Daily Record, The (Baltimore): MD Tax Education Foundation releases study on slot machine revenues

Jeff Hooke, an investment banker who also is on the board of the Maryland Tax Education Foundation, recently authored an analysis of the profitability of a Baltimore slots facility. The premise was based on an outlet that pays a $100 million licensing fee and retains 25 percent of the slots win. MTEF, a non-partisan, nonprofit organization in Rockville, does not advocate the introduction of slot machines into Maryland, according to Hooke. But if the state approves slot machines, MTEF believes the state should receive the best possible economic deal, whether from racetracks or other third parties, the group says. The study used for this q&a was reviewed by investment bankers Peter Gavian of Corporate Finance of Washington and Bill Pearce of Emerging Markets Partnership, and economist David Curry.

Stepping outside the usual format, The Daily Record is reprinting the q&a that accompanied the study.

What are the conclusions of MTEF's study?

The study concludes that the proposed slots monopolies will be highly profitable. Accordingly, the facility can support higher license fees, which are tax deductible. This study contradicts published reports in which the racetrack owners indicate that under the proposed arrangement, their slots facilities will lose money.

How much daily win can the Pimlico slots facility expect per slot machine?

In similar high-population-density areas, such as suburban Chicago and downtown Detroit, the daily win per machine (i.e., the daily profit after payments to bettors) ranges from $400 to $500 (Detroit) to $400 to $750 (Chicago). These areas have more competition than Baltimore, suggesting that Baltimore's win should exceed this range per machine per day. This analysis uses $600 in win per machine per day.

Baltimore will have far fewer slot machines per capita than either Detroit or Chicago. This disparity suggests unfulfilled demand and higher usage (i.e., higher win). For example, a Baltimore area with 12,000 machines might yield $400 in win per machine per day; if only 3,000 machines were available the win would be much higher. For this reason, the analysis uses $600 per day.

How much annual revenue is $600 in daily win per machine?

The Pimlico facility can expect $657 million in annual gross revenues (i.e., 3,000 machines x 365 days x $600). The analysis assumes a 25 percent participation rate for the track in the slots' revenues. In dollar terms, this annual revenue equals $164 million. The remaining 75 percent goes to the state, local governments and purses.

The track owners say the proposed arrangement isn't enough to pay operating expenses. Is that true?

Slot machine facilities are highly automated, and have fewer costs per revenue dollar than many other forms of entertainment, such as restaurants, sporting events and motion pictures. Furthermore, this analysis assumes the State of Maryland pays for the slot machines, which represent one of the largest single expense categories.

We estimate annual operating expenses of the Pimlico slots facility to be $98.6 million, which is 60 percent of annual revenue of the facility. Larger casino companies that provide labor- intensive table games (craps, 21 and roulette) and hotel rooms have operating expense-to-revenue ratios of 70 percent to 75 percent.

How did MTEF derive this number?

We analyzed the expense margins of Dover Downs Entertainment, excluding its hotel and harness track. We also reviewed the operating expenses of Charles Town Raceway, excluding its horse track and new parking structure. We considered the expense requirements of a number of larger gambling companies. Our conclusions were then applied to the proposed Pimlico facility. By way of example, we project Pimlico's annual operating expenses to be more than double the operating expenses of Dover Downs.

What is the forecasted pre-tax, pre-interest profit then?

Earnings Before Interest and Taxes (i.e., EBIT) equals net revenue ($164) minus operating expenses ($98.6), or $65.4 million per year.

How much is the construction cost of a new slot facility?

The new slot facility will require a building of 100,000 square feet. This will be the size of a large Wal-Mart store, but it will require more expensive furniture and fixtures. Dover Downs spent approximately $31.5 million for its 80,000-square-foot facility. This analysis uses $50 million, or 61 percent more than Dover Downs' cost to reflect Baltimore's more expensive construction environment and larger size.

Won't the Baltimore slots facility require a new hotel and new parking lot?

No. Baltimore has thousands of hotel rooms. The Pimlico racetrack has a massive parking lot that is 90 percent empty for most days of the year. Similarly, Rosecroft and Laurel will not need expensive hotels or parking lots. Adding a mid-sized hotel of 300 rooms might cost $50 million to $60 million. The hotel would generate income, but its return on investment would be less than the pure slots facility.

Won't the slot facility need lots of working capital?

No. Slots are a cash business, like supermarkets, which typically have negative working capital. They receive payment for goods and services from their customers immediately, even though their suppliers wait 15 to 30 days before receiving payment.

The up-front cost looks like $100 million for the license and $50 million for the building. If you include furniture and fixtures of $10 million and start-up costs of $10 million, the initial investment is $170 million. Will the forecast profit cover this investment?

Yes. The facility is profitable from Day One. Its projected return on stockholders' investment is 36.5 percent. Most publicly-traded companies return 15 percent or less. U.S. Treasury Bonds yield 4 percent.

What about the briefing given by the state Department of Legislative Services?

In this particular case, the Legislative Services Department used outdated information, such as a presumed $217 daily win per machine, which bore little relevance to Maryland's demographics and daily win in comparable localities. MTEF's estimate of daily wins has been widely distributed in Annapolis since September 2002.

How much can former Maryland Jockey Club owners expect to earn from the slot facilities?

A number of the former MJC owners have agreements with Magna Corp. that provide them with a stipulated percentage of the slots facilities' pre-tax income after amortizing the costs of capital investments and license fees. Based on our analysis, a former owner with a 12.5 percent share of this adjusted pre-tax income would receive approximately $8 million per year, assuming the former owner's share of the initial investments is borrowed, amortized over 10 years, and deducted from his cash allocation. A number of other individuals, estates and partnerships will also share in the slots income.

Will the other slots facilities be equally profitable?

Laurel's results should be slightly below Pimlico's. Due to its proximity to Northern Virginia and Metropolitan Washington, we expect Rosecroft to exceed Pimlico's results.

After it is successfully in operation, how much could the Baltimore slots facility be sold for?

If it has the same P/E multiple as Dover Downs Entertainment (DDE), it would have a value of $438 million.