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Trendspotting: Investing in the Gambling Industry

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Sellers of ″sin″ don't always do better in bad times. Will online gambling help?

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In a casino, the house always wins in the end.

That bald fact should be a pretty strong argument in favor of investing in casino stocks.

But despite the sweet odds, casino gambling isn't doing well in either of America's gambling mega-centers: Las Vegas and Atlantic City.

And the way the industry is headed, it looks as if it's about to test the basic assumption that the house always wins. What happens when there are just too many gambling palaces open at once? Can Americans' appetites for gambling, or their pockets, possibly sustain all of them at once?

Not just in the real world, but on the Internet. There's even talk about mobile phone gambling.

Given the proliferation of legal gambling venues real and virtual, investors are going to need to use skill as well as luck to pick a winner.

Here are some of the issues, and the players.

Good News/Bad News

During the recession, Las Vegas and Atlantic City disproved the old assumption that sellers of "sin" do even better in bad times.

Las Vegas experienced its first two-year revenue decline since 1978, when it began to lose its near-monopoly on legal gambling in the US. Revenues fell 4.7% in 2008 and 5.5% in 2009.

On the other side of America, New Jersey gambling revenues slid 13% last year, and several of its 11 casinos were in bankruptcy.

It seems there's a flaw in the logic about "sin" businesses in a recession. With casinos popping up around the country on Indian reservations, riverboats, and offshore dinner cruises, nobody needs a plane ticket to gamble anymore. And in a pinch, there's always a Megabucks lottery drawing near you.

So, is any public company beating the odds? Yes.

Wynn Resorts (WYNN) on April 29 reported revenue up 23% to $909 million, with small thanks due to Las Vegas. Viva Macau, the new gambling capital of the world.

Wynn credited its earnings surprise to a 32% increase in business there, compared with 9% in Vegas. A third Wynn casino in Macau is on the drawing board now.

Another competitor worth a look is Melco Crown Entertainment (MPEL), which operates only in Macau. It beat all of its competitors in its latest numbers, rising 70% to a record $1.76 billion in April.

Finally, there's Boyd Gaming (BYD), which hit the news recently when hedge fund manager Paulson & Co. bought a big chunk of it. Its latest earnings showed solid growth in the Midwest and South, where most of its casinos are located. The 20% or so of its business that's located in Las Vegas was not so hot.

So, not all of the action is in Macau, although quite a lot of it is. Overall, casino revenue nearly doubled there in May to more than 17 billion patacas, and that's a lot of patacas. (Actually, it's about $2.1 billion.)

What's Next

Since 2006, federal law has banned Internet casinos from accepting American customers, mostly by barring credit card companies from authorizing payments to them.

That law leaks like a sieve, and it's about to bust wide open as state after state considers expanding legal gambling as a way to raise money.

That may be good news for the land-based casinos, some of which will be licensed to open up online in return for forking over a cut of 20% or so to the seriously broke states that host them. At the moment, New Jersey appears to be closest to a vote to permit Internet gambling.

The online casinos would be open only within state boundaries -- which is how the states will circumvent the federal ban. If it passes, the New Jersey law would at least initially benefit only the casinos now operating in Atlantic City -- currently Harrah's, Trump, Bally's, Borgata, and Caesar's Palace.

You have to wonder, though, at what point casinos will start to cannibalize each other. It also can't be good for the parts of their business that aren't coin-operated -- hotels, restaurants, clubs.

The risk is much greater when you consider the number of new gambling venues, real and virtual, that are under consideration.

States including Illinois, Maryland, and New York are looking into video lottery terminals or online lottery sales to augment their treasuries. Massachusetts is considering installing slot machines at the racetrack to get back some of those dollars that are getting sucked across the border to Connecticut's Indian casinos.

And then there are the Internet entrepreneurs.

Online poker is the great current success story. But a number of sites are offering, or soon will offer, the chance to wager on "skill-based games," which they argue are not covered by the federal law against games of chance. There are other gray areas. One is whether the operation is a casino if it, say, charges a membership or entrance fee rather than a cut.

All of which may make the gambling industry much more interesting in the long run. However, it must be noted that the last time it got this interesting, a couple of Internet entrepreneurs wound up in jail for welcoming American customers into their offshore-based online casinos.

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