Macau casinos: placing bets on future demand

A week after The Venetian opens, specialists express their views on who will win and who will lose in the competitive Macau gaming market.
All eyes were on Macau on August 28, the day Las Vegas Sands formally unveiled its newest offering, The Venetian Macau. It is the worldÆs largest casino and is widely expected to catapult the city into a new era of prosperity.

The Venetian occupies 10.5 million square feet making it the second largest building in the world (behind one of BoeingÆs US plants) and the largest in Asia. With its 850 gaming tables and 3,000 all-suite rooms, it has increased both gaming capacity and hotel rooms in Macau by over 20% in one shot. It also has one million square feet of retail space.

The landscape in Macau today may have changed beyond recognition but it was as recently as 2004 that Las Vegas Sands opened the first foreign-operated casino in the region. Macau saw gaming revenues increase 54% the quarter after it opened and the number of visitors soared 91% year-on-year. The opening of Steve WynnÆs eponymous casino in September 2006 had a similar effect: gaming revenues jumped 44% in the next quarter, compared with the same quarter of the previous year.

The combined effect of the new casinos and favourable demographics in the region resulted in Macau becoming the largest gaming market in the world in 2006, with an estimated MOP57.5 billon ($7.3 billion) of revenues (up 22% year-on-year). And analysts are optimistic that the future holds more of the same. Deutsche Bank predicts revenues will continue to grow at a 25% compound annual growth rate over the next few years to reach $16.6 billion by 2010.

Who wins and who loses?
There is consensus among specialists that The Venetian will increase the number of visitors to Macau. But will all casino operators benefit from this growth?

ôOur overall impression from industry players is that the opening of The Venetian will only expand the market for MacauÆs gaming, retail, hotel and conference businesses,ö comments Deborah Mei, a managing director in Morgan StanleyÆs investment banking division.

Karen Tang, analyst at Deutsche Bank, differentiates between offerings in her answer: ôQuality supply drives demandö.

ôHigh-quality casinos will definitely be winners but the income growth of old-fashioned casinos with fewer facilities is expected to be slower,ö says Tang. ôInvestors may have a concern about over-supply û we expect there will be 4,500 gaming tables by the end of 2007, increasing from 1,100 tables in 2004 û and the number of tables will increase to 9,500 by 2010. But note that the demand has caught up with the supply. In the first half of 2007, gaming revenue surged 49% year-on-year. Therefore, we are positive on the long-term performance.ö

But other specialists are guarded, noting that The Venetian will intensify already stiff competition. There are several substantial local gaming operators, including Galaxy Entertainment, which runs the StarWorld Hotel and casino as well as four CityClub casinos. Its newest project, the Galaxy Resort casino, is slated for a 2008 opening.

Another sizable operator is Nasdaq-listed Melco PBL Entertainment, a joint venture between Hong Kong-listed Melco, a diversified Macau-focused company run by the eldest son of long-time Macau gambling tycoon Stanley Ho, and AustraliaÆs largest conglomerate and gaming group Publishing & Broadcasting Limited. Melco PBL currently owns three gaming assets in Macau: Crown Macau, Mocha and City of Dreams (the latter is scheduled to open in the second quarter of 2008).

ôThe revenue per table is going down because the supply of casinos has already kicked in. This year youÆre going to have more supply coming into the market. Margins are probably to go down because revenue per table is moving down,ö says Morgan Stanley equity analyst Rob Hart.

According to a CLSA research report dated August 13, incumbents will see a bigger visitor pool, but some of their business will also flow to The Venetian. It notes that the location of The Venetian lowers the spillover to other casinos as the Cotai Strip is not within walking distance from MacauÆs ôdowntown areaö and casinos such as Sands, Lisboa and Wynn.

ôThe Venetian opening effect seems to have worked on the US names rather than local Macau names,ö CLSAÆs gaming analyst Gavin Ho suggests in the report. He says the market is also looking for proof of execution and that has resulted in a relatively strong performance by Hong Kong-listed Galaxy Entertainment, which has seen its market share rise to 21% in the first half of 2007 from 14% in 2006.

Some specialists expect the mass market will flourish but the VIP, or the high-roller market, will suffer.

ôItÆs very likely (the gaming industry will continue to show strong growth) especially for the mass market sector," says Morgan StanleyÆs Hart. "As long as China's GDP growth keeps as strong as it is, and Hong KongÆs growth continues to be healthy, we can expect there will be something around 20% (economic) growth in Macau, which is very good for the mass market.ö

ôSome people going to Macau, specifically to The Venetian, will stay a little bit longer than they would have otherwise, but no doubt thereÆs going to be more competition, for instance, in the VIP markets,ö adds Hart. ôThe pressure from The Venetian to the VIP market is higher than the mass market side.ö

Hart highlights a very pertinent point. VIPs accounted for 65% of gaming revenue in Macau in 2006. According to Hart, VIP revenue growth in Macau is currently about 60% with VIPs from Malaysia, Singapore, Korea and Japan all coming to Macau. The Venetian is devoting time and resources to attract this clientele away from its competition.

Meanwhile, Credit Suisse anticipates increasing margin pressure on concessionaires and advises investors to go for junket operators. The report suggests that intensifying competition has driven gaming concessionaires to adopt more glamorous development strategies on which returns are falling, while at the same time commission rates paid to retain junket services are increasing.

