Mr. Brewer III

Hospitality Law

Rolling the Dice: There May Be Risks When Hospitality Companies Put Their Brand on Gambling

By William A. Brewer III, Co-Founding & Co-Managing Partner, Bickel & Brewer

According to the Greek philosopher Heraclitus, "The only constant is change." The leisure industry, not unlike other industries, is in a state of constant transition. With change comes risk; the risk associated with entering a new business, and the risk of lost opportunity. As recently as 1978, Nevada was the only state to offer casino gambling.

However, significant developments have taken place in the latter half of the 1990's, as the number of states permitting casino gambling increased from one, to 27 by the new millennium. Casinos can now be found on riverboats and in resort locations, perhaps with the most explosive growth occurring on Indian reservations. Not surprisingly, with the expansion of casinos and the popularity of commercial gaming, Nevada was one of the fastest growing states during the second half of the 20th century.

High Stakes: Gambling Means Big Business

Gambling is indeed a growth industry. According to the American Gaming Association, over the course of the last ten years from 1995-2005, total commercial casino revenues nearly doubled from $16.0 billion in 1995, to $30.3 billion in 2005. Additionally, total gaming revenues increased by approximately 74 percent for the period 1995-2004, from $45.1 billion to $78.6 billion.

Just after the state of Nevada passed the Corporate Gaming Act in 1969 to permit publicly traded companies to have gambling licenses, some of the major hotel brands entered the Casino Industry. Over the years, as other states have approved gambling, these companies have expanded their efforts in this market.

The rapid expansion and popularity of gambling can be traced to several major events:

The explosive growth in casino gambling was not limited to the U.S. In fact, the U.K., Australia, and Canada have also participated in this growth spurt. The industry's development trends are currently off of mainland China on the island of Macau.

As the lines cross between the hotel and leisure businesses, many of the well-recognized hotel brands have either joint ventured with casino companies or have merged, thus creating a whole new sub-sector.

Competition in the physicality of this industry is fierce and growing more intense. Size, geographic footprint, and positioning have begun to take on increased levels of importance. Gone are the days when customers sought the destination of Las Vegas just to gamble, or would drive a few hours from New York to Atlantic City to only play the slots and the tables. Recognizing the increased financial opportunities and bigger consumer spending patterns, the gaming and hotel companies are merging in order to create a sort of one-stop "entertainment" shopping.

Evidencing this trend are significant mergers within the past year (e.g. MGM Mirage's purchase of Mandalay Resorts for $7.9 billion, and Harrah's acquisition of Caesar's for $9.3 billion). Now the stage is shifting to Macau, where MGM and Las Vegas Sands are competing to attract the more than 10.5 million Chinese visitors annually to their island.

Going Global

The casino business is now in global competition. Last year, Macau overtook Atlantic City with $5.6 billion in casino gambling revenues, second only to Las Vegas with $6 billion. The U.S. companies doing business in Macau are looking to attract the wealthier mainland Chinese customers. Currently, 80 percent of the traffic is local. The objective of the U.S.-based casino/lodging companies is not to attract the "day trippers," but rather to appeal to customers who intend to stay for two to three days, or more. With that in mind, it is estimated that the number of hotel rooms in Macau will triple by 2009.

Both Wynn Resorts and Las Vegas Sands plan to build theme style hotel/casinos in Macau, similar to those in Las Vegas. The stakes are high, and the rewards can be substantial. For example, Las Vegas Sands recouped its investment in Macau within six months, and reported revenues of $592 million for the six months ending on June 30, 2006, outpacing their Las Vegas Venetian hotel by approximately $140 million.

With an estimated $25 - $30 billion expected to be spent on new casinos, shops, hotels, and condominiums by the end of 2010, companies are expecting Americans to continue gambling. In support of this projection is the growth in the casinos operated by Indian Reservations, which at $22 billion in 2005, has more than doubled since 2000.

The question that hotel executives should consider is whether or not demand for gambling will continue to increase at a fast enough rate to support the ancillary businesses (e.g. hotels, restaurants).

