. This business model suggests that a casino is just one piece of an entertainment mosaic. The casino, of course, is the centerpiece that brings customers to the particular locale, while allowing major resort operators to price even highly upscale restaurants and hotels competitively.

Michael Pollock and Fredric Gushin are the managing directors of
Spectrum Gaming Group. Paul Bromberg is chief operating officer
of Spectrum OSO Asia.