Key Considerations in Restructuring a Gaming Company

As the Great Recession wreaks havoc on the once recession-proof gaming industry, many gaming companies are struggling to survive. These companies are highly regulated, capital-intensive businesses with high fixed-cost structures. Personal income and consumer spending drive gaming revenues. For more than one year, both have been declining. Net revenues at gaming companies during the last year declined because of weak foot traffic and patrons reallocating their entertainment dollars. Revenue from hotel operations has a high elasticity of demand, and the decline in leisure travel, along with the slowdown in business and group travel, has placed downward pressure on hotel room rates. This, coupled with an overall decrease in consumer spending that is not expected to let up in the short term, is causing gaming companies to struggle.

Las Vegas, a destination market, is being hit harder than regional markets because people are staying closer to home to save on travel costs. Gaming companies building new facilities have an additional burden of draining much-needed cash, whereas those with planned additions in the future face lower immediate cash needs and lower financial risk. Recognizing that gaming companies are facing declining revenues and margins, aggressive steps must be taken to restructure debt and reduce costs. In anticipation of an economic turnaround, gaming companies will need to adjust their operations and expectations to be successful in the new-normal economy, where consumer preferences change and the deleveraging process plays out.

To turn a gaming company around, the advisor must understand the internal and external forces that precipitated the downturn. A successful restructuring will entail both operational and financial changes. Gaming restructurings are similar to other industries but have distinct complexities and unique aspects such as round-the-clock staffing requirements, loyalty programs and multiple product offerings that include gaming, restaurant, entertainment, retail and lodging operations. With these unique aspects in mind, management should consider hiring an advisor with relevant experience and expertise in each of these areas. To restructure, companies must navigate the industry’s financial, regulatory and operational environments.

Financial and Regulatory Considerations

The gaming industry faces many challenges when it comes to turning around a company’s financial performance, and changes must go beyond cost reduction. Balance-sheet issues must be addressed and loan covenants must be reset to reflect economic reality. If the restructuring contemplates a sales process, sellers must realize that regulatory approval can impact the process and potentially limit the universe of buyers as a result of stringent licensing requirements.

Relative to a restructuring, the largest issue that gaming companies face is the regulatory environment. Companies are regulated according to their operational jurisdictions. Gaming laws are established at the state and local levels with variable degrees of oversight. In most cases, gaming licenses are not property of the estate and are not assignable. Therein lies the first challenge as companies consider the restructuring process. If the restructuring process contemplates a change in management or ownership, new management and equity sponsors must be willing to go through a strict licensing procedure that often requires the submission of detailed financial, operational and, in some cases, personal information. The regulatory environment impacts the speed of the restructuring as it slows the restructuring process and potentially limits the universe of buyers or the willingness of parties-in-interest to convert debt to equity.

Operational Issues

Casinos manage a lot of cash. Players buy chips with cash and winnings are paid out in cash. From an operational perspective, the cage is the central nervous system of the casino, and all financial transactions go through it. As in all distressed situations, cash is king and must be protected. However, not only must the focus be on actual legal tender, but cards and chips must be tightly controlled as well. The internal controls around cash, chips and cards (the “three Cs”) are critical to the integrity of the operations and must comply with gaming regulations. While a few lost chips may not be damaging the operations (chip counts will decline as patrons keep smaller denominations as souvenirs), a lost deck of cards to an experienced card player could have a significant impact on the casino’s win rate. Managing the “three Cs” and having the appropriate level of surveillance are critical. Appropriate surveillance must be in place and all customer transactions, chip fills and credit transactions should be monitored on a 24/7 basis. Soft count[1] and hard count[2] rooms should also be monitored. It is critical to understand the cash needs of the casino because it would be disastrous for the casino to run short of cash. ATMs should be routinely monitored and refilled, and the main bank should have sufficient cash to fund customer payouts.

Floor management, or gaming mix, must be tightly managed and allow for flexibility based on demand. Capacity and demand must also be carefully monitored and balanced. The “master gaming report” is an important management tool and will provide daily drop[3] amounts and hold or win rates.[4] This information is valuable in assessing which games have high player interest and can be used as the basis for opening and closing tables. The report also provides insight into potential issues that could be missed by surveillance. For example, if the report shows atypically low win rates for a given game, it could indicate dealer fraud or other issues that surveillance may have missed. If management determines that new games should be introduced, they must apply to the gaming authority or commission for approval, which may limit their ability to add new games.

Two major categories of cost include payroll and capital expenditures. Employees, who must be licensed by the appropriate gaming authority, represent the largest cost category in a casino operation. They are the face of the casino and fill a critical role as front-line marketers. The business requires frequent capital investment to refresh the casino and update gaming equipment. These are major cash uses and must be carefully managed.

Even when cash is tight, it is important to maintain promotional activities. In addition to advertising and public relations, loyalty or frequent-player programs are critical components to promotion. These programs allow casinos to monitor gambler-playing activity, which helps target promotional activities while maintaining an acceptable profit margin. Large portions of casino revenues are derived from 20 to 30 percent of gamblers. These gamblers typically wager smaller amounts but are frequent players and represent a key asset to the operation because it is cheaper to retain than acquire customers, and customer loyalty should be rewarded. Although frequent players win occasionally, over time they lose because the odds are always with the house. Consequently, promotional activities are important because they increase the entertainment value for the player. Promotions are typically in the form of food and beverage, lodging or entertainment comps or other rewards. It is imperative that the repeat customer base not be damaged, and any cuts in promotional activity should be carefully considered.

Although there is a glimmer of light at the end of the tunnel, with third-quarter GDP growing for the first time in a year, casino operators will likely face continued pressure long after the economy begins to recover. Many states are looking for additional tax revenues and are considering expanding gaming by adding slots at racetracks and allowing further resort development, which will increase competition. As a high fixed-cost business that is hypersensitive to demand, casino operators, lenders, investors and other constituents need to be proactive in understanding the various dynamics at play. With that understanding, they can carefully make financial and strategic operating decisions that ensure long-term viability as they navigate an uncertain future.