In 2005, escalation in gambling revenues grew at a slower rate; however this has not cooled the appetite for expansion. MGM is planning a $7 billion City Center Complex in Las Vegas, including 6,800 hotel rooms and condominiums. Las Vegas Sands and Wynn Resorts are expected to each spend $1.6 billion on resorts. In the aggregate, it is estimated that $20 billion could be invested in Las Vegas within the next few years, which will significantly increase the supply of hotel rooms according to Standard & Poor's.

In Biloxi, Mississippi, new projects being developed could cost between $3 - $5 billion over the next few years. It is estimated that the number of casinos could double, and hotel rooms could expand from 12,000 to more than 30,000.

Too Much, Too Fast: What Happens if the Bubble Bursts

Casino hotels represent a multi-billion dollar, worldwide business which brings together name-brand hotel management companies and casino owners in a marriage of hospitality and gaming. Seeking to benefit from the tremendous opportunities presented by seemingly-endless growth in the casino industry, hospitality companies enter into joint ventures with casino owners who finance the development and operation of their gaming facilities either through public markets or private equity funds. Typically, the hospitality companies' contribution to those joint ventures is the management of the operations, and their primary return on that "investment" is in the form of management fees and any performance-based incentives. Their casino-owning joint venture partners, on the other hand, are typically responsible for the acquisition and development of the facilities. They are the ones responsible for raising capital in the debt or equity markets and making the necessary representations and disclosures in connection therewith. Often, however, it is the reputation, name-recognition, and goodwill of the hospitality company that acts to induce sources of capital to invest in those casino operations. Thus, the hospitality companies are often placed "front and center" in a high-risk investment scheme, notwithstanding the fact that their primary motivation in participating in these joint ventures is to manage the properties and earn a reasonable fee in return.

However, history has proven that gaming ventures are never "sure bets." The question is, when events fail to unfold as planned, to what extent is the hospitality company exposed? Attention must be devoted to an examination of the hospitality company's potential liability in connection with: (1) securities-related lawsuits relating to representations made by the casino-owning joint venture partners to bondholders, shareholders, and the markets regarding the development, business operations, and financial performance of the casino hotels; (2) civil and/or criminal investigations and actions by gaming regulators and other governmental agencies; and (3) disputes between the joint venturers arising out of a failure of the business or less-than-expected financial returns.

Hospitality companies are well-advised to "look before they leap" into casino hotel ventures. Precautionary measures should be undertaken to ensure that the respective responsibilities and obligations of the management company and the casino owner are clearly and carefully defined in the contract documents.

The hospitality company should insist upon reviewing any public statements or representations to actual or potential investors regarding the venture and the casino hotel operations. Management companies should also demand full disclosure from the casino owners of any filings with gaming regulators, state or federal securities commissions, and other governmental agencies - especially where such submissions describe activities conducted by the management company. In short, as with any commercial transaction, the parties should envision "worst case" scenarios in order to ensure that their legal rights are considered and protected to the fullest extent possible.

Litigation in the business world is a fact of life. Litigation is especially likely to follow failed business ventures, economic downturns, investment losses, and disappointing financial performances. It is attracted to deep pockets which, in the case of failed casino hotel operations, are often those of the hotel management company's. Accordingly, name-brand players in the hospitality industry who dare to enter the potentially-lucrative gaming field should be on their guard to preserve their "upside" by protecting their "backside."

William A. Brewer III is co-founding and co-managing partner of the national litigation firm of Bickel & Brewer, with offices in Dallas and New York. Under Mr. Brewer's direction, the firm has become renowned for its innovative handling of major disputes in the hospitality industry. For the past decade, Bickel & Brewer has represented hotel franchisors, management companies, owners, developers and investors in the highest profile litigation in the hospitality industry. Visit www.bickelbrewer.com or contact Bill at 214-653-4811 or wab@bickelbrewer.com

William A. Brewer III is co-founding and co-managing partner of Bickel & Brewer, with offices in Dallas and New York. Under Mr. Brewer's direction, Bickel & Brewer has become renowned for its innovative handling of disputes within the hospitality industry. For the past decade, Bickel & Brewer has represented hotel franchisors, management companies, owners, developers and investors in the highest profile litigation in the hospitality industry. He is a member of various philanthropic organizations, including the New York City Partnership and the Board of Trustees of Albany Law School. Mr. Brewer III can be contacted at 214-653-4811 or wab@bickelbrewer.com Extended Bio...

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