Motley Fool Money - Why Do Casinos Lose Money?

Episode Date: February 6, 2023

If the house always wins, why are gambling companies having trouble turning a profit?  (0:21) Jason Moser discusses: - Privately-owned restaurant companies Cava Group and Panera Brands mulling a return to the public markets - How Panera has evolved since its last time as a public company - A key metric he's watching when Chipotle reports earnings on Tuesday afternoon (9:40) Ricky Mulvey and Matt Frankel discuss the struggles gambling businesses having making money and one business breaking the trend.  Stocks discussed: CMG, PDYPY, MGM, DKNG, CHDN Host: Chris Hill Guest: Jason Moser, Matt Frankel Producer: Ricky Mulvey Engineers: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Baseball is back and the first pitch is on Netflix. The New York Yankees, led by seven-time all-star Aaron Judge, head to the San Francisco Bay to take on Rafael Devers' San Francisco Giants. This season kicks off with one exclusive opening night game. Watch MLB Opening Night, the New York Yankees versus the San Francisco Giants live on Netflix. Wednesday, March 25th at 8 p.m. Eastern 5 p.m. Pacific. If the house always wins, how come gambling businesses are having trouble making money? Motley Fool money starts now.

I'm Chris Hill, joining me today. Motley Fool senior analyst, Jason Moser. Happy Monday. Happy Monday, indeed. 2020 was the weakest year for traditional IPOs since the dot-com bubble burst, but the IPO market may finally be heating up again. And it looks like restaurants are leading the way. This morning, Kava Group, which is the parent company of the growing Mediterranean-style

restaurant chain. Cava filed paperwork confidentially with the SEC to go public. And the Wall Street Journal is reporting that Panera is working on a return to the public markets. So what is your reaction to either or both? Well, I mean, I'm not terribly surprised, I guess. You certainly see this happen from time to time, particularly if you see a business like Panera, for example, acquired by JAB. several years back, right? And part of that, I mean, Parenthood was a pretty good investment for a

while, right? I think a lot of people did very well with it. Ron Shake seemed to feel like living life as a publicly traded company was just far more difficult than it really needed to be. And I understand that, right? You have a lot of accountability and you're always under the microscope. And so I think it was nice move for him to be able to step back and let JAB take hold of that. Now you've got Panera in a bit of a different position than it was when it went private, it's not just Panera anymore. J.B. has taken Panera and they've combined it with Caribou and with Einstein bagels to create Panera brands. So it's more than what it used to be.

And Kava very similarly actually acquired a publicly traded company in Zoe's Kitchen, right? And it took Zoe's private, ultimately converting most of it. if not all of those Zoe's kitchens over to Kaaba models. But that was a way for them to be able to get access to a lot of growth at once. So it does, restaurants are always tricky. On the one hand, everybody's going to eat. You got to love the recurring nature of sales. But there's a lot of competition that comes with it, right?

There's a lot that can go wrong. And I think at least with these businesses, Panera more so than Kava, at least Panera had more than one way to succeed, right, with three different brands under that umbrella. Kava is going to be a little bit more specific. And so there is a little bit of a risk there in how well it translates to ultimately what I would think would be a global opportunity that they're seeking. But yeah, I mean, it remains to be seen. But I certainly understand the desire to get back into the public markets.

Yeah, I haven't looked at a map to see where Kava locations are. I know they're in the greater Washington, D.C. area where you and I live. So for those listening who may not be familiar, just think Chipotle, but instead of Mexican food, it's Mediterranean food. And it's, you know, the ones I've been to, they do a very good job. It's good food. If they can achieve a quarter of the footprint and success of Chipotle, I think they're well on their way.

You mentioned Ron Shake and Panera. I will always remember the day that Panera went private. And Ron Shake, the CEO at the time, was sitting on the set at CNBC. And he could not have been happier that his company was going private. And he talked about how one third of his time as CEO was spent on things related to Panera being a public company. And he's someone who's like, He was interested in getting that time back and focusing more on the restaurant. I'm interested to see what the COVID group wants to do with the money, because that's always a great question whenever a company is getting ready to go public. What are they going to do with the money they get?

