How to Care for and Feed the Golden Goose
Casinos face unique challenges in order to maintain profitability and remain competitive under the new paradigm of falling economic conditions. These factors are made more difficult in the commercial gaming sector due to rising tax rates and in the Indian gaming sector due to self-imposed tribal general fund contributions and/or per capita distributions. There is also a growing trend towards state-imposed fees.
It is difficult to determine how much to “render to Caesar” while keeping the funds available to grow market penetration, maintain market share and improve profitability. This must be done well.
This article discusses how to plan and prioritize casino reinvestment strategies.
The Cooked Goose
It would seem obvious not to cook the goose who lays golden eggs. However, it is surprising how little attention is given to its ongoing proper care and feeding. Developers/tribal councils, financiers and investors are all eager to reap the benefits of a casino. There is also a tendency to not allocate sufficient profits to asset maintenance and enhancement. This raises the question of how much profit should be reinvested and for what purposes.
There are no set rules because each project is unique. Most of the big commercial casino operators don’t distribute net profits to stockholders as dividends. Instead, they reinvest the funds in improving their existing venues and seeking out new ones. These programs may also be funded by additional debt instruments or equity stock offering. These financing options will be more prominent due to the lower tax rates for corporate dividends. However, the core business must maintain its prudence and continue to reinvest.
The net profit ratio, which is earnings before income taxes and depreciation, for publicly-held companies was 25%. This average figure includes deductions of gross revenue taxes and interest. On average, nearly two-thirds of remaining profits are used for asset replacement and reinvestment.
Low-tax jurisdictions that allow casinos to reinvest in properties are more likely to have them. This will increase revenues and eventually help the tax base. New Jersey is an example of this, since it requires certain reinvestment allocations as a revenue stimulant. Illinois and Indiana, which have higher effective rates, are at risk of having their reinvestment reduced, which could eventually reduce the casino’s ability to increase market penetrations. This is especially true as the competition in neighboring states increases. A combination of efficient operations and equity offering can result in higher profit available for reinvestment.
The way a casino company allocates its casino profits is crucial to its long-term viability. This should be a key part of its initial development strategy. Although short-term loan amortization/debt repayment programs might seem attractive to get out of an obligation quickly, they can severely limit the ability to reinvest/expand in a timely manner. This applies to any profit distribution to investors, or, in the case Indian gaming projects, to tribes’ general fund for infrastructure/per-capita payments.
Many lenders also make the error of requiring large amounts of debt service reserves. They place restrictions on reinvestment and further leverage, which can severely limit a project’s ability maintain its competitiveness and/or take advantage of available opportunities.
While we don’t advocate that profits be reinvested in the operation, it is important to consider an allocation program that accounts for the “real” costs associated with maintaining the asset and maximising its impact.
Three areas are essential for capital allocation, and they should be considered.
- Maintenance and replacement
- Cost Savings
- Revenue Enhancement/Growth