The Impact of a Depression on Legal Gambling

written by I. Nelson Rose

#152 © Copyright 2009, all rights reserved worldwide. Gambling and the Law® is a registered trademark of Professor I Nelson Rose,

“Buy when there is blood in the streets, even if the blood is your own.”

Baron Nathan Rothschild

This is not just an economic recession – it’s a worldwide depression.

The distinction is important, like the difference between neurosis and psychosis. A neurotic may have problems, even severe, distressing ones. But a psychotic has at least temporarily lost touch with reality.

The legal gaming industry is facing a psychotic global economy.

Take, for example, Penn National Gaming’s common stock. In mid-2008, the company was in the final stages of being acquired by bank-financed private equity funds, when the credit crisis hit. The banks were desperate to get out of the deal, but Penn Gaming’s lawyers had done a great job writing in protections for the company. So, the would-be buyers gave Penn Gaming a non-refundable $700 million in cash and another $775 million in what amounts to an interest-free loan – $1.475 billion – to not buy the company.

The stock market reacted by driving the price of Penn Gaming’s common shares down from the mid-$40s to $11.82. With about 90 million shares outstanding, this gave the company a market capitalization of $1 billion.

Forget about the company’s four Argosy and four Hollywood casinos, its three other casinos, including the Empress Joliet and nearly a dozen OTB facilities and racetracks, some with slot machines, including Penn National Race Course. The market put a value of $1 billion on Penn Gaming’s $1.475 billion in cash.

(Of course, the company has debts. But it was having no trouble making its payments even before receiving the cash windfall.)

This reflects another characteristic of a depression that is not normally found in a recession: deflation, when prices plummet way past what items are worth. Las Vegas casinos are now giving away hotel rooms to locals, literally for free. Even non-residents can find recently renovated rooms on the Strip for under $30.

So, while most of the major casino companies are struggling to fend off bankruptcy, the lucky few with cash, and courage, are picking up bargains. Bargains, that is, unless things get even worse and stay there for years.

Economic depressions have immediate impacts on gaming law. I have had more than one large U.S. investor hire me to advise them about bankruptcy procedures – in Macau. Gaming companies are so international that bond-holders of American casino companies want to know about loans secured by property in Asia, even though the casinos in Macau are making far more than their U.S. counterparts.

Unlike a recession, a depression is worldwide. The Great Depression was long-lasting and horrible, hitting country after country. What makes this depression so frightening is that the economic crisis didn’t take years to spread, only days. The pieces of the global economy are so interconnected and communication is so instantaneous that the U.S. gaming industry would have been hurt, even if major casinos had not committed themselves to spending billions in Macau and Singapore.

Of course, it was the enormous borrowing to fund takeovers and expansions at home and abroad that created the threat of bankruptcies. Lenders had insisted on covenants, such as debt to equity ratios, that seemed reasonable when a casino company’s stock was at $140 a share. But a company can find itself in technical breach when its stock slides below $10.

In a depression virtually all business dries up. The two million Americans who lost their jobs in President Bush’s last year are not buying cars, or taking vacations. So cash flow has constricted everywhere, cutting off money that would have been used to make required periodic payments on bonds and other debts. And since one of the major sources of the economic crisis was a worldwide credit freeze, companies cannot easily refinance.

Economic depressions can cause industries to topple like dominoes. Gaming revenue is way down, so purchases of slot machines have been put off. Which means slot manufacturers don’t need as many parts from their various suppliers. This hurts not only the manufacturers and suppliers, but the truck drivers who deliver the goods.

Legal gaming is a service industry. Casinos can’t afford to sell hardware like slot machines, but they can lay off personnel.

The multiplier effect works both ways: If every job directly created by a casino means two or three indirect outside jobs are created, then what happens when the casino job is lost? For example, laid-off employees and their families don’t eat out as much, hurting restaurants and their workers in the casino town.

All segments of the industry are looking for ways to save money. One of the most interesting, legally, are gaming tribes reexamining their compacts. The most dramatic example was the startling announcement from Sycuan, near San Diego, that it would forego both building a second casino and expanding its 2,000 slot machines to 7,500. Instead, the tribe will be putting in Class II machines. The primary reason, besides business being slow and money for expansion being hard to get, is that the tribe had agreed to give the state of California 25% of its slot machine revenue, but nothing on its Class II devices.

Governments, especially state and local ones, are businesses, in that they have to match their expenditures with their revenue. Unlike the federal government, which can simply print more money, states often are required to have balanced budgets. So legislators and governors, who which always hate to cut services, have to come up with ways to raise revenue.

The easiest taxes to raise are the sin taxes. The theory is that people should not be gambling, drinking and smoking anyway, so why not soak them? Plus, economists and legislators usually see gambling as a vice, not as entertainment. Vices are inelastic, meaning buyers will purchase the same quantity regardless of the price.

Of course, in the real world, casinos compete not only against other casinos, but also against racetracks and theaters and Starbucks®, any place people can spend their disposable income.

Legislators have to understand that if they raise gaming taxes they will cost the state jobs, and eventually revenue. The best example is Illinois: When the state raised the top gaming tax rate to 70%, casinos killed expansion plans.

The good news is that economic depressions call for radical cures. Atlantic City would never have reversed its ban on smoking during normal times. Top officials in Delaware, grandfathered-in under the federal Professional and Amateur Sports Protection Act, plan to legalize sports betting in the next few months. I have advised the Washington State cardclubs that now is the time to push for the right to have a small number of slot machines, to level the playing field with tribal casinos, raise state revenue and create jobs.

So, if Obama and the other world leaders can get us out of this mess, we will look back on Depression 2.0 as a time not only of despair, but of opportunities.

© Copyright 2009. Professor I Nelson Rose is recognized as one of the world’s leading authorities on gambling law and is a consultant and expert witness for governments and industry. His latest books, Internet Gaming Law and Gaming Law: Cases and Materials, are available through his website,

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