Andrew Tottenham - September 4, 2014

Dire Straits


The European land based casino industry is not in a good place. Many countries have seen revenues contract sharply since the glory days of 2007/2008. For example, in 2013 in Greece total casino GGR has dropped almost 60% from the €744 million won in 2008. In the Netherlands GGR in casinos has declined from €627 million in 2008 to €452 million in 2013 (-30%). In the same period France has seen GGR decline over 16% from approximately €2.6 billion to just under €2.2 billion and Spanish casinos have experienced a 40% reduction. The UK has seen revenues grow but strip out the high end London casinos and the new casinos that opened since 2008 and it is a lacklustre total growth of approximately 10% for the past six years.

Many excuses have been made as to the causes of the decline since the smoking ban (banning smoking has seen revenues reduced by between 10% and 20%); igaming, cash transaction controls, the introduction of vlts, gaming arcades, etc, etc. However, the overriding factor that determines whether the pie grows or shrinks is the state of the economy.

In the good times, pre-2008 casinos generated record revenues as European economies grew based on cheap debt and ballooning property values. EBITDA followed suit and some owners borrowed heavily against their cash flow to expand. Casinos are ideal businesses for debt financing; they have little need for working capital, credit is limited or illegal and so what you win is cash and goes straight to the bank. Casinos have very little in the way of inventory and no cash tied up in “work in progress”. Added to that, inventory does not need to increase as business expands. In the first eight years of this century public companies were punished by analysts and investors for not having enough debt on their balance sheet. However, whilst debt used properly can be a good tool, in times of recession it can and does bite back. Companies like Codere in Spain or Partouche in France were crushed under the weight of their debt when revenues downturned. In the inevitable restructuring that took place equity holders did not have many cards to play and finished up significantly diluted.

Many European casino owners made hay while the sun shined but when the recession came only some did what was needed to weather the storm; as revenues decline costs have to be reduced. Casinos are labour intensive; usually, after gaming tax labour costs are the next largest expense. If you need to reduce costs labour is the line item that needs to be addressed urgently. The difficulty with the post 2008 recession was that almost as many people visited casinos as before the crisis but the spend per visit reduced considerably. Similar visitation levels means that an operator will require the same amount of labour to service the guests but with lower spends per visit the operator will generate less revenue and so margins suffer. However, during good times there is little pressure on cost and practises get lax and so there is always room for cost-cutting. In this latest recession in order to stay afloat managers have had to get much more creative with organising their resources and significantly reduce overhead without negatively impacting the customer experience.

Post-recession (if I can call it that), casinos in countries with rigid labour laws and/or poor management have seen labour costs as a proportion of post gaming tax revenue soar to 70% or more as revenue has declined. This is impossible to sustain and something must give. Usually, gaming tax and local taxes go unpaid and payment terms to suppliers are extended whether voluntarily or not. Some owners stuck their heads in the sand and just hoped things would improve. The operating environment has become so bad that in many cases the owners are looking for injections of capital from third parties and perhaps third party management too or they are looking to sell.

The municipality of Venice recently tried to sell the loss making Casino di Venezia, actually two casinos, through a public tender. The terms of the tender were complicated but reading through the material it appears the municipality was expecting up-front payments and further guarantees of hundreds of millions of Euro for a loss making business. To make matters worse the unions had demanded that the municipality sign an agreement with the unions guaranteeing that the number of employees would not be cut and existing salary levels maintained for seven years! This was the price the municipality had to pay to get the unions on board with the sale. Not surprisingly this was the death knell and no companies lodged expressions of interest. It is beyond me that the municipality and their advisers expected someone to pay to take over a loss making business but not be able to cut the largest expense item on the P & L?

A number of owners of troubled companies have asked us to find operators who would be willing to take over the management and provide equity capital. The challenge is that when you look at their balance sheets the equity has no, and in some cases negative, value. Valuations for businesses are no longer 6 or 8 times EBITDA. Although borrowed money is cheap valuations are now running at 3.5 to 4 times and even less for businesses in locations perceived as “high risk”.

How can they hope to attract an investor when their balance sheet is in such bad shape? The outlook is not good. Businesses have to be valued on their current results and not what they could be with a turnaround; an investor/operator is not going to want to pay for the value that they create. Deals can be structured whereby new capital and management get a bigger piece of the upside but current owners need to get real about what it is they are bringing to the table.

Our advice to owners who find themselves in this situation is, if they can avoid it, not to raise external capital now; raising capital in their current condition will be the most expensive deal they ever do. If they have some capital of their own to inject, enough to buy some time, is put together an urgent cost reduction plan that gets them to positive cash flow as fast as feasibly possible. The owner will need sufficient cash to keep the business afloat until it gets to positive cash flow and make sure they have extra for contingencies. They will also need a management team that is up to the task – this is not as easy as it appears.  A sense of urgency is critical; things can and do happen very quickly. Staff and lenders need to know how bad the situation is and what the consequences of failure will be. Also, as we have seen in some cases, the plan cannot be dependent on investing and growing revenues just a rapid reduction in costs. Once positive EBITDA has been achieved discussions can then start with potential equity investors but don’t expect a “good deal” if your equity is still under water.