If and when Panera files, I'm interested to see that as well too, but not just the money, but what that business looks like now. You and I remember when Panera was a public company, that was struggling because they had a confusing footprint in their locations. Ron Shake had the famous memo where he basically compared Panera restaurants to a mosh pit and just said, we got to make these more efficient. They appear to have done that, and much of that has happened while the business has been private. So, I'm, as an investor, I'm not necessarily ready to throw my money at both of these.

I am very interested to read more. Yeah, I am. I mean, I was a shareholder a time ago in Panera. That was kind of the gateway to me teaching my kids a little bit more about what I did for a living and ultimately helping them start their own portfolios as well. So there is, I do have a little bit of an emotional connection to Panera, Chris. I'm not going to lie. In looking at the two today, I mean, I do, I like the idea. I mean, Panera being more than just Panera now. I mean, that to me makes it a far more attractive potential opportunity. I'm with you. I'm in the book. I want to learn more. I want to read more. I'm not saying you got to jump in there and this is a no-brainer.

I do think when you look at Kava, and your point there, it is very local here, right? It is a DC-based concept. And so, Kava was very much in sort of this Middle Atlantic region, for the most part. Buying Zoys gave them access, I think, something like 300 restaurants at the time. So it really helped springboard their footprint. And so I would imagine the money is going to really go towards helping open more stores and maybe put the balance sheet in a little bit of a better position. But I think that when you look at Kava, it's something like 300, 150 stores today. And then you look at where Chipotle is today, right? I think just over 3,100 stores now. They're still targeting. I mean, I think they're calling for somewhere in the

neighborhood of 7,000. I feel like we can discount that a little bit. Even if you discount that 20%, you get it back down as something in the mid-5,000s. And that's a big opportunity for additional growth, even from today. And so Chipotle is, I don't think, exemplary of every restaurant opportunity out there. I think it's one that has really succeeded over time for a lot of different reasons, but I think it at least gives you an idea of what Kava could be one day if that concept continues to gain traction because they don't have to worry about sort of the Mosh Pit experience that Ron Shake was always talking about. And as a consumer going into Padera, I think you and I both would agree. We felt that experience, right? It was

disorderly at best. It's far different now. Kava, you hit the nail on the head. It is like Chipotle, just Mediterranean. They have nailed that throughput experience down. And furthermore, the restaurant business today is in a far different place with mobile ordering, with delivery, with picking up at the store. So these are businesses that I think have really handled the way the restaurant industry has changed in such a short period of time. Speaking of Chipotle, they report after the closing bell on Tuesday. What is one thing you're going to be watching for in their results? Well, I think the restaurant-level operating margin is a good metric to pay attention to,

because from that one thing, you get a lot of additional information. And so looking at last quarter, for example, when they talked about restaurant-level operating margin of 25.3 percent, and that was up from 23.5 percent a year ago. They talk about the increase being primarily due to the benefit of sales leverage, being able to push more traffic through the store, right? That's one of the neat things about restaurants. If they can ramp that traffic up, it really shows the operating leverage that some of these businesses can generate because you have a lot of those fixed costs that just go

in keeping a restaurant open. But you see also a little bit of a better glimpse into how delivery impacts their model, delivery fees can actually help margins. But by the same token, we'll also get some information from that operating margin number in regard to food costs and increases or decreases in hourly wages for employees. So you get a lot of information just from that one metric. Jason Moser, thanks for being here. Thank you. There's an estimated $900 million that will be wagered legally on Super Bowl 57. With more states

legalizing sports betting, you'd think more of the business The businesses involved would be rolling in profits. That's not the case. Philadelphia Eagles fan Matt Frankel and Cincinnati Bengals fan, Ricky Mulvey, gear up for the big game by taking a closer look at the reasons why so many gambling companies can't seem to turn a profit and one business that's bucking the trend. Casinos have been around for thousands of years. Who started gambling?

