Casino industry: Rise of the machines

29 January 2007

After a half decade-long slumber, the prospects for gaming equipment manufacturers appear to be awakening.

Emerging U.S. and international gaming markets, casino growth in existing jurisdictions and a rollout of the much-anticipated server-based slot machines give Wall Street analysts reasons to once again tout slot makers' earnings potential.

Most analysts believe 2007 is the starting point of a cycle that could propel profits for the sector through the end of the decade.

Deutsche Bank Securities, in looking at the potential for slot machine expansion worldwide, said it believes manufacturers could be filling orders for more than 1.1 million new slot machines through 2010 if all the growth predictions pan out.

With a profit surge, slot makers could end an earnings lull that has affected the industry for the last few years. Early in the decade, game manufacturers earned millions from a machine replacement cycle brought about by ticket in-ticket out technology, also known as coinless gaming.

From the late 1990s through 2004, equipment providers changed out hundreds of thousands of slot machines worldwide, supplanting older games with devices featuring cashless capabilities, as quickly as jurisdictions licensed the technology and casino operators signed sales orders.

Gaming analysts believe accelerated earnings are once again lining up like triple sevens.

"For the first time in memorable history, we believe that the gaming equipment sector is set to capitalize on the confluence of two major events; global gaming expansion and a new replacement cycle," Deutsche Bank gaming analyst Bill Lerner said. "The unit opportunity will be nothing short of phenomenal, clearly benefiting all major gaming equipment suppliers."

Lerner said equipment providers such as Reno-based International Game Technology, WMS Industries, Shuffle Master and Bally Technologies may finally capitalize on the dollars invested into research and development of new gambling technologies, such as server-based gaming, which could let customers and casino operators change out the configuration of a slot machine.

"It's been six years since ticket in-ticket out really took off," Lerner said. "When server-based gaming commences, the earnings power for the gaming supplier will be significant."

Aimee Marcel-Remey, who follows the slot machine industry for Jefferies & Co., said investors are buying stock in the manufacturers as a long-term investment. The ticket in-ticket out replacement market caused the stocks of equipment makers such as industry giant IGT to more than double in value, but some purchasers missed out.

"A lot of people are trying to get into the stock now because there doesn't seem to be many risks over the next six months," Marcel-Remey said. "Some people won't mind holding onto the stock for a year because there is much more visibility about what potential is out there."

Jeffrey Compton, a Las Vegas-based gaming consultant who advises casinos on implementing players clubs, said slot machines have a much short life span than in the past because of the multitude of themed games flooding the marketplace.

"People can get bored rather quickly and sometimes the hot, new games are done after six months," Compton said. "This is especially true with the games themed after TV shows, board games and such. They have a much shorter life cycle."

Classic three-reel slot games, such as Double Diamonds and Red, White and Blue, Compton said, continue to be strongly played. Most of the machines have been updated to reflect ticket in-ticket out technology with multidenomination capabilities and multiple line payouts, he added.

"We've seen a lot more innovations and new technology in the slot machine field in the past seven to 10 years than we have in the whole history of slot machines," Compton said. "There is a small audience that doesn't care for ticket in-ticket out games, but for the most part, people have gotten over the hump and are used to the benefits."

Morgan Joseph gaming analyst Adam Steinberg predicted gaming technology companies are in the early stages of the first comprehensive replacement cycle since ticket in-ticket out.

"In 2007, we anticipate learning more about the pricing model for downloadable technology (and) increased customer acceptance of (radio frequency identification) technology," Steinberg said in a Jan. 3 investors note.

He added that the expected opening later this year of the $1.8 billion Palazzo by Las Vegas Sands, domestic casino expansions and international casino growth, will help the equipment providers.

Meanwhile, Pennsylvania is no longer a speculative location for slot makers. The Keystone State has the potential to absorb 61,000 slot machines at 14 casino and racetrack locations by 2009, making it the largest new American gaming jurisdiction of consequence since the 1990s.

Three of a planned seven racinos have opened, including a casino operated by Harrah's Entertainment at the Chester Downs racetrack outside of Philadelphia.

At least two more racetrack casinos are expected to open this year, including The Meadows Park near Pittsburgh, a 3,000-slot machine racino which is operated by Las Vegas-based Cannery Casino Resorts.

In December, the state approved the operators for five stand-alone casinos, including the shuttered Bethlehem Steel plant that will be turned into a $600 million complex by Las Vegas Sands Corp. Company officials said the site will open in 2008 with 3,000 slot machines.

Lerner said investors in slot machine companies are aware of the potential Pennsylvania provides.

However, other states offer similar opportunities to the equipment makers. Oklahoma's Indian tribes are expected to add 25,000 slot machines to their gambling halls through 2008; California Indian casinos that sign new compacts with the state could add 22,500 games by 2008; and Mississippi's Gulf Coast casino industry, ravaged by Hurricane Katrina in 2005, is looking at potentially 20,000 new slot machines by 2008.

"While the jurisdictions presented are largely bagged and tagged, we believe several other significant new market opportunities could come to fruition over the next few years that would be additive to these estimates," Lerner said, citing potential gaming development in Dade County, Fla.; Kentucky, Maryland, Ohio and Texas.

"We note that there will likely be other new casino openings, many tribal, which are not quantified," Lerner said. "Nor is the large Japanese (slot machine) replacement cycle accounted for at this point."

Macau offers the largest international expansion opportunity, with the potential for 50,000 new slot machines by 2010. With the $2.4 billion Venetian Macau, the $1 billion MGM Grand Macau and an expansion to the $1.2 billion Wynn Macau all expected to open by the end of the year, slot makers are racing to fill orders for games that will appeal to Chinese gamblers.

On the Cotai Strip alone, Las Vegas Sands Corp. plans to add 16,000 slot machines well into the next decade as it builds out seven different hotel sites.

Analysts expect IGT, WMS, Bally and Aristocrat to feed the slot machine growth in Chinese casinos.

Stifel, Nicolaus Capital Markets gaming analyst Steven Wieczynski said Macau could be the start of an Asian expansion.

"Macau should be instrumental in terms of generating interest from other Pacific-Asian nations to start looking at expanding (or) legalizing casino style gaming," Wieczynski said. "Mainland China, Japan and South Korea all represent large scale opportunities."

Shuffle Master, which sells table games and table-game equipment, is another manufacturer expected to benefit in Asia. Deutsche Bank expects roughly 15,000 to 20,000 new table games will be added in casinos worldwide over the next five years, the bulk landing in Asia.

"If they can place their (automated card) shufflers on 50 percent of those tables, that's a pretty good piece of the business," Lerner said.

Gaming analysts expect server-based slot machines to begin entering the market by year's end. Most of the major slot machine manufacturers are researching and developing server-based systems, also referred to as downloadable technology. Slot-machine boxes would have pull-down menus of different games, denominations, wagering limits and payouts, allowing customers to tailor-make their play.

Marcel-Remey said IGT is well ahead of the curve on server-based gaming. The company began testing prototypes last year at Treasure Island and the Barona Casino near San Diego.

Lerner said the entire the nation's entire slot machine floor, roughly 900,000 games, could be converted to server-based slots.

"Assuming that the server-based gaming cycle follows the same curve as the cashless cycle, we believe about 80 percent of these units could be replaced over a three to four-year period beginning in 2008," Lerner said.

Copyright GamingWire. All rights reserved.

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