Both CLSA and Credit Suisse feel fundamentals are strong, for example, for Teem Foundation, a junket operator which accounts for 25% of Sands Macau and 45% of Wynn MacauÆs VIP business. CLSA expects the company to thrive on the back of The Venetian opening as it will operate 20-25 VIP tables here.

Credit Suisse worries less about over-supply, however, estimating demand growth will be strong enough to absorb new supply. It notes that although the number of gaming tables and slot machines increased by 99% and 91% respectively in 2006, daily gross gaming revenue per table dropped 26% and revenues from slot machines dropped only 3%. The revenues stabilised when Wynn Macau opened in the third quarter.

More uncertainties?
There is consensus on one thing: if The Venetian growth story sours, other Macau gaming players will also share some of the fallout.

ôWith The Venetian only opening recently, weÆll have to wait and watch how this performs. So far Macau has mainly been a day-trip destination for people coming just to gamble. The success of Cotai is predicated upon people staying several days, shopping, eating and participating in other activities,ö observes Morgan StanleyÆs Hart.

Infrastructure to support the rapid economic growth is also a concern. ôFrom a macro-perspective, there is a risk of a shortage of quality labour in Macau. On top of this, new casinos will open at Cotai. Public transportation and related infrastructure take time to develop and may not be able to handle the growing numbers of visitors,ö says Tang at Deutsche.

Earlier this year, the government of Guangdong province tightened the Macau individual visiting scheme in an effort to cool down the trend of Chinese visitors making gambling trips to Macau. At the time, a number of questions were raised about Macau's future if China were to restrict its citizens from going there. But specialists suggest this is no longer a concern.

ôThe policies enforced by the Guangdong government were adopted around May then abolished in August - they were only temporary measures. If we look at the second quarter results of Wynn, its growth remains strong. The impact of those policies on casinos was insignificant,ö says Tang.

Hart suggests that some slowdown could even be beneficial. ôThe advantages of a slowdown of arrivals are significant to Macau, because the infrastructure is challenging. The internal infrastructure is under strain. ItÆs not necessarily a bad thing if arrival growth slowed from around 20% to 10% or 15%,ö he says.

Is Singapore a threat?
The success of Macau has made Singapore realise the revenue potential of gaming and it is now trying to get a piece of the action. Specialists argue, however, that Singapore is not copying the Macau model, but has its own strategy. The city-state has successfully positioned itself as a leisure-cum-shopping destination and hopes to use the attraction of the casinos to build upon that platform. Visitors to Singapore are expected to extend their stay to allow for time at the casinos.

ôItÆs a different model to Macau. It just adds to the overall Singapore offering. Macau is a pure gaming destination right now. You have a lot of people going there just for gaming,ö says Morgan StanleyÆs Hart. ôThere will be almost no impact on the mass market (when Singapore opens its casinos) because 85% of people going to Macau are from Hong Kong and China. They are not going to fly all the way to Singapore to gamble.ö

ItÆs the VIP market, again, which seems to be at risk.

ôWhen the Singapore casinos open, you could potentially see VIPs going to Singapore to gamble instead so thereÆs a question mark over VIP revenue growth from 2009 especially,ö cautions Hart. ôFor VIPs, flying to Singapore makes sense - the junkets could potentially give you more dollars in Singapore than in Macau, because in Macau thereÆs a 39% gaming tax and in Singapore itÆs 8%-9%.ö

SingaporeÆs first casino, also built by Las Vegas Sands, is targeting a 2009 opening and the second, awarded to Malaysian casino operator Genting, will follow in 2010. Current indications from the Singapore government are that no further licenses will be granted after these two. It is too early to draw any definite conclusions about the Singapore impact, but observers are watching the developments closely.

Macau is still appealing to investors
Investor interest in gaming-related equities has cooled a fair amount since the Macau stock fever witnessed two years ago, but specialists says investors have never really taken their eyes off the table. They are now eyeing the increase in visitors that could arise from the attempt to convert Macau from a collection of casinos to a resort destination where people enjoy luxury accommodation, recreation and shopping as well as gambling. This is the Las Vegas model and is in line with what The Venetian is trying to do. Further, existing players are continuing to deliver strong earnings and nothing on the horizon seems set to change that.

ôMost Hong Kong gaming stocks posted gains after US-listed companies like Wynn and Las Vegas Sands saw their stock prices double last year," says Morgan StanleyÆs Hart. "What we have seen this year is a more mixed performance because the stock markets have already anticipated all the good news, and the stock prices are expensive.ö Hart notes, however, that news from Macau gaming sector is likely to remain positive.

Some observers have expressed concerns that the funding for new casino projects could dry up, but Morgan Stanley banker Deborah Mei is still optimistic. ôThe fundamental Macau gaming story is as strong as ever although new financing structures will need to take into account the volatility in institutional credit markets and, in the near term, focus on the Asian bank market.ö

There could also be a new category of investors interested in Macau casinos. ôWe are seeing hedge fund and private equity interest in equity and mezzanine investments in Macau,ö elaborates Mei.

Despite being only 60 kilometres from Hong Kong, Macau used to be a far quieter city, lacking the economic triumphs and glories of its neighbour and famed mostly for its quaintness. The handover of Macau to China by Portugal in