Small and Large Casinoson the Las uegas Strip:

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Some analysts view theopening of Bellagio as

an omen for small

casinos on the Strip.One analyst evenpredicted that fivesecond-tier Las Vegasresorts would closewithin 18 months of

Bellagio.s opening.

(Las uegas SunJ

by Zheng Got, Ph.D.

the "Strip"), is reportedly the most expan-sivehotel-casinoeverbuilt.Itsgrandopen-ing in October 1998 marked, as viewed bymany analysts, the beginning of an era inwhich higher-end hotel-casinos will com-

pete for upscale tourists and gamblers byoffering them a mix of elegant gambling,lodging, dining, shopping, and entertain-ing experiences.

The successful opening of MirageResort's Mirage Casino & Hotel on theStrip in 1990 and the nationwide gamingboomintheearlyl990stouchedoffanewwaveofcasinoexpansionsalongthestrip.Since 1993, many new casino mega-re-sorts have been launched into operation,including Mirage's Treasure Island, Cir-cus Circus Entertainment, Inc.'s Luxorand Monte Carlo Gointly owned by Mi-rage Resorts, Inc.), and MGM Grand,Inc.'s MGM and New York-New York.Following the debut of Bellagio, threemore high-end gaming properties will becompleted in 1999 in Las Vegas: CircusCircus Enterprises' Mandalay Bay,Sheldon Adelson's Venetian, and Hilton,

Inc.'s Paris. Furthermore, a new Aladdincasino resort is scheduled to join the se-riesofgrandopeningsinearly2000.Whencompleted, the five new Strip mega-re-sorts, at a total cost of $6 billion, will add15,000 rooms to Las Vegas' current100,000-room inventory.

The new casino mega-resorts in LasVegashavecausedfinancialanalysts'con-cem about Las Vegas' worsening overca-

pacity along the Strip. Wall Street iswatching the new developments in LasVegas with unease. The declining air ser-vices to Las Vegas, the jammed traffic inand around the city, the lingering Asianfinancial crisis, and the threat of a pos-sible global recession all seem to indicatebad timing for the openings of those newmega-resorts. Some analysts view theopening of Bellagio as an omen for smallcasinos on the Strip. One analyst even

predicted that five second-tier Las Vegasresorts would close within 18 months ofBellagio's opening (Las Vegas Sun). Todetermine whether this is a valid predic-tion, a close examination of the financialperformances and conditions of the smallcasinos vis-a-vis those of the casino gi-ants on the Strip is needed.

Zheng Gu, Ph.D„ is an associate professor at the college of hotel administration at the University of Nevada, LasVegas.

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This article compares the aggregatefinancial conditions and performance ofsmall hotel-casinos with those of largehotel-casinos on the Strip using the 1997Nevada Gaming Abstract. The Abstractseparates casinos on the Strip into two

groups: 15 small operations with annualgaming revenues of $1 million to $72million and 21 large operations with an-nual gaming revenues of $72 million andover. The Abstract reports the aggregateoperation results of the five revenue cen-ters of the two groups, their aggregateincome statements and aggregate balancesheets.

First the operation results of the fiverevenue centers-casino, rooms, food,beverage, and other-of the two groupsare compared. Then the two groups' ag-gregate income statements are examined.Finally, financial ratios derived from in-come statements and balance sheets of thetwo groups are compared. Most of thecomparisonsaremadewithverticalanaly-sis, in which each item is divided byrelevant departmental revenue or by thetotal revenue of the casino.

Casino DepartmentThecasinodepartmentconstitutesthelarg-est revenue center of a hotel-casino. Inrecentyears,Stripcasinoshaveseenfasterincreases in non-gaming revenues. As aresult, the casino department's revenue asa percentage of total revenue has beendeclining. In 1990, the aggregate gamingrevenue of all Strip casinos was 57.8 per-cent of total revenue. In 1997, it dwindledto51.5percentoftotalrevenue.Lasvegasis making efforts to reposition itself as amulti-entertainment destination ratherthan a gambling capital. The decliningshare of gaming revenue reflects the rev-enue diversification resulting from thechanging nature of Las Vegas.