Who's the first big-time riverboat gambler? Who cares? Talking about gambling today with the Super Bowl. coming up. And frankly, Matt Frankel, why a lot of these betting companies aren't profitable. Some more states open up. Many of them are in growth mode, but something that really stood out to me about the company Draft Kings is that its operating income in the trailing 12 months was negative $1.5 billion. And they are not alone in that category of unprofitable casinos. So let's start with this question. How do you lose money running a casino?

See, it seems counterintuitive, doesn't it? After all, a casino, it's a business that doesn't really sell a product. It's a business that people go into planning on just literally giving their money to. I mean, I've walked into a casino and said, here, I'm going to lose this $100 and then I'm done. So it seems kind of counterintuitive, but there are some, it's expensive to run a casino. I mean, just physical casinos have the disadvantage that they need a physical property. And it always costs more, almost always cost more to build a casino than it's worth. Just as an example, the MGM Resorts recently built the MGM Springfield. They spent $960 million to do it and ended up selling

it to a real estate investment trust for $400 million. So that debt just sits on their balance sheet. They're paying interest on it, and they didn't even recoup the investment. Physical casinos have taxes, rent insurance. All casinos, online or physical, have marketing expenses. Customer acquisition costs are very high because there's so much competition. And the more legalization it gets, which is kind of the thesis behind gaming right now, the worst the individual casinos are going to do. Look at Atlantic City. Atlantic City was a dominant gambling town two decades ago. And then they opened up gambling in Philadelphia, in New York, in Connecticut, and online, and it just completely died. So there are a lot of costs involved with not only

running a casino, but keeping up with the other casinos and getting the customers to want to give you their money. Well, one of the issues with the online ones, it's got to be the marketing expenses, because they give you a little taste hoping you'll hang on for a long time. Then it's fairly easy for gamblers to do the, what is it, the $5 bet and then the automatic $200. And then if you spread that around the different sports books, you can have a pile of money to bet and hopefully not get addicted to it.

I want to focus in on Draft Kings, though, because that's not, as you mentioned, that's not a gambling company with a large physical presence. They do have sports books open. And I'm wondering if they're focusing on the right things. The stock's gone up because it's announced a layoff, good for them. However, the Draft King CEO said this back in November in an interview, Jason Robbins, quote, down the road, we will be valued on a multiple of Ibada, and all that matters is maximizing that number.

And as long as we do that, we'll have the highest valued company we can have." When you hear a quote like that from leadership, do you think that company is focusing on the right things? Well, yes, I mean, positive. Hibbado would be great. But Draft Kings is like a textbook example of how much it costs to get gamblers to give you their money. Just to kind of put some numbers behind it.

In the latest quarter, Draft Kings did just over half a billion dollars, so $502 million. in total revenue, out of that 322 million worth sales and marketing. So that layoff that you mentioned is going to help them in like their administrative costs and things like that. But when you're spending over 60 percent of your revenue on just sales and marketing, and that's not including just general business expenses, it doesn't leave a lot of room for profitability. So that's the big thing. I think they should focus on customer loyalty, customer retention, because the more loyal your customers are, the less you have to spend on sales and marketing. So, yes, they're focused on the right things. I don't know if they're going to get there in the ways that

they're trying to do. Yeah. It's not like other industries where there's high switching costs, it seems, where as more states open up, I don't see how the land grab for gamblers' dollars ends, even if you have, even if you're five years past, let's just say full legalization in the United States. Yeah, it's literally the opposite of high switching costs, right? There are other sites that will pay you $200 in free bets to come over to them. And you can just kind of cycle through those. It's literally the opposite of a sticky business.

Switching incentives, not cost. There is no cost. There's switching incentives. Looking a little bit more at the macro environment, you're going to see this on Sunday as gambling companies try to bring more of the experience into their advertising. Fan duel is doing the Gronk kick, which is a live commercial where Rob Grancowski is going to kick.

