Analyzing the Current Growth Options for Casino Companies
by Sudhir Kale and Peter Klugsberger

Analyzing the Current Growth Options for Casino Companies

by Sudhir Kale and Peter Klugsberger

If you can stomach the self-aggrandizement and puffery, press releases and annual reports can make for some insightful reading. Looking beyond the glossy packaging, buzzwords, and the creative depiction of financial statements, a trained eye can spot prescient glimpses of a company’s corporate strategy and track its path toward satisfying shareholders’ expectations with regard to market capitalization.

One common phenomenon plaguing most CEOs from developed countries is domestic market saturation. This is particularly true of the gaming industry where, until recently, healthy market growth enabled shareholders to routinely pocket double-digit returns on their investments and embedded in their psyche the indomitable expectation that their gaming stocks will consistently outperform the market. The sustainability of such stellar performance is now under threat for most companies and several gaming hotshots are scrambling to come up with a clear business strategy that will provide the shareholders with results to which they have grown accustomed.

Based on our exhaustive review of annual reports and press releases from gaming companies, we have concluded that gaming CEOs peg their business model to one of the three generic business strategies: cutting costs, acquiring other companies, or geographic diversification. Cost curtailment, as we will soon discuss, can never deliver long-term competitive advantage. While mergers and acquisitions (M&A) instantaneously inject revenues into the income statement, for the most part, they tend to destroy shareholder value rather than add to it. Geographic expansion into emerging markets still promises handsome returns provided the company possesses the requisite managerial talent to deal with the cultural, structural, and economic mores and nuances of the international marketplace.

Cost Optimization

InfoWorld columnist Bob Lewis declares, “Don’t cut off your own head: Corporate cost-cutting as a goal is always a mistake.” He goes on to elaborate, “Improved efficiency is a good goal, which may involve reducing unit costs. Improved effectiveness and increased productivity are good goals, either of which may require cost reduction as well. But cost-cutting must be a means to a different end or all you're doing is playing with numbers.” Lewis’ advice is not without empirical support. Professor Gary Hamel of Harvard Business School studied the performance of Standard & Poors 500 companies and found that of the fifty companies where earnings growth outpaced revenues growth by a factor of five or more, 43 experienced significant downturns within three years.

Cost cutting is intuitively appealing because these savings translate directly into improving the bottom-line, at least in the short-term. Once identified, the elimination of overheads and other slack resources invariably drives up a company’s earnings per share (EPS). Realistically though, most of the listed casino companies already run very efficient operations and further cost-cutting will result, at best, in modest savings, and at worst in cutting off the head.

Mergers & Acquisitions

Many companies seem enamored with the idea of ‘buying’ new revenue streams rather pursuing the path of gradual organic growth. The theory behind mergers and acquisitions (M&A) is that the sum of two or more companies creates more value than each of them would be able to realize on their own. After all, a great big acquisition can provide the CEO with that shot of top-line growth that shareholders demand. Unfortunately, experience shows that 70% to 80% of acquisitions fail, meaning they create no wealth for the shareholders of the acquiring company. Most often, they destroy wealth. The real winners in the recent M&A frenzy, it seems, were the CEOs of the participating companies and the lawyers representing the companies. Gillette Company Chief Executive Officer (CEO) James M. Kilts reportedly made a cool $165 million, including stock options and severance, when Procter & Gamble acquired the firm. Gary Loveman, the chief executive of casino giant Harrah's Entertainment Inc., will receive about $94 million in stock options and other rights on consummation of the world’s largest casino buyout deal. But given the unfavorable odds for the shareholders, one should think twice before embarking on this uncertain endeavor.

For unsuspecting shareholders, determining whether a merger or acquisition turned out to be an appropriate strategy is not easy to figure out. In the case of one prominent gaming company whose ‘investor relations’ section we perused, the revenue chart exhibited considerable top-line growth reminiscent of the fabled ‘hockey stick’. Such illustration of revenues, however, was somewhat deceptive, as it did not include the financing costs needed to acquire the new revenue streams. The true picture only became evident when we looked at other measures such as earnings per share (EPS), which factor in both the incremental revenues as well as the financing costs. Comparing the pre- and post-acquisition EPS, it became readily evident that the promised synergies had yet to materialize.

In order for M&A to work, the company taking the initiative needs to think long and hard about how it will create ‘new’ value for its customers. Value enhancement could occur through innovative products, new processes, building a cohesive culture founded on customer-centrism, or on providing a superior customer experience. Moreover, for a company choosing M&A as the primary means of growth, a vast pool of star performers that can easily be deployed as ‘cultural change-agents’ in a SWAT style manner will be needed. The primary role of these individuals is to instill in the new corporate entity the best practices, the culture, and values of the acquirer. Success of the M&A hinges on the caliber, the experience, and the personality of the change agents. Given the scarcity of such individuals, managerial capital remains a serious bottleneck in the path to successful M&A.

Geographic Expansion

Buoyed by the miracle that is Macau, many gaming CEOs are now convinced that the grass is greener in Asia. The Asian market with Macau, Singapore, South Korea, and possibly Thailand and India promises to fulfill every investor’s dream. These markets present huge pent-up demand, low cost labor, and relatively stable legal frameworks. But many developing countries lack the soft infrastructure needed for markets to work efficiently. Access to capital, managerial talent, and accurate customer information still poses hurdles in the high potential emerging markets of Asia. In light of such constraints, how realistic is it to expect that Western business models can be seamlessly and swiftly transferred to these nascent markets? A very good example of such ethnocentric orientation was illustrated in an interview with MELCO’s Chairman, Lawrence Ho. The reporter was curious why MELCO ended up entering into a business partnership with an Australian company rather than the more obvious choice of a leading American group. Mr. Ho stated quite bluntly that he was put off by “strange” suggestions made by some US casino operators, which included promoting Macau casinos by email marketing to 1.3 billion Chinese and dropping flyers into every Chinese home. US operators desirous of forming a partnership with Mr. Ho were apparently unaware of the low Internet penetration in China (under ten percent) and of the fact that the majority of the Chinese population still lives in rural villages, which makes them very hard to reach. The “one size fits all” marketing approach envisaged by some US casino companies demonstrates their lack of experience in tapping international markets. To make international expansion work, casino companies will have to adapt their management and marketing strategies to suit the cultu

Date Posted: 31-May-2007

Sudhir Kale, Ph.D. is Associate Professor of Marketing at Bond University in Australia. He is also the founder of GamePlan Consultants (www.gameplanconsultants.net), a company that consults and trains for casinos on the marketing aspects of gaming. Sudhir has published over fifty articles on the management and marketing of casinos and is a frequently invited speaker at top gaming conferences and executive development programs. He can be reached at skale@gameplanconsultants.net.

Peter Klugsberger has worked in the gaming industry for nearly two decades with one of the largest international casino operators. His past assignments have involved stints in Australia, Denmark, Slovakia, Switzerland, and Venezuela. Peter holds a Global Executive MBA from the IESE Business School. You can reach Peter at pklugs@yahoo.com.

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