Table 1 compares the aggregate casinodepartment performance of the small ca-sinos with that of the large ones. Effi-ciency is measured by gaming revenueper square foot of gaming space and gain-ing revenue per employee of the casinodepartment. It is evident that the largecasinos have an advantage against thesmall casinos. As the table indicates, in1997 the large casinos achieved per-square-foot gaming revenue more thandouble that of the small casinos and their

peremployeegamingrevenuewasalmosttwicethatoftheirsmallcompetitors.While

20 . March 1999

Table 1. Casino Department

Gaming revenue per square foot

Gaming revenue per employeeTotal gaming revenueBad debtComp expenseGaming taxes and licensesPayroll and related expenses

Other departmental expensesTotal departmental expensesDepartmental income

Small Operation

$830$89,139100.0%

0.2%

12.6%

8.7%

25.4%

10.3%

57.2%

42.8%

Note: All items, except the first two, are expressed as % of total gaming revenue.

`Table 2. Rooms Department

Rooms revenue per employeeAverage room rate per dayAverage occupancyRooms revenuePayroll and related expensesOther expensesTotal departmental expensesDepartmental income

Small Operation

$68,282

$50.51

88.5%

100.0%

32.7%

12.1 %

44.8%

55.2%

Note: All items, except the first three, are expressed as °Mo of rooms revenue.

Table 3. Food Department

Food revenue per employeeFood revenueCost of salesGross marginPayroll and related expenses

Other expensesTotal departmental expensesDepartmental income

Small Operation

$34,753100.0%

54.1 %

45.9%

63.1 %

9.7%

72.8%-26,9%

Note: All items, except the first one, are expressed as % of food revenue.

Table 4. Beverage Department

Beverage revenue per employeeBeverage revenueCost of salesGross margin

Payroll and related expensesOther expensesTotal departmental expensesDepartmental income

Large Operation

$1,938

$161,284

100.0%

4.5%

13.20/o

7.1%

18.8%

15.3%

58.9%

41.1%

Large Operation

$109,215

$81.21

93.7%

100.0%

25.3%

10.9%

36.2%

63.80/o

Large Operation

$45,731100.0%

36.7%

63.3%

61.9%

6.4%

68.30/o-5.0%

Small operation Large operation

$47,153 $63,841100.0% 100.0%

32.8% 22.9%

67.2% 77.1%

35.0% 39.2%

5.2% 4.8%

40.2% 44.0%

27.0% 33.1 %

Note: All items, except the first one, are expressed as % of beverage revenue.

economy of scale may partially explainthelargecasinos'betterrevenueefficiency,the heavier promotion by large casinosshould be another contributing factor totheir better performance in revenue mak-

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ing. In 1997, from every dollar of gamingrevenue, the casino departments of thelarge casinos gave back 13.2 cents tocomp players, while the small casinos

gave back 12.6 cents.

Although the large casinos demon-stratedbetterperformanceincreatinggam-ing revenue in their casino departments,the vertical cost analysis in Table 1 showsthat those casino giants were slightly lesscost-efficient than their small competi-tors. The ratio of overall department ex-

pensestogamingrevenuewas58.9percentfor the large casinos, compared unfavor-ably with the small casinos' 57.2 percent.

The large casinos' payroll and relatedexpenses incurred in their casino depart-ments, 18.8 percent, were significantlylower than their small counteaparts' 25.4

percent and their taxes and licenses ex-penseswerealsolower.Thelargecasinos,however, incurred higher expenses interms of bad gaming debt, comp, andother items including commissions andrace wire fees. The 4.5 percent bad debtexpense of the large casinos was signifi-cantly higher than the small casinos' 0.2

percent. According to the 1997 NevadaGamingAbstract,thedollaramountofthebad gaming debt of the large casinos to-taled $148.7 million, compared with thesmall casinos' $0.57 million. The hugebad gaming debt of the large casinos maylargely be due to high rollers'uncollectibles. It reflects the high opera-tion risk associated with high-roller play-ing.

Although the large casinos are moreefficientincreatinggamingrevenue,theirgaming related costs leave much to bedesired,especiallytheirbaddebtandotherdepartmental expenses. In 1997, from $ 1of gaming revenue, the large casinos gen-erated about $0.41 income in their casinodepartments and the small casinos gener-ated $0.43. If the large casinos can reducetheircasinodepartments'directexpenses,bad debt in particular, their efficiency ingenerating gaming revenue will contrib-utemoretothecoverageoftheiroverheadexpenses and their bottom-line profits.

