on the Las uegas Strip:

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1 Small and Large Casinos on the Las uegas Strip: AcaREF±=:.:!ij:-. :`±±i L-a-+ ::3`3#±s E±! siet by Zheng Got, Ph.D. Some analysts view the opening of Bellagio as an omen for small casinos on the Strip. One analyst even predicted that five second-tier Las Vegas resorts would close within 18 months of Bellagio.s opening. (Las uegas SunJ the "Strip"), is reportedly the most expansivehotel-casinoeverbuilt.itsgrandopening in October 1998 marked, as viewed by many analysts, the beginning of an era in which higher-end hotel-casinos will compete for upscale tourists and gamblers by offering them a mix of elegant gambling, lodging, dining, shopping, and entertaining experiences. The successful opening of Mirage Resort's Mirage Casino & Hotel on the Strip in 1990 and the nationwide gaming boomintheearlyl990stouchedoffanew waveofcasinoexpansionsalongthestrip. Since 1993, many new casino mega-resorts have been launched into operation, including Mirage's Treasure Island, Circus Circus Entertainment, Inc.'s Luxor and Monte Carlo Gointly owned by Mirage Resorts, Inc.), and MGM Grand, Inc.'s MGM and New York-New York. Following the debut of Bellagio, three more high-end gaming properties will be completed in 1999 in Las Vegas: Circus Circus Enterprises' Mandalay Bay, Sheldon Adelson's Venetian, and Hilton, Inc.'s Paris. Furthermore, a new Aladdin casino resort is scheduled to join the seriesofgrandopeningsinearly2000.when completed, the five new Strip mega-resorts, at a total cost of $6 billion, will add 15,000 rooms to Las Vegas' current 100,000-room inventory. The new casino mega-resorts in Las Vegashavecausedfinancialanalysts'concem about Las Vegas' worsening overcapacity along the Strip. Wall Street is watching the new developments in Las Vegas with unease. The declining air services to Las Vegas, the jammed traffic in and around the city, the lingering Asian financial crisis, and the threat of a possible global recession all seem to indicate bad timing for the openings of those new mega-resorts. Some analysts view the opening of Bellagio as an omen for small casinos on the Strip. One analyst even predicted that five second-tier Las Vegas resorts would close within 18 months of Bellagio's opening (Las Vegas Sun). To determine whether this is a valid prediction, a close examination of the financial performances and conditions of the small casinos vis-a-vis those of the casino giants on the Strip is needed. Zheng Gu, Ph.D is an associate professor at the college of hotel administration at the University of Nevada, Las Vegas. Register on-line for HFTP even[s! Tl'.E B,c,:-::..::.7-..:. : i

2 This article compares the aggregate financial conditions and performance of small hotel-casinos with those of large hotel-casinos on the Strip using the 1997 Nevada Gaming Abstract. The Abstract separates casinos on the Strip into two groups: 15 small operations with annual gaming revenues of $1 million to $72 million and 21 large operations with annual gaming revenues of $72 million and over. The Abstract reports the aggregate operation results of the five revenue centers of the two groups, their aggregate income statements and aggregate balance sheets. First the operation results of the five revenue centers-casino, rooms, food, beverage, and other-of the two groups are compared. Then the two groups' aggregate income statements are examined. Finally, financial ratios derived from income statements and balance sheets of the two groups are compared. Most of the comparisonsaremadewithverticalanalysis, in which each item is divided by relevant departmental revenue or by the total revenue of the casino. Table 1. Casino Department Gaming revenue per square foot Gaming revenue per employee Total gaming revenue Bad debt Comp expense Gaming taxes and licenses Other departmental expenses $830 $89, % 12.6% 8.7% 25.4% 10.3% 57.2% 42.8% $1,938 $161, % 13.20/o 7.1% 18.8% 15.3% 58.9% 41.1% Note: All items, except the first two, are expressed as % of total gaming revenue. ` Table 2. Rooms Department Rooms revenue per employee Average room rate per day Average occupancy Rooms revenue $68,282 $ % 32.7% 12.1 % 44.8% 55.2% $109,215 $ % 25.3% 10.9% 36.2% 63.80/o Note: All items, except the first three, are expressed as Mo of rooms revenue. Casino Department Thecasinodepartmentconstitutesthelargest revenue center of a hotel-casino. In recentyears,stripcasinoshaveseenfaster increases in non-gaming revenues. As a result, the casino department's revenue as a percentage of total revenue has been declining. In 1990, the aggregate gaming revenue of all Strip casinos was 57.8 percent of total revenue. In 1997, it dwindled to51.5percentoftotalrevenue.lasvegas is making efforts to reposition itself as a multi-entertainment destination rather than a gambling capital. The declining share of gaming revenue reflects the revenue diversification resulting from the changing nature of Las Vegas. Table 1 compares the aggregate casino department performance of the small casinos with that of the large ones. Efficiency is measured by gaming revenue per square foot of gaming space and gaining revenue per employee of the casino department. It is evident that the large casinos have an advantage against the small casinos. As the table indicates, in 1997 the large casinos achieved persquare-foot gaming revenue more than double that of the small casinos and their peremployeegamingrevenuewasalmost twicethatoftheirsmallcompetitors.while Table 3. Food Department Food revenue per employee Food revenue Note: All items, except the first one, are expressed as % of food revenue. Table 4. Beverage Department Beverage revenue per employee Beverage revenue $34, % 45.9% 63.1 % 9.7% 72.8% -26,9% Note: All items, except the first one, are expressed as % of beverage revenue. economy of scale may partially explain thelargecasinos'betterrevenueefficiency, the heavier promotion by large casinos should be another contributing factor to their better performance in revenue mak- $45, % 63.3% 61.9% 6.4% 68.30/o -5.0% $47,153 $63, % 22.9% 67.2% 77.1% 35.0% 39.2% 5.2% 4.8% 40.2% 44.0% 27.0% 33.1 % ing. In 1997, from every dollar of gaming revenue, the casino departments of the large casinos gave back 13.2 cents to comp players, while the small casinos gave back 12.6 cents. 20. March 1999 Visit HFTP at hip :// tp.org!

3 Although the large casinos demonstratedbetterperformanceincreatinggaming revenue in their casino departments, the vertical cost analysis in Table 1 shows that those casino giants were slightly less cost-efficient than their small competitors. The ratio of overall department expensestogamingrevenuewas58.9percent for the large casinos, compared unfavorably with the small casinos' 57.2 percent. The large casinos' payroll and related expenses incurred in their casino departments, 18.8 percent, were significantly lower than their small counteaparts' 25.4 percent and their taxes and licenses expenseswerealsolower.thelargecasinos, however, incurred higher expenses in terms of bad gaming debt, comp, and other items including commissions and race wire fees. The 4.5 percent bad debt expense of the large casinos was significantly higher than the small casinos' 0.2 percent. According to the 1997 Nevada GamingAbstract,thedollaramountofthe bad gaming debt of the large casinos totaled $148.7 million, compared with the small casinos' $0.57 million. The huge bad gaming debt of the large casinos may largely be due to high rollers' uncollectibles. It reflects the high operation risk associated with high-roller playing. Although the large casinos are more efficientincreatinggamingrevenue,their gaming related costs leave much to be desired,especiallytheirbaddebtandother departmental expenses. In 1997, from $ 1 of gaming revenue, the large casinos generated about $0.41 income in their casino departments and the small casinos generated $0.43. If the large casinos can reduce theircasinodepartments'directexpenses, bad debt in particular, their efficiency in generating gaming revenue will contributemoretothecoverageoftheiroverhead expenses and their bottom-line profits. Fiooms Department The rooms department is usually the second largest revenue center of a hotelcasino.forlasvegasstriphotel-casinos, rooms revenue was about 21 percent of total revenue in 1997, four points higher than 1990s 17 percent. Table 2 indicates that, on average, an employee in a