Friday, May 13, 2005

The kind of place God would build if He had the money”

Steve Wynn has returned to Las Vegas. Five years after a knock-down, hostile takeover of his Mirage Resorts by Kirk Kerkorian’s MGM Grand, Mr. Wynn unveiled The Wynn Las Vegas. The hotel opened on April 28th, with the aim of setting the new standard for luxury on Las Vegas’s famous Strip. Wynn Resorts (ticker: WYNN) spent five years and $2.7 billion building the 2,700 room, 9,500 employee, 217 acre property, making it the most expensive mega-resort hotel in the world. But does Wynn's triumphant jewel of a hotel truly offer visitors value? And if so, can that competitive advantage be sustained in a crowded and fickle market?

Mr. Wynn’s history would certainly lead one to expect success. Wynn's Mirage, opened in 1989, pioneered the "entertainment and recreation" paradigm on the Strip, and set off the town's explosive growth in the 1990's. Later, his $1.6 million Bellagio, opened in 1998, redefined Las Vegas class and luxury.

Now Mr. Wynn is attempting to move Las Vegas in a new direction. Las Vegas has become an international destination that attracts an increasingly aging population with money and sophisticated tastes. Further, conventioneers account for 15% of Las Vegas visitors, up from 5% in 1980. The result has been less gambling, and more luxury and entertainment: gaming now accounts for 25% of Las Vegas tourism revenues, down from 33% in 1980.

The Wynn Las Vegas is designed to compete on this stage. Like the Bellagio, it is vaguely theme-less, but lushly posh. Sunlight streams through a lobby adorned with brightly festooned plantings that dangle above whimsically colorful marble mosaics. Privacy is paramount: high-paying guests use a separate entrance away from the casino floor, and a waterfall-light attraction is inside, visible only to restaurant and hotel guests. The space has 200,000 square feet of attractive and modern meeting space, and is located very close to both the Sands Expo and the Las Vegas Convention Centers.

Bubbling anticipation and a hugely successful opening have created hype in some quarters of Wall Street. Marc Falcone of Deutsche Bank states that “although shares will remain volatile, investors may be hard-pressed to find a company with such rapid growth over the next several years." Nonetheless, the project has met complaints from the outset, as other analysts expressed concerns about cyclical trends, competition, and financing.

The project was funded and begun at the tail end of the 2001 recession, a time when tourism was being clobbered by September 11. The increasingly wide availability of legalized gaming, and the feeling that Las Vegas offered nothing fresh, compounded the effect. Las Vegas visitor revenues had increased on average nearly 8% per year from 1990 to 2000, but only 1.75% per year from 2000 to 2004. And the massive build-out in the late 1990’s left excess capacity: there were 131,000 rooms in 2004, up from 73,000 in 1990. Hotel occupancy rates had dropped to below 90%, levels not seen since the early 1990’s recession. This lead to a repricing of the Wynn Resorts' 2002 IPO, from $23 to $13 a share, and forced the company to seek junk bond financing costing $130 million a year in interest financing.

On the high end, the luxury market is witnessing increasing minimum efficiencies of scale. Las Vegas Sands is erecting the luxury, 3000 room Palazzo across the street from the Wynn Las Vegas; Mandalay Bay recently completed the ultra-modern, 1000 room THE Hotel, right next to its exclusive Four Seasons tower; and the MGM Mirage opened a new 900 room luxury tower at the Bellagio. Gambling in Macau is expanding, and Singapore is now allowing it. Both locations are close to Asian "Whales," gamblers who bet upwards of $10,000 a hand. Because this market is relatively finite, this growth in well-financed, luxury capacity is essentially chasing the same dollars.

Perhaps the biggest slam on Steve Wynn is his profligate ways. As the CEO of Mirage, he notoriously leased his renowned art collection to the Bellagio for $5 million a year, and had the company pay for his private jet. Today, those trends are tempered, but lurking. He leases the art collection to the Wynn for $1, and pays for the jets himself. But marketing and promotion costs were estimated at $38.1 million in the first quarter of 2005, and should be as high going forward. Consequently, Steven Kent of Goldman Sachs feels that Wynn Resorts is a “speculative investment in an industry that is overpriced relative to hotel and cruise ship companies and where there is little positive catalyst.”

Our concerns encompass these issues, but ask a broader question: Will Mr. Wynn’s strategy generate a long-term competitive advantage and yield profits commensurate with the risk of this venture?

On the face of it, the idea is a slam dunk: demographic and cultural trends favor a luxury “entertainment and recreation” experience. Wynn’s positional competitive advantage flows from this logic: The hotel’s amazing design sprung almost magically from the incredible imagination and local development prowess of Mr. Wynn. And Mr. Wynn has wisely chosen to name the hotel after himself, to create a marketing asset that is essential for differentiating social goods.

But with increased competition, experiential goods like pretty buildings with lots of amenities are becoming something of a commodity. To compete, then, the Wynn Las Vegas must keep service standards exceptionally high to target and retain price-insensitive clientele. But Mr. Wynn is more of a dreamer than a doer, which bodes poorly for his capabilities operating a luxury hotel and keeping costs in line.

Anecdotal evidence bears this out. On a recent visit to explore the Wynn Las Vegas, one of our group members found a cockroach (!) in his room, and a call to housekeeping offered only an apology and a suggestion to call the front desk for a room change. No employees assisted his wife with her luggage or opened the doors at the front entrance. And the casino floor, like any in Las Vegas, was swarming with fanny pack toting tourists playing the nickel slots. Pretty shoddy.

In the end, larger, better capitalized firms - MGM Mirage in particular - are better positioned to dominate the Wynn's market. The have the money and the talent to build high end buildings; they can sustain competition and cyclical downturns better; and most importantly, they can run these facilities better and at a lower cost. Yes, as Gary Loveman, CEO of rival Harrah's, quipped, the Wynn Las Vegas is "the kind of place God would build if He had the money." But would He stay there?

Suzanne Davidkhanian
Keith Guerrini
Yvette Nicholas

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