Fiooms DepartmentThe rooms department is usually the sec-ond largest revenue center of a hotel-casino.ForLasvegasstriphotel-casinos,rooms revenue was about 21 percent oftotal revenue in 1997, four points higherthan 1990s 17 percent. Table 2 indicatesthat, on average, an employee in a largecasino's rooms department generatedabout $41,000 more revenue than his orher peer in a small casino in 1997. Thehigherperemployeeroomsrevenueofthe

large casinos was evidently due to theirhigher average daily rate (ADR), $81.21and higher occupancy, 93.7 percent. Forthe small casinos, their ADR and occu-

pancy were $50.51 and 88.5 percent re-spectively.Inotherwords,thelargecasinoson the Strip achieved revenue per avail-ablerooms(REVPAR)of$76.09,whereas

and rooms departments, the employees infood and beverage departments of thelarge casinos generated higher revenues

peremployeethantheirpeersofthesmallcasinos.

It is common that casinos use low-

priced buffets to attract players. This factexplains the high food cost percentages,

The risk of these small casinos. inability to makepayments on their interest and rent is increasing.It is highly possible that some of them will default

on their payments. The prediction of their going outof business does not sound like an overstatement.

the small casinos on the Strip achieved aREVPARofonly$44.7.Thelargecasinosfar outperformed small casinos in gener-ating rooms revenue.

Theverticalanalysisofthecostsoftherooms department shows that the largecasinosweremorecost-efficientthantheirsmall competitors, especially in terms oflabor cost. The labor cost of the roomsdepartment of a small casino was 30 per-cent higher than that of a large casino.From every dollar of rooms revenue, alarge casino used $0.36 to cover the directcostsoftheroomsdepartment,whilesmallcasinos had to spend $0.45 for the samecoverage. The higher direct costs of thesmallcasinoslefttheirroomsdepartmentswith less to contribute to the coverage ofthe casinos' overhead costs, only $0.55from $ 1 of rooms revenue, compared withthe large casinos' $0.64.

Thelargecasinosonthestriparenewerthan the small casinos and are equippedwithmoreamenitiesandattractions.Theyare also better located. Therefore, they areable to achieve higher ADRs and in themeantimemaintainhigheroccupancy.Thecompetitive advantage of the rooms de-

partment of the large casinos is also re-flected in their lower departmental costratio, which is probably due to economyof scale.

Food and Beverage Dep@rimentsCombined, the food and beverage depart-ments of casinos on the Strip contributedabout 16 percent to total revenue in 1997,slightly lower than 1990's 17 percent.Tables 3 and 4 show the two departments'operation results for the small and largecasinos. Like their colleagues in casino

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54.1 percent for the small casinos and36.7 percent for the large casinos. Thefood cost percentage of the small casinoswas 17 percentage points higher than thatof the large casinos. In other words, forevery dollar of food revenue, small casi-nos had to spend $0.17 more on purchas-ing food inventory. Economy of scale

givesthelargecasinosacompetitiveedgein lowering their food cost.

The unusually high labor cost ratiosfor both small and large casino groups,63.1 percent and 61.9 percent of foodrevenues respectively, were probably dueto two reasons: low selling prices andhigh payroll and related expenses associ-ated with unionized culinary labor force.Because of high food and labor costs, thefood departments of both groups wereoperating under breakeven in 1997, butthe food operation loss of the small casi-nos was much worse due to its substan-tially higher food cost ratio. While thelarge casinos suffered a five-cent loss forevery dollar of food sales, the loss perdollar of food sales for the small casinoswas $0.27. When using cheap food tocompete with the large casinos for cus-tomers, the small casinos are in an ex-tremely disadvantageous position. Thefood operation of a small casino could bea major drag on its profitability.

As shown in Table 4, the beveragedepartments for both small and large ca-sino groups were operating abovebreakeven in 1997, but the large casinosfared much better than small casinos. Thebeverage operation of the small casino

group achieved departmental income as27 percent of beverage sales, comparedunfavorably with the large casinos' 33.1

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percent. Although the small casinos hadlower labor cost percentage, 35 percent,in comparison with the large casinos' 39.2

percent, their beverage cost ratio, 32.8percent,faroutweighedthelargecasinos'22.9 percent. The higher beverage costwas the main reason of the small casinos'6.1 points under-performance in bever-age department's income.

