For the last few years, the “go-to” gaming analyst in the industry has been Deutsche Bank’s Bill Lerner. He was the first gaming analyst to leave Wall Street and actually live in Las Vegas,  a move that gave him respect and inside knowledge of the gaming industry. Several important gaming executives, including MGM Mirage’s Jim Murren and Pinnacle Entertainment’s Dan Lee, have cut their industry teeth as gaming analysts, and Lerner was one of the best.

Earlier this year, Lerner, along with Deutsche Bank colleagues Rich Moriarty and Grant Govertsen, left the investment bank to start their own research and consulting firm, Union Gaming Group. The group started with a bang, advising MGM Mirage through a difficult transition and helping to line up part of the $2.5 billion in financing the company needed to reduce debt and finish the CityCenter project.

Casino Connection Publisher Roger Gros sat down with the principals from Union Gaming Group at their Las Vegas offices in May.

Casino Connection: You three have been on Wall Street for many, many years. Why did you decide to leave Deutsche Bank and start to head up your own company?

Rich Moriarty: This is something we’ve talked about for over a year now. Luckily, Deutsche Bank brought the three of us together. Given the state of what’s happening on Wall Street and what’s going on in the gaming  industry, we felt like it was a terrific time for the three of us to get together and go out on our own.

Deutsche Bank is a big player in the gaming business. Without the weight of that name behind you, do you expect to have the same kind of access and will you be able to gather the same kind of information you had in the past?

Bill Lerner: That was something that we certainly contemplated when we were anticipating a departure from Deutsche Bank. There are certain resources that we’ve had the benefit of that we won’t have anymore. The early indications so far have been very encouraging. From an access perspective, I don’t envision any real issue. In fact, many of the folks in different aspects of the industry have been in to talk to us about how we might be able to work together differently than in the past. Many institutional investors that are our clients have been very supportive of what it is we have in mind. We haven’t run into any issues. It’s a fair consideration, but so far, so good.

There’s a suggestion that we’re going to see a lot of sales of individual properties from the big companies like Harrah’s, MGM, Las Vegas Sands, Station, etc. Do you believe that’s going to happen to any great extent, and what will be the trigger that really starts that?

BL: I think there’s going to be fragmentation to resolve balance sheet issues. I think that will result in a number of new gaming companies being formed, or will result in the rounding out of portfolios for existing gaming companies.

There are a lot of folks who think they can essentially steal properties from some of these troubled gaming companies. But what I think is going to be challenging with that mindset is that it doesn’t resolve any leverage issues for any of these gaming companies to sell assets cheaply enough to be attractive for many of the folks who want to buy gaming assets.

There’s a handful of companies with great reputations in gaming that are looking to capitalize, like Wynn, Penn National and private individuals with a lot of capital that have been out of gaming for some time but have expertise and the ability to get licensed.

Do you think the regulation that has been submitted in Nevada that will allow companies to own up to 25 percent of a casino without going through the onerous licensing system there will help loosen things up a little bit?

BL: At the end of the day, Nevada Gaming Control and the Gaming Commission have the same desire and fiduciary responsibility in mind. Whether they might make some process less onerous or not, they want to protect the state and the reputation of the state when it comes to this industry. If they can be more practical in their structure, then I think that’s what they have in mind.

Let’s talk about Las Vegas specifically. Is the problem that we see with the gaming companies and the resorts on the Strip that their revenues are dramatically lower, or is it the debt load that the big corporations have taken on at this point?

BL: I’d say the overwhelming majority is debt burden, and the minority is macroeconomic issues that have impacted consumer spending. The latter is transitory, I hope and think; but the former, the balance sheet issues, are self-imposed and need massive attention.

I don’t think you’ll likely see new development projects anytime soon, but when they are putting shovels in the ground five or 10 years from now, I don’t think you’ll see the shovels go in without the projects being fully funded.

Everybody’s anticipating the opening of CityCenter now that the financing issues have been mostly resolved, but isn’t this another potential problem for competitors, and even for MGM Mirage, since it’s going to vastly expand the room inventory on the Strip?

BL: Yeah. With CityCenter, let’s say you have 6,000 incremental rooms, primarily at the higher end, on the base of 150,000 rooms or so. One more room being added to Vegas right now is one too many. So it’s going to be a problem for room rates citywide.

There’s a whole other discussion about whether the return on invested capital there will ever exceed the cost of capital. But what’s more important at this point is that it’s all relative. Most investors attribute no cash flow benefit from the opening of CityCenter, even if there is cannibalization with their own portfolio, the net of it, we think, will be incremental cash flow for MGM Mirage.

The opening of the property, the prospect of selling or closing some residential inventory, and maybe there’s a strategy to get that done, and the elimination of the negative carry, the huge debt burden for the joint venture associated with, finally with cash flow, might be incrementally positive for the MGM shares.

But it’s certainly not going to help the high-end competitors, the Caesars, the Wynn and Las Vegas Sands to a large extent.

BL: It’s interesting because CityCenter, despite the budget, despite the physical plant, the size of it, the casino square footage is actually small. As gaming is supposed to be part of the return profile there in a relevant way, we’ve got to assume that the high-end will be a focus.

Since it’s a 50/50 joint venture, the treatment or the strategy for MGM is delicate. You would be cannibalizing to some degree your existing high-end exposure, and giving half of that benefit to your joint venture partner. That’s a real delicate proposition.

Let’s talk about the locals market. Do you think that is going to rebound to some extent?

Grant Govertsen: We do think it’s going to rebound, maybe a little bit slower than the Strip, even when you consider the number of rooms that were originally thought to be coming online are not going to be coming online now. So that has a pretty big impact on unemployment. I believe the numbers are roughly two-and-a-half new jobs for every room that’s developed on the Strip. With the number of these casinos not being developed, you’re probably talking about tens of thousands of new jobs that won’t be created. The return to normalcy in the locals market is going to take a little bit longer than on the Strip.

Is that a function of the down economy in the locals Las Vegas market that that’s going to take awhile to rebound?

GG: Yeah, because obviously you’ve got some pretty nasty residential issues that we’re working through now as well, and one of the highest unemployment rates in the country, so there’s a lot of negative things going wrong right now.

BL: The dynamic in the locals Las Vegas market is still unique. We believe that it’s a cyclical issue that the locals Las Vegas market is enduring right now, of course exacerbated by some of the specific issues Las Vegas has to deal with, which is the housing crisis and the higher-than-average unemployment. But once the national macroeconomic environment improves, I think you’ll start to see a migration back to Las Vegas, especially if California becomes more fiscally onerous, which they are teeing up to be.

If I was a buyer of casino assets, while it’s pretty sexy to look for assets on the Strip, I would certainly suggest to folks with capital and a desire to own a faithful gaming profile, that the Las Vegas locals market, if you can pry an asset away, has perhaps the best return profile to offer.

By Roger Gros

Roger Gros is publisher of Casino Connection and editor and publisher of Global Gaming Business magazine, the industry’s leading gaming trade publication. Prior to joining Global Gaming Business, Gros was president of Inlet Communications, an independent consulting firm. He was vice president of Casino Journal Publishing Group from 1984-2000, and held virtually every editorial title during his tenure. Gros was editor of Casino Journal, the National Gaming Summary and the Atlantic City Insider, and was the founding editor of Casino Player magazine. He was a co-founder of the American Gaming Summit and the Southern Gaming Summit conferences and trade shows. He is the author of the best-selling book, How to Win at Casino Gambling (Carlton Books, 1995), now in its third edition. Gros was named “Businessman of the Year” for 1998 by the Greater Atlantic City Chamber of Commerce.