large casino's rooms department generated about $41,000 more revenue than his or her peer in a small casino in The higherperemployeeroomsrevenueofthe large casinos was evidently due to their higher average daily rate (ADR), $81.21 and higher occupancy, 93.7 percent. For the small casinos, their ADR and occupancy were $50.51 and 88.5 percent respectively.inotherwords,thelargecasinos on the Strip achieved revenue per availablerooms(revpar)of$76.09,whereas and rooms departments, the employees in food and beverage departments of the large casinos generated higher revenues peremployeethantheirpeersofthesmall casinos. It is common that casinos use lowpriced buffets to attract players. This fact explains the high food cost percentages, The risk of these small casinos. inability to make payments on their interest and rent is increasing. It is highly possible that some of them will default on their payments. The prediction of their going out of business does not sound like an overstatement. the small casinos on the Strip achieved a REVPARofonly$44.7.Thelargecasinos far outperformed small casinos in generating rooms revenue. Theverticalanalysisofthecostsofthe rooms department shows that the large casinosweremorecost-efficientthantheir small competitors, especially in terms of labor cost. The labor cost of the rooms department of a small casino was 30 percent higher than that of a large casino. From every dollar of rooms revenue, a large casino used $0.36 to cover the direct costsoftheroomsdepartment,whilesmall casinos had to spend $0.45 for the same coverage. The higher direct costs of the smallcasinoslefttheirroomsdepartments with less to contribute to the coverage of the casinos' overhead costs, only $0.55 from $ 1 of rooms revenue, compared with the large casinos' $0.64. Thelargecasinosonthestriparenewer than the small casinos and are equipped withmoreamenitiesandattractions.they are also better located. Therefore, they are able to achieve higher ADRs and in the meantimemaintainhigheroccupancy.the competitive advantage of the rooms department of the large casinos is also reflected in their lower departmental cost ratio, which is probably due to economy of scale. Food and Beverage Dep@riments Combined, the food and beverage departments of casinos on the Strip contributed about 16 percent to total revenue in 1997, slightly lower than 1990's 17 percent. Tables 3 and 4 show the two departments' operation results for the small and large casinos. Like their colleagues in casino 54.1 percent for the small casinos and 36.7 percent for the large casinos. The food cost percentage of the small casinos was 17 percentage points higher than that of the large casinos. In other words, for every dollar of food revenue, small casinos had to spend $0.17 more on purchasing food inventory. Economy of scale givesthelargecasinosacompetitiveedge in lowering their food cost. The unusually high labor cost ratios for both small and large casino groups, 63.1 percent and 61.9 percent of food revenues respectively, were probably due to two reasons: low selling prices and high payroll and related expenses associated with unionized culinary labor force. Because of high food and labor costs, the food departments of both groups were operating under breakeven in 1997, but the food operation loss of the small casinos was much worse due to its substantially higher food cost ratio. While the large casinos suffered a five-cent loss for every dollar of food sales, the loss per dollar of food sales for the small casinos was $0.27. When using cheap food to compete with the large casinos for customers, the small casinos are in an extremely disadvantageous position. The food operation of a small casino could be a major drag on its profitability. As shown in Table 4, the beverage departments for both small and large casino groups were operating above breakeven in 1997, but the large casinos fared much better than small casinos. The beverage operation of the small casino group achieved departmental income as 27 percent of beverage sales, compared unfavorably with the large casinos' 33.1 Register on-line for HFTP events! The Bottomline. =1