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As demonstrated in Table 5, unlike theirrevenue performance in casino, rooms,food,andbeveragedepartments,thesmallcasinos beat the large casinos in terms ofcombined revenue per employee fromother revenue centers. While the smallcasinos' cost of sales ratio, 26.6 percent,wasstillsignificantlyhigherthanthelargecasinos' 12.7 percent, their payroll andrelated expenses ratio,12.1 percent, andtheir other expenses ratio,11.8 percent,were substantially lower than the largecasinos' 23.3 percent and 22.9 percentrespectively. The disadvantage of highercost of sales of the other revenue centersof the small casinos was dominated bytheir advantage of lower labor and otherexpenses. Thus the small casinos' depart-mental income of other revenue centers asa percentage of their combined revenue,49.5 percent, beat the large casinos' 41.1

percent.The other revenue centers of the small

casinos were the only bright spots whencompared with those of the large casinos.Theirbetterdepartmentalincomeofotherrevenue centers, however, did not helpraise their bottom-line profitability muchbecauseoftherelativelyinsignificantshareof other revenue centers in those casinos'total revenue. As Table 6 shows, for thesmall casinos, revenues from other rev-enue centers consisted only 8.2 percent ofthe total revenue, compared with the largecasinos' 11.5 percent.

Aggregate Income StaEemen€Table 6 is an aggregate income statementof the Strip casinos with every item shownas a percentage of total revenue. The rev-enue distribution suggests that the largecasinos' revenue, with a smaller contribu-tion from casino department, was morediversified than that of the small casinos.The small casinos' food and beverageoperations had greater weights in totalrevenue than the food and beverage op-erations of their large competitors. The

22 . March 1999

Table 5. Other Revenue Centers

Departmental revenue per employeeDepartmental revenue

Cost of salesGross margin

Payroll and related expenses

Other expensesTotal departmental expensesDepartmental income

Small operation Large operation

$121,361 $119,602

100.0% 100.0%

26.6°/o 12.7%

73.4% 87.3%

12.1 % 23.3%

11.8% 22.9%

23.9% 46.2%

49.5% 41.1%

Note: All items, except the first one, are expressed as % of the departmental revenue.

Table 6. Aggregate Income Statement

Total revenueSmall operation Large operation

100,0% 100.0%

Gaming revenueRooms revenue

Food revenueBeverage revenueOther revenue

Cost of salesGross margin

Payroll and related expenses (revenue centers)

Other departmental expensesDepartmental income

Advertising and promotion

Payroll and related expenses (non-revenue centers)Depreciation and amortization

RentInterest expenseOther general and administrative expensesTotal overhead expenses before income taxesIncome before taxes and extraordinary items

Nclte: All items are expressed as °Mo of the hotel-casinos' total revenue.

Table 7. Ratio Analysis

Current assets to current liabilities

53.6% 51.3%

19.8% 21.9%

12.4% 10.8%

6.0% 4.5%

8.2% 11.5%

10.8% 6.5%

89.2% 93.5%

31 % 23.6%

21.9% 29.8%

36.3% 40.7%

4.0% 2.4%

8.0% 6.7%

4.9% 6.8%

5.9% 0.4%

4.8% 1.3%

9.0% 9.0%

36.6% 26.6%-0.3% 14.1%

Small operation Large operation

71.5% 109.50/o

Total equity to total liabilities

Total equity to total current liabilities

Current liabilities to total liabilities

Total comp expense to gaming revenueEntertainment expenses to gaming revenueTotal revenue to average total assetsTotal revenue less comp sales to average total assetsReturn on invested capital

Fieturn on average assets

70.5% 177.5%

158.5% 394.6%

44.5% 45.0%

14.7% 15.0%

1.1% 2.1%

78J% || JO/o72.6% 71.7%

4.9% 14.4%

3.5% 12.0%

greater weight of small casinos' moneylosing food operation should have aggra-vated the loss of the small casinos.

The large casinos' combined cost ofsales, 6.5 percent of total revenue, wasmuch less than the small casinos' 10.8

percent.Thelargecasinos'costadvantagewas also evident in their combined rev-

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enue centers' labor costs, 23.6 percent oftotalrevenue,incomparisonwiththesmallcasinos' 31 percent. The other departmen-talexpensesincurredbythelargecasinos'revenue centers, however, amounted to29.8percentoftotalrevenue,significantlyhigher than the small casinos' 21.9 per-cent.Thebaddebtofthelargecasinoswas

illim

mainly responsible for this high ratio. Abig part of the large casinos' advantage incost of sales and labor cost was offset bytheirhigherotherdepartmentalexpenses.As a result, their aggregate departmentalincome was only 4.4 percent better thanthat of the small casinos.

