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Hangover:  Capital Allocation, the Pursuit of Luxury & Competitive Dynamics in Gaming

JAN JONES ● 2010. Hangover:  Capital Allocation, the Pursuit of Luxury & Competitive Dynamics in Gaming. LET THE GOOD TIMES ROLL. Consolidation Accelerates. Harrah's buying Caesars – The $5.2B cash and stock deal would create the world's largest casino operator.

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Hangover:  Capital Allocation, the Pursuit of Luxury & Competitive Dynamics in Gaming

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  1. JAN JONES ● 2010 Hangover:  Capital Allocation, the Pursuit of Luxury & Competitive Dynamics in Gaming

  2. LET THE GOOD TIMES ROLL

  3. Consolidation Accelerates Harrah's buying Caesars – The $5.2B cash and stock deal would create the world's largest casino operator. MGM Grand to Acquire Mirage Resorts for $4.4 Billion By ANDREW POLLACK Published: March 7, 2000 July 15, 2004: 10:16 AM EDT MGM Mirages Offers $7.9B For Mandalay Penn National Gaming to acquire Argosy Gaming Co. Tara Murphy, 06.14.04, 10:00 AM ET Wednesday, November 3, 2004

  4. Technology Makes Profound Advances Major Efficiency Achievement For Operators Guest’s Gaming Experience Meaningfully Enhanced 2010+ 2000’s 1990’s Slots accept bills (eliminating coins-in) Slot machines accept mailed offers Linked progressives Hybrid and community games Touch-screens introduce interactive elements Multi-line low denom. games Tickets replace cash in slots Multi-denom. games

  5. Cheap & Abundant Capital Fuels Development Corporate Bond Spreads Bond Spread to Treasuries

  6. A Dramatic Shiftoccurs in theGaming Industry

  7. The Tide Goes Out U.S. Commercial Casino GGR & Stock Appreciation 10% GGR Decline Gaming Stock Composite (1) Gaming Stock Composite Price Index (1) GGR ($ bn) (2) GGR ($ bn) (1) Domestic focused gaming stocks indexed to 100 at December 31, 1999 (2) As reported by the American Gaming Association

  8. The Tide Goes Out Unprecedented Luxury Capital Investment Consolidation Slows High Taxes Dominate New Jurisdictions Regulatory Tightening Modest Technology Advancement Scarce and Costly Capital

  9. Increasingly Burdensome Tax Rates Effective State Gaming Tax Rates Active Rates (1) Pending Rates (2) (1) American Gaming Association 2009 State of the States survey (2) Company estimates based on publicly available information

  10. Stranded or Restructured Properties

  11. Industry Pricing Dynamics Discounting Excess Supply Perishable Product Low Marginal Cost

  12. LET THE GOOD TIMES ROLL

  13. LET THE GOOD TIMES ROLL

  14. “There is a global market for only five computers”IBM Founder Thomas Watson “Everything that can be invented has been invented”US Patent Office Commissioner Charles Duell, 1899 “Man will not fly for 50 years”Wilbur Wright, 1903 “The Japanese auto industry isn’t likely to carve out a big slice of the U.S. Market for itself”Business Week, 1968 “640k ought to be good enough for anybody”Bill Gates “I don’t need bodyguards”Jimmy Hoffa

  15. LET THE GOOD TIMES ROLL

  16. Online Gaming – A critical tool for brick and mortar casinos Offers best growth opportunity given current market factors Will increase, not cannibalize, gaming revenues and profits Will attract more Gen X and Y customers Will add distribution channel to all customer segments

  17. Attractive economics Cost of entry in online gambling is lower than in traditional casinos which allows large and small operators to enter market – alone or through networks Upfront costs Ongoing costs Online Business Model Software1 $ Millions E-Commerce $ Millions Jurisdiction fee $ Thousands Licensing % of revenue Marketing % of revenue Build own website  5-15 0.5-1 100K - 500K 30-40 License agreement with software providers   100K - 500K 5-302 30-40 • $300M - $500M up-front cost for traditional casinos3 300-500M 5.1-17M * * 1 Includes affiliate network cost 2 Sports betting (5%), Poker (10-25% of rake), casino (10-30% of gross winnings) 3 Based on ~1,000-room tower with additional amenities SOURCE: Press search, company websites

  18. Attractive economics Margins and cash flow generation are very strong … resulting in strong free cash flow generation that can drive growth and investment in the brick and mortar facilities Key principles * EBITDA margin Several factors drive margins and cash generation … 27% * • No material fixed assets, therefore no material capital expenditure • Operators benefit from a negative working capital (customers leave cash with operators) • Networks allow operators to enter the market and compete Overall purpose 24% * * 28% * 30% * 22% SOURCE: Z-Man’s Gaming Almanac 2009

  19. Under 40 Mix of new customers by age-group Percent Mix of new customer by age-group Percent Over 40 Online gambling helps target customers better While the 40+ age-group currently provides 85% of our income … .the gambling market is moving towards a younger demographic … and they now account for a larger portion of the total spend There are more young people in the new visitors that visit casinos today … CAGR * 785K 880K CAGR * $138M $134M * * 5% 8% * 0% * 3% * * * * * -2% * 1% * * * * * * -1% 1% -1% * * * * -1% * * -1% 2% * * * * SOURCE:, McKinsey analysis

  20. Online gambling will benefit all stakeholder Increase share of budget of existing customers by using aggressive cross-selling techniques Increase offline visits and spend Initiate online participation and spend • Lucrative sign-on bonus for local players based on offline spend • Free online $ for regular offline players • Free entry to online tournaments • Online points redeemed offline for as room and spa comps • Targeted coupons and promotions based on online play • Rapid progression to VIP status based on online play • Facilitate spend from online account during offline visits SOURCE: McKinsey analysis

  21. Internet gaming is likely to increase gaming industry revenues & profits and not cannibalize them Retailers have adopted innovative cross-channel strategies that could translate well to the gaming industry to incent online customers to casinos Strategy Implication for gambling Retailer • Significantly expanded assortment online to cater to the “long-tail” • Offer low-popularity slot and table games online to improve utilization ($/sq. ft.) of casino space • Offer coupons online that can be redeemed in the casino to increase multi-channel spend • Created promotions on website to drive customers to store and increase in-store spend • Identify low-worth and high-worth customers to encourage low-worth segments to gamble online and high-worth segments to play at casino • Built customer database fn ~60M households to improve focus on cross-channel data and insights SOURCE: Company websites, SEC filings, Internet Retailer 2007, Business week, McKinsey analysis

  22. …..and those retailers that have not adapted to the on-line market are facing severe competitive challenges or have gone out ofbusiness • Recording Industry (iTunes v. Tower Records) • Newspapers (Google news v. Local papers) • Britannica Encyclopedia v. Wikipedia • Sotheby’s v. EBAY

  23. US online gross yield $ Billions Online with liberalization Current online market Pre-UIGEA1 +31% p.a. +29% p.a. +1% p.a. Liberalization of online gambling presents a very large opportunity … Current trajectory Projected growth with liberalization CAGR 2013-17 * * * 31% UIGEA1 bill passed * * * Potential liberalization * * * * 1% 21% * * * * * * * * * * * * * * 2017 1 2006 Unlawful Internet Gambling Enforcement Act SOURCE: H2 Gambling Capital; Morgan Stanley Research

  24. LET THE GOOD TIMES ROLL

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