4 percent. Although the small casinos had lower labor cost percentage, 35 percent, in comparison with the large casinos' 39.2 percent, their beverage cost ratio, 32.8 percent,faroutweighedthelargecasinos' 22.9 percent. The higher beverage cost was the main reason of the small casinos' 6.1 points under-performance in beverage department's income. tife F EBeveffiue 6 ffi efs As demonstrated in Table 5, unlike their revenue performance in casino, rooms, food,andbeveragedepartments,thesmall casinos beat the large casinos in terms of combined revenue per employee from other revenue centers. While the small casinos' cost of sales ratio, 26.6 percent, wasstillsignificantlyhigherthanthelarge casinos' 12.7 percent, their payroll and related expenses ratio,12.1 percent, and their other expenses ratio,11.8 percent, were substantially lower than the large casinos' 23.3 percent and 22.9 percent respectively. The disadvantage of higher cost of sales of the other revenue centers of the small casinos was dominated by their advantage of lower labor and other expenses. Thus the small casinos' departmental income of other revenue centers as a percentage of their combined revenue, 49.5 percent, beat the large casinos' 41.1 percent. The other revenue centers of the small casinos were the only bright spots when compared with those of the large casinos. Theirbetterdepartmentalincomeofother revenue centers, however, did not help raise their bottom-line profitability much becauseoftherelativelyinsignificantshare of other revenue centers in those casinos' total revenue. As Table 6 shows, for the small casinos, revenues from other revenue centers consisted only 8.2 percent of the total revenue, compared with the large casinos' 11.5 percent. Aggregate Income StaEemen Table 6 is an aggregate income statement of the Strip casinos with every item shown as a percentage of total revenue. The revenue distribution suggests that the large casinos' revenue, with a smaller contribution from casino department, was more diversified than that of the small casinos. The small casinos' food and beverage operations had greater weights in total revenue than the food and beverage operations of their large competitors. The Table 5. Other Revenue Centers Departmental revenue per employee Departmental revenue $121,361 $119, /o 12.7% 73.4% 87.3% 12.1 % 23.3% 11.8% 22.9% 23.9% 46.2% 49.5% 41.1% Note: All items, except the first one, are expressed as % of the departmental revenue. Table 6. Aggregate Income Statement Total revenue Gaming revenue Rooms revenue Food revenue Beverage revenue Other revenue (revenue centers) Other departmental expenses Advertising and promotion (non-revenue centers) Depreciation and amortization Rent Interest expense Other general and administrative expenses Total overhead expenses before income taxes Income before taxes and extraordinary items Nclte: All items are expressed as Mo of the hotel-casinos' total revenue. Table 7. Ratio Analysis Current assets to current liabilities Total equity to total liabilities Total equity to total current liabilities Current liabilities to total liabilities Total comp expense to gaming revenue Entertainment expenses to gaming revenue Total revenue to average total assets Total revenue less comp sales to average total assets Return on invested capital Fieturn on average assets greater weight of small casinos' money losing food operation should have aggravated the loss of the small casinos. The large casinos' combined cost of sales, 6.5 percent of total revenue, was much less than the small casinos' ,0% 53.6% 51.3% 19.8% 21.9% 12.4% 10.8% 6.0% 4.5% 8.2% 11.5% 10.8% 6.5% 89.2% 93.5% 31 % 23.6% 21.9% 29.8% 36.3% 40.7% 4.0% 2.4% 8.0% 6.7% 4.9% 6.8% 5.9% 0.4% 4.8% 1.3% 9.0% 9.0% 36.6% 26.6% -0.3% 14.1% 71.5% /o 70.5% 177.5% 158.5% 394.6% 44.5% 45.0% 14.7% 15.0% 1.1% 2.1% 78J% JO/o 72.6% 71.7% 4.9% 14.4% 3.5% 12.0% enue centers' labor costs, 23.6 percent of totalrevenue,incomparisonwiththesmall casinos' 31 percent. The other departmentalexpensesincurredbythelargecasinos' revenue centers, however, amounted to 29.8percentoftotalrevenue,significantly higher than the small casinos' 21.9 percent.thebaddebtofthelargecasinoswas 22. March 1999 percent.thelargecasinos'costadvantage was also evident in their combined revvisit HFTp at http..// ep.org!

5 illim mainly responsible for this high ratio. A big part of the large casinos' advantage in cost of sales and labor cost was offset by theirhigherotherdepartmentalexpenses. As a result, their aggregate departmental income was only 4.4 percent better than that of the small casinos. The total overhead expenses before income taxes of the large casinos were 26.6 percent of their total revenue, 10 percent below the small casinos' 36.6 percent.inotherwords,foreverydollarof the total revenue, a small casino had to spend 10 cents more to cover the overheads.thesmallcasinos'muchhigher rent and interest expenses were the major contributorstotheirhigheroverheadcosts. Their advertising and payroll and related expenses, to a lesser degree, also contributed to their higher overheads. In 1997, the departmental income of the small casinos, 36.3 percent of the total revenue, was only 4.4 percent below the large casinos' 40.7 percent. After subtracting overhead costs, the small casinos hadanaggregatelossbeforeincometaxes and extraordinary items equivalent to 0.3 percent of total revenue, compared with the large casinos' aggregate income beforeincometaxesandextraordinaryitems at 14.1 percent of total revenue. The small casinos fell behind the large casinos by 14.4 percent in income before taxes and extraordinary items. The small casinos' overheads, rent, and interest expenses in particular, significantly widened the gap betweenthetwogroups'bottom-lineprofits. The under-performance of the small casinos was largely due to their overhead expenses. gbaei Amaiysis For an in-depth analysis of the financial conditions and performance of the small and large casinos on the Strip, Table 7 provides ratios derived from the aggregate income statement and balance sheet of the two groups of casinos. The ratios aboutcurrentassets,currentliability,total equity, and total liabilities indicate that the large casinos had better liquidity and were less leveraged by debt. The higher debt leverage of the small casinos explains their higher interest expense. As shown by the ratios of total comp expensetogamingrevenueandentertainment expenses to gaming revenue, large casinos spent more on comp and entertainment to attract customers. The ratios of total revenue to average total assets and total revenue less comp sales to average total assets seem to indicate the small casinos' better efficiency in using assets to generate revenue. These ratios, however, could be misleading, because the smallcasinosalongthestriparegenerally older than their large competitors. Their low assets book value could inflate the revenue/assets ratio. Their higher ratios do not necessarily indicate better efficiency in generating revenue. Return on invested capital is a ratio of income before income taxes and extraordinaryitemsplusinterestexpensedivided by average assets less average current liabilities. It represents the return to equity and long-term debt. Return on average assets is income before income taxes and extraordinary items plus interest expense divided by average assets. It measurestheretumtototalfinancing.thetwo ratios show that the large casinos provided better returns on equity and debt investments than the small casinos. 6 meluisions The analysis shows that large casinos are generally more efficient in using their human resources and assets to generate revenue. The large casinos on the Strip alsoenjoyanobviouscostadvantagewith overall lower cost of sales and lower labor cost.thelargecasinos'revenueefficiency and cost advantage are probably resulting from economy of scale. The large casinos' cost advantage is even greater in terms of overhead expenses. Their significantly lower interest expense is a result of their less reliance on debt financing and possibly their lower costofborrowing.therentofpremisesis a huge burden for the small casinos but is almost nil for large casinos. Because of theirlowercostofsales,lowerlaborcosts, and lower rent and interest expenses, the large casinos can afford to spend more on comp and entertainment to attract customers. In comparison with the large casinos, the small casinos are generally less efficient in generating revenue and have to endure higher cost of sales and higher labor cost. Further, they have a heavier burden of overheads mainly because of interest and rent. In 1997, they were operatingjustbelowbreakeven.thecompetition in Las Vegas is likely to become more intense with the openings of more new large casinos. The risk of these small casinos' inability to make payments on their interest and rent is increasing. It is highly possible that some of these small casinos default on their payments. The prediction of their going out of business does not sound like an overstatement.. References Nevada Gaming Control Board, IVcvc!dcz Gami.#g Absfrc}cf,1997. Wilen, John, "`Second-tier' resorts do nothing to compete," Lc!s Vegczs S#", 14A, October 16, Register on-line for HFTP events! The Bottomline. 23