A New Way to Play the Gambling Sector...And Win

By Bill Edson - March 8, 2013 | Tickers: CZR , MGM , ZNGA | 0 Comments

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Zynga (NASDAQ: ZNGA ) is a very interesting way to play online gambling. Unlike brick-and-mortar casino resorts, it does not require extensive capital expenditures to scale up operations. If virtual gaming becomes a more mainstream investment thesis, it could rival Macau as a growth story and be a perceived driver of growth in the gaming industry.

Problems With Brick and Mortar

Despite the glitz, operating casinos is a tough business. Even the hospitality business is more attractive.

Consider the case of MGM Resorts (NYSE: MGM ) . It posted a net loss of $1.2 billion in 2012, or $2.50 per share, compared to a loss of $113.7 or 23 cents the previous year, largely due to write-offs of land holdings. MGM decided to discontinue plans to construct multi-billion dollar resorts, recording land related charges of $366 million in Las Vegas and $167 million in Atlantic City. “Instead of resorts, we build new nightclubs, entertainment complexes, improving our room product. We have found a return on investment for that capital is much higher than building a new resort,” Murren said in an interview.

Will Zynga Hit the Jackpot?

Zynga might be able to realize new revenue growth opportunities based on online gambling recently being legalized in the state of Nevada. The company will soon be able to engage in real-money wagering. Zynga currently sells virtual goods that can be utilized in its Facebook games. Zynga’s investors can sigh in relief because legalization provides the company with a new avenue for growth. So far the company has been stymied by the shift in consumer interest to mobile device gaming.

Fortunately, the company has already signed a real-money gambling deal with Bwin.Party Digital Entertainment to provide this type of gaming to U.K. consumers. The legalization in Nevada is expected to inspire legalization in other U.S. states. Analyst Edward Williams of BMO Capital Markets said , “As states legalize some form of online gaming, you’re likely going to see Zynga positively impacted.” This new income stream is expected to bring revenue contributions “in the billions.”

Caesars Entertainment (NASDAQ: CZR ) , through Caesars Interactive Entertainment, also took advantage of Nevada’s legalization of online gambling as the company acquired Bingo Blitz. This will expand Caesars’ reach into the social and mobile markets. Caesars recently published its 2012 fourth quarter and full year results . Revenues for the fourth quarter declined from $2.1 billion in the same period in 2011 to $2.0 billion, a 4.3% drop. This was primarily due to property closures caused by Hurricane Sandy. The amount of destruction caused by the weather-related condition has slowed the economic recovery of the Atlantic City region.

The opening of Horseshoe Cleveland in May 2012 and Caesar’s online business segment, luckily, have offset revenue declines due to the property closures; this brought at least a minimal increase in 2012 net revenues for the company of $13.4 million or 0.2% from the previous year. “Trips,” a performance measure for gaming activity declined 10.9% in the fourth quarter of 2012 for Caesars compared to the same quarter of 2011 and declined 4.1% for the entire year. Spend per trip, however, increased 6.2% in the fourth quarter and 0.9% for the whole of 2012. The noticeable rise in the fourth quarter was primarily due to a strong performance of the company in the international high-end segment.

Las Vegas Sands , MGM Resorts, and Wynn Resorts , the three largest casino operators in the world, are also trying to cash in on the potential of online gambling. However, there could be too many firms entering this new market at once. CEO Mogul Sidney Adelson of Las Vegas Sands expressed such concerns. Las Vegas Sands President and COO Michael Leven, however, announced during the Global Gaming Expo last month that the company will pursue this new gambling market. MGM CEO James Murren, in support of the American Gaming Association’s position to take into consideration the protection of consumers through the intervention of the Federal Government, said , “Americans are illegally gambling today online with no protections whatsoever whether they’re underage or have any type of addictive behavior.”

Valuation

Zynga is attractively priced relative to physical gaming stocks:

Only Caesars and MGM are cheaper on a price-to-sales basis, though they are highly leveraged. Zynga’s regular operations have higher growth expectations than all of the brick and mortar gaming stocks except Melco Crown .

Conclusion

Zynga is the best way to play online gambling. It is priced as a value stock but could be able to capitalize on online gaming as a new source of revenues, and ultimately earnings. Its balance sheet is stronger than many brick and mortar casinos, and it has a more established online presence.