And if he makes the field goal, then gamblers win. I think it's $10 million of a prize pool. Draft Kings and Cores have this bet where gamblers can essentially pick out the details of a commercial, everything from like, how many people are in the bar, how many of the men have facial hair. And the reason they're trying to do that is they're trying to set themselves apart as entertainment companies. But I wonder, you know the insurance business pretty well. Are these companies more like car insurance where you have a commodified product and the only thing that separates

what you do is the marketing? Yeah, I mean, there are some ways that Draft Kings in particular differentiates themselves. They continually add, like you said, innovative bet features. They recently added early payout. So that's a cool feature that I saw that if your team's 40, points ahead and you have a bet on it, they'll go ahead and pay you out before the game's over so you can go ahead and use that money for another game. Things like that are kind of differentiators. But yeah, at the end of the day, it's really not that hard for other companies to add these features in. It's a programming thing. So, yeah, it is definitely a commoditized thing. And, I mean, the big bull case right now is it's only legal in about a third of the

states. So as time goes on, if driving... If Graph Kings were to say triple its revenue, would that result in profitability? And that's kind of where it needs to go if there's a real path to profitability here. So is the path to profitability just eye-gaming then? More of these companies are lobbying for essentially allowing online casinos on their apps, which I should mention has terrible second-order effects because if you're a problem gambler, then having a slot machine in your pocket gives you access to the game whenever, wherever you want, and you have no social impacts of going to a casino, and it's easier to hide the addiction because

you don't have to leave your couch. All right. So is that the only way that these companies can get profitable, though, is by introducing the slot machines onto their applications? I don't think so. And the reason why is because the kind of gamblers that would make that a profitable business, meaning people who go and spend a couple thousand dollars at a time and can afford to do it, not the problem gamblers, but, people who can afford to do that, they want to be well taken care of, like how brick-and-mortar casinos do. It's really tough to compete for that kind of gambler as an online operation. It's still a pretty small part of Draft King's business. Draft King's is only, the sports betting part of it,

is only in states right now that cover 37% of the U.S. population. So there's a lot of room to grow that. The eye gaming business is only in about 11% of the population states-wise. But I don't see that as a big profit driver going forward. Yeah, I could give people something to do. You can play online blackjack while you're during timeouts in your football game and things like that. But I see it as more of an adjacent business as opposed to a path to profitability all in itself. There's no stop in the dopamine drip. We've talked about why a lot of these companies are unprofitable.

However, it is an addictive product, and that can create a sticky revenue stream. And some have beaten the market. Are there any that you think investors should pay attention to in the gambling entertainment space? Sure. And one in particular is one that's actually partnering with Draft Kings. Churchill Downs, they're best known because for their namesake racetrack, they host a Kentucky Derby.

They're partnering with Draft Kings to develop the horse betting capability. But they are a very profitable casino company. They have physical casinos. They do have some online operations, but they're mostly physical casinos and racetracks. They ran a 15% net profit margin in the most recent quarter. Just to put that in perspective, Draft Kings ran something like a negative 80% net margin. So they were very net profitable. All their business segments were profitable, including horse racing, gaming, online. They were profitable in all their different business segments, and they're growing, or buying back shares, things that value stocks do, not unprofitable gaming companies.

So you don't have to have unprofitability to be a successful casino company. Churchill Downs, I believe, is beaten the market over time. It is solidly beaten the market over the past five years. It's kind of like finding out, like, when you realize that the railroads have just, what is it? On some stretch of time, the railroad companies have solidly beaten the NASDAQ. Sure. Old money does okay.

as we wrap up, we've got the Super Bowl coming this weekend, and the Philadelphia Eagles are taking on an illegitimate opponent out of the state of Missouri. Any storylines or picks you want to chat about before we wrap up? Well, you won't get any arguments from me there. I'm born and raised right outside of Philadelphia. So I'm a very diehard Eagles fan, so I'm going to be rooting for my birds this weekend. I'm also biased as someone from Cincinnati.

I think that's enough said about my thoughts on the kids. Kansas City Chiefs. Matt Frankel, always great catching up with you. Thanks for having me. As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against. So, don't buy ourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.