Gaming Stocks: Know When to Hold 'Em

Until little more than a month ago, British-based online gambling companies must have felt as if they were holding an ace-high flush. They had been minting money, catering mainly to U.S. gamblers who would pay to play on sites such as Partypoker.com. Companies such as PartyGaming PLC, 888 Holdings PLC and Sportingbet PLC took full advantage of the Texas hold'em craze that's swept across the former colonies, infiltrating cable TV, casinos, dorm rooms and -- we wouldn't dismiss the possibility -- senior-citizens' centers.

What could go wrong? Well, the Brit gaming companies may have been flush, but they didn't count on a full House and Senate (aka the U.S. Congress) clamping down on Internet gambling. Just that happened in legislation approved September 30. As a result, shares of the British online gaming firms fell faster than a stack of chips in an earthquake. For instance, Sportingbet dropped from about $200 to $50 a share, down from its 52-week high of $452.

From this episode investors can glean two important lessons. The first is that the Brits have no clue about election-year politics in the U.S. Given that disgraced lobbyist Jack Abramoff may have helped kill Internet gambling legislation in the past and given the need for Republicans in particular to wave their pro-morality credentials in the wake of the Foley-page scandal, the chance of Congress passing the online gambling ban was as bankable as a royal flush.

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The other lesson is that just because one slice of the gambling world craps out doesn't mean that there aren't opportunities in other segments. Although the U.S. has effectively banned online gambling and Britain is talking about regulating it, the gambling industry as a whole hasn't been affected. In fact, the betting here is that gamblers will find a way around the laws and continue to wager online.

More generally, people love to gamble and will generally continue to do so, regardless of the circumstances. Consider the experience of recent months. Gas prices exceeded $3 a gallon at just about the same time that the real estate bubble was starting to deflate. Those developments should have made most of us feel poorer and less inclined to spend at casinos. But "in reality, those things don't affect gaming for long," says Dan Ahrens, portfolio manager of the Gaming and Casino fund (symbol GACFX).

Ahrens says investors overreacted to the perception that consumers would gamble less and drove down gaming shares. But when state-by-state results came in for September, the results were strong where they mattered most: New Jersey, Nevada and the Gulf Coast states. Many of the big gaming stocks rebounded.

Ahrens still sees value in MGM Mirage (MGM), which closed October 31 at $43.02 and trades at 18 times estimated 2007 earnings of $2.33 per share. MGM lacks the flash of some competitors, but it's a steady grower and its shares are much reasonably priced. Compare it, for example, to such high flyers as Wynn Resorts (WYNN, $73.54), trading at 35 times '07 estimates of $2.08 per share, and Las Vegas Sands (LVS, $76.20), trading at 42 times next year's profit forecast of $1.83 per share.

Patient, long-term investors should consider Boyd Gaming (BYD), Ahrens says. Boyd recently reported mediocre quarterly results, and the shares, at $39.47, are down 28% from their April high. Boyd doesn't own a showcase edifice on the Vegas strip -- at least not yet. Its casinos are off the strip, on the Gulf Coast and in the Midwest. Its best-known property is Atlantic City's Borgata Hotel Casino Spa, in which it has a 50% interest.

What Boyd does have is lots of property on the Vegas strip -- an important asset considering how well casinos there are performing. And the stock's price-earnings ratio -- 18 based on '07 earnings estimates of $2.15 per share -- is modest.

So, if you're an online gambler or you gambled on the shares of online gambling sponsors, our sympathies go out to you. You may instead want to double down on the shares of old-fashioned, bricks-and-mortar gambling companies.