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  • Factors Affecting Profitability at Casinos in the Competitive Northeast

    PreparedBy:

    GGH - Morowitz Gaming Advisors, LLC & Global Gaming & Hospitality, LLC

    February2017

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    INTRODUCTION

    Casinogamingisamaturingindustry.TheproliferationofgamingthroughouttheUnitedStatesmeansthatalmosteveryAmericanhas,orwillhave,convenientaccesstoacasinowithincloseproximity.Thismaturationhashadprofoundimpactsonthelegacygamingoperations.Operatorscannolongerrelyonroomexpansionorothercapitalexpenditureprojectstoinducegrowthorcreate reasonable returnson invested capital.Revenues inalmosteveryU.S.market (exceptthosewithnewgamingsupply)haveexperiencedanemicorevennegativerevenuegrowth.Thecasino industry is now firmly entrenched in a new era of share stealing and hypercompetitiveness.Operatorsmustnowrationalizetheirofferingsandrepositionthemselvestocompetemoreeffectivelyinthisenvironment.

    GlobalGaming&HospitalityandMorowitzGamingAdvisors(GGH)acknowledgetherealityofthisdilemmaandarecommittedtoprovidinggamingoperatorsandinvestorswithanalyticsthatcanhelpthemoptimizethefinancialperformanceoftheirgamingoperationsandinvestments.In that regard,we have undertaken a project to codify our observations analyzing gamingoperationsthroughouttheU.S.,whileprovidingourperspectiveregardingongoingtrendsandbestpracticesinthemanagementofcasinooperations.ThisisthefirstofaseriesofWhitePapersthataredevotedtoinforminggamingoperatorsoftheresultsofouranalysesaswellasprovidingactionablerecommendationstoenhanceoperatingperformance.

    TheNortheastcasinomarketplaceisoneofthemostcompetitivegamingmarketsintheU.S.and,therefore,hasexperiencedsomeofthemostsignificantimpactsofcompetition.Theanalysisthatfollowsfocusesonthisdynamicallycompetitivemarket.

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    EXECUTIVESUMMARY

    GGH recentlyanalyzeddata in thecompetitiveNortheastgamingmarket.Weundertook thisanalysisinordertoidentifythedriversofprofitabilityamongasampleofcasinoswhoreportthisdata, including the importance of promotional allowances and free play. The results of ouranalysisareinterestinginthattheyshowthatdrivingprofitability(definedasEBITDA)isnotjusta functionof tax ratesormarketingspend.There ismuchmore to thestory. As thegamingindustrymaturesandmarketsbecomemorecompetitive,managingtheinterplaybetweentaxes,marketingspendandoperationalcomplexitywillbecomeofcriticalimporttoalloperators.Ouranalysisindicatesthefollowing:

    Drivingrevenueperunitcapacityvs.peersisthemostimportantpredictorofprofitabilityandnetoperatingmargin(EBITDA/NetRevenues).Thisabilityisrelatedmostlytolocation(proximity topopulation concentrations)and then tooverall strategicpositioningandexecution; however, achieving high revenues relative to capacity requires the rightbalanceofamenitiesand facilities fortheparticularmarketandcompetitivesituation.Achievingthatbalancerequiresdiligenceamongoperatorstonotoverspendonfacilitiesoramenitiesthatareoftenlowornegativeprofitmarginproducers.

    There isno correlationbetweenhigh taxesandmarginsbecauseprofitableoperatorsadjustmarketingstrategiesandoperationalcomplexity(i.e.mixofamenitiesandcapitalspending)inordertomaximizeEBITDAmargins.

    Optimizingpromotionalallowancesandfreeplay iscriticaltoachievinghighmarginsCasinosthatoverusefreeplayandpromotionalallowancestomaximizerevenuemaybedoingmoreharmthangoodtotheirbottomline.Moreisnotalwaysbetterasoftentimescasinosspendtoomuchonlowprofitorunprofitablecustomers.Achievingtherightmixof spend requires an understanding of the casinos positioning in themarket and adisciplinedapproachtodeploymentofpromotionalallowancesexpenditures.

    Inahypercompetitivemarket,forpropertiesthathavetodomorewithless,understandingyourpositioninthemarket,focusingonthecorecustomeranddevelopingavaluepropositionforwhichcustomersarewillingtopay,whilereducingoverallmarketingspend,isthebeststrategytoproducinghighermarginsandEBITDA.

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    THEANALYSIS

    InthecompetitiveNortheastgamingsector,gamingtaxes,marketingcostsandpayrollarethethreelargestexpensesonthecasinosprofitandlossstatement.Asthegamingindustrycontinuestomatureandrevenuegrowthisnolongerassured,managingtheseexpensecategoriesisthekeytomaintainingorgrowingoperatingmargins.Laborcostsaretypicallymanagedthroughsophisticatedprocessessuchasbalancingstaffingtodemand,optimizingtheparttimeandfulltimeemployeemix,andreplacinglaborwithtechnologyandcapitalinvestmenttoenhanceproductivity.

    Insomejurisdictions,likeNevadaandAtlanticCity,gamingtaxesarefixedandappliedtobothslotandtablerevenuesatthesamerates.However,inmanyotherjurisdictions,tablerevenuesaretaxedatratessignificantlylowerthanslotrevenuesandbalancingtheinteractionoftheserevenuestreamsisextremelyimportanttooptimizingoperatingprofits.

