The Golden Goose: Proper Care and Feeding
The new paradigm of declining economic conditions across a wide range of consumer spending presents casinos with a unique challenge: how to keep profitability high while remaining competitive. These factors are compounded in the casino sector by rising tax rates. In the Indian gaming industry, self-imposed contributions to tribal general accounts and/or per-capita distributions and a growing trend of state-imposed fees add to the complexity.
The daunting task of determining how much to “renderunto Caesar”, while still retaining the necessary funds to increase market penetration, market share, and profitability is one that must be carefully planned and executed.
This context is the basis of this article. The author has extensive experience in managing these types of investments and has time and grade in developing them.
While it seems obvious to not cook the goose that lays golden eggs, it is astonishing how little care is given to it. The advent of a new casino has brought about a lot of excitement for investors, tribal councils, and financiers. They are eager to get the financial rewards, but there is a tendency to not allocate enough of the profits to asset enhancement and maintenance. The question arises as to how much of the profits should go towards reinvestment and what goals.
Each project is unique and each has its own set of circumstances. There are no clear rules. Many of the largest commercial casino operators do NOT distribute net profits as dividends. They reinvest these profits in improvements at existing venues, while also looking for new locations. These programs can also be funded with additional debt instruments and/or stock options. While the tax rates on dividends paid by corporations will be lower, this will shift the focus of these financing methods while maintaining the core business prudence in reinvestment.
Publicly held companies, as a whole, had a net profits ratio (earnings before taxes & depreciation), that averaged 25% after deducting gross revenue taxes and interest. The average profit is used to reinvest and replace assets.
In low-tax gaming jurisdictions, casinos are more likely than others to reinvest their profits in their properties. This helps boost revenues and ultimately the tax base. New Jersey is a good case in point, as it mandates certain allocations of reinvestment as a revenue stimulant. Illinois and Indiana have higher effective rates. They run the risk that reinvestment will be reduced. This could lead to a decrease in the casinos’ ability to grow market penetrations. Effective management, which is a combination of efficient operations, favorable borrowing and equity offerings, can lead to higher profit available for reinvestment.
It is critical that a casino enterprise determines how it will allocate its casino profits. This decision should be part of the initial development strategy. Although it may seem appealing to pay off short-term loans quickly and avoid debt prepayment obligations, these programs can reduce your ability to reinvest/expand promptly. This holds true for all profit distributions, whether to investors or, as in the case with Indian gaming projects distributions to the tribe’s general funds for infrastructure/per capita.
Additionally, lenders often require excessive debt service reserves and place restrictions upon reinvestment or additional leverage. This can severely limit the ability of a project to remain competitive and/or meet any available opportunities.
We don’t recommend that profits from the operation be returned to the company, but we encourage the creation of an allocation plan that considers the actual costs of maintaining the asset while maximizing its impact.