The total overhead expenses beforeincome taxes of the large casinos were26.6 percent of their total revenue, 10

percent below the small casinos' 36.6percent.Inotherwords,foreverydollarofthe total revenue, a small casino had tospend 10 cents more to cover theoverheads.Thesmallcasinos'muchhigherrent and interest expenses were the majorcontributorstotheirhigheroverheadcosts.Their advertising and payroll and relatedexpenses, to a lesser degree, also contrib-uted to their higher overheads.

In 1997, the departmental income ofthe small casinos, 36.3 percent of the totalrevenue, was only 4.4 percent below thelarge casinos' 40.7 percent. After sub-tracting overhead costs, the small casinoshadanaggregatelossbeforeincometaxesand extraordinary items equivalent to 0.3percent of total revenue, compared withthe large casinos' aggregate income be-foreincometaxesandextraordinaryitemsat 14.1 percent of total revenue. The smallcasinos fell behind the large casinos by14.4 percent in income before taxes andextraordinary items. The small casinos'overheads, rent, and interest expenses in

particular, significantly widened the gapbetweenthetwogroups'bottom-lineprof-its. The under-performance of the smallcasinos was largely due to their overheadexpenses.

gBaEi® Amaiysis

For an in-depth analysis of the financialconditions and performance of the smalland large casinos on the Strip, Table 7provides ratios derived from the aggre-gate income statement and balance sheetof the two groups of casinos. The ratiosaboutcurrentassets,currentliability,totalequity, and total liabilities indicate thatthe large casinos had better liquidity andwere less leveraged by debt. The higherdebt leverage of the small casinos ex-

plains their higher interest expense.As shown by the ratios of total comp

expensetogamingrevenueandentertain-ment expenses to gaming revenue, largecasinos spent more on comp and enter-tainment to attract customers. The ratios

of total revenue to average total assets andtotal revenue less comp sales to averagetotal assets seem to indicate the smallcasinos' better efficiency in using assetsto generate revenue. These ratios, how-ever, could be misleading, because thesmallcasinosalongthestriparegenerallyolder than their large competitors. Theirlow assets book value could inflate therevenue/assets ratio. Their higher ratiosdo not necessarily indicate better effi-ciency in generating revenue.

Return on invested capital is a ratio ofincome before income taxes and extraor-dinaryitemsplusinterestexpensedividedby average assets less average currentliabilities. It represents the return to eq-uity and long-term debt. Return on aver-age assets is income before income taxesand extraordinary items plus interest ex-

pense divided by average assets. It mea-surestheretumtototalfinancing.Thetworatios show that the large casinos pro-vided better returns on equity and debtinvestments than the small casinos.

6®meluisions

The analysis shows that large casinos are

generally more efficient in using theirhuman resources and assets to generaterevenue. The large casinos on the Stripalsoenjoyanobviouscostadvantagewithoverall lower cost of sales and lower laborcost.Thelargecasinos'revenueefficiencyand cost advantage are probably resultingfrom economy of scale.

The large casinos' cost advantage iseven greater in terms of overhead ex-

penses. Their significantly lower interestexpense is a result of their less reliance ondebt financing and possibly their lowercostofborrowing.Therentofpremisesisa huge burden for the small casinos but isalmost nil for large casinos. Because oftheirlowercostofsales,lowerlaborcosts,and lower rent and interest expenses, thelarge casinos can afford to spend more oncomp and entertainment to attract cus-tomers.

In comparison with the large casinos,the small casinos are generally less effi-cient in generating revenue and have toendure higher cost of sales and higherlabor cost. Further, they have a heavierburden of overheads mainly because ofinterest and rent. In 1997, they were oper-atingjustbelowbreakeven.Thecompeti-tion in Las Vegas is likely to become moreintense with the openings of more new

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large casinos. The risk of these smallcasinos' inability to make payments ontheir interest and rent is increasing. It ishighly possible that some of these smallcasinos default on their payments. Theprediction of their going out of businessdoes not sound like an overstatement. .

ReferencesNevada Gaming Control Board, IVcvc!dcz Gami.#gAbsfrc}cf,1997.

Wilen, John, "`Second-tier' resorts do nothing tocompete," Lc!s Vegczs S#", 14A, October 16, 1998.

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