    Marketing costs, includingpromotionalallowances,area controllableexpensearea inwhichcasino operators canmanage the often significant impact on their propertys bottom line.Optimizingmarketingcostsrequirestheoperatortohitthesweetspotwherethemarginalreturnonmarketingdollarsremainspositive that is,the lastdollarofmarketingexpenseresults inmorethanadollarofadditionalrevenue.Unfortunately,manyoperatorsdonotuseasystematicapproachtoidentifying/deployingthesecostsonaperplayerorpertierbasis,whichoftentimesresultsinoverspendingonlow(ornegative)margincustomerretention.

    InthehypercompetitiveNortheastgamingsector,managingtheinterplaybetweenmarketing,gaming tax rates and promotional costs can be the difference between success and failure,includingoperatingatapremiumtotheMarketsaverageprofitabilitymarginsor,conversely,atadeficit.CompetitionintheNortheastheatedupattheendof2006,withtheopeningofcasinosinthePoconoMountainsandatYonkersRaceway,whichalteredtheprevioussupply/demanddynamic. Consequently, since the end of 2006, theNortheast andMidAtlantic states havebecome a hypercompetitivemarket place,with 53 casinos serving patrons in almost everygeographicareafromMarylandthroughMaine.

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    To identify the best approaches to achieving profitability, GGH analyzed casino tax rates,promotional costs (including free play), gaming revenues and operatingmargins from 2007throughthepresentatseveralcasinosintheNortheastthatreportthisdatapublicly.

    Our analysis indicates some important trends. First, tax rates are not themost importantdeterminantofnetEBITDAmargins.Second,theabilitytodriveoutsizedgamingrevenueisthemostimportantdriverofmargin,regardlessoftaxrate.Third,promotionalallowancesandfreeplay are an important part of a casinos ability to drive gaming revenue andmargins, andultimatelyinwhetheracasinosucceedsorfailsasaconsequenceoftheeffective,profitableuseof these tools.Conversely,overspendingordeployingpromotionalallowancesand freeplayineffectivelycanhaveahighlynegativeimpactonprofitability.Achievingthecorrectbalanceinpromospendiscritical.

    TaxratesarenotthemostimportantdeterminantofNetEBITDAmargins.

    Casinos in theNortheastoperateunder significantlydifferent tax regimes,dependingon thestateoforigin.Connecticut imposesnotaxontablerevenuesbuta25%taxonslotrevenues.Pennsylvaniaimposesanapproximate54%taxonslotrevenuesanda16%(previously14%)taxontablerevenues.AtlanticCitychargesonetax(9.25%)onbothslotandtablerevenues.1Yetmanyofthecasinosinthesedifferentstatesultimatelycompetewitheachotherforthesamecustomers. Importantly, our analysis indicates that tax rates are not the most importantdeterminantofoperatingmargins,especiallyinmorerecentyears.

    Beforecompetitionheatedup,mostoftheAtlanticCitycasinosoperatedatfairlyhighmarginsbecause of favorable gaming supply/demand metrics. However, as competition increased,

    1Gamingtaxratesarebasedonstatutoryratesindifferentstates(seestateregulatorybodiesforexplanation).

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    revenuesdeclinedatmanycasinosandmarketingcostsincreased,leadingtolowerprofitmarginsandfailuresatseveralcasinos.

    In2016,themarketstabilizedandthecasinoswiththehighestmarginswereMoheganSuninConnecticut, theBorgata inAtlanticCityandSandsBethlehem inPennsylvania casinoswithwidely disparate tax rates. As the following charts indicate, these casinos owe their highermarginstoacombinationofhigherrevenuesandmoreefficientuseofpromotionalallowancesandfreeplay.

    NortheastBenchmarksEBITDAMarginsandTaxRatesSince2007

    Source: Company earnings releases and public filing and State gaming commission reports

    GGHanalyzedtherelationshipbetweentaxratesandmarginsfurtherbyregressingtaxratestoEBITDAmarginsfor2016.Theregressionanalysisindicatesthatthereisvirtuallynocorrelationbetweentaxratesandmargins,withlowertaxedcasinosexhibitingawidevariationinmargins,while,somewhatparadoxically,highertaxedcasinosgenerallywereamongthehighestmargincasinos.GGHconcludesthatthehighertaxrateenvironmentrequiresgamingoperatorstoutilizeefficiency strategies, including facility capital investment, marketing spend and amenityavailability,thatresultinastreamofrevenuesthatachievehigherprofitmargins.

    2007 2008 2009 2010 2011 2012 2013 2014 2015 2016MoheganSunConnecticut 17.3% 17.0% 17.4% 17.3% 16.9% 16.9% 16.3% 16.3% 16.3% 16.0%MoheganSunPocono 55.0% 55.0% 55.0% 52.0% 48.6% 48.0% 47.1% 46.0% 46.2% 46.7%SandsBethlehem 55.0% 50.6% 42.4% 41.0% 38.6% 37.6% 36.9% 36.6%AtlanticCity 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 9.3%

    2007 2008 2009 2010 2011 2012 2013 2014 2015 2016MoheganSunConnecticut 26.1% 21.8% 23.2% 22.3% 25.6% 24.9% 27.0% 25.2% 28.5% 29.5%MoheganSunPocono 15.9% 14.1% 15.2% 15.4% 10.4% 18.6% 19.0% 17.1% 19.6% 17.8%SandsBethlehem 0.0% 0.0% 11.4% 19.5% 22.7% 24.2% 24.8% 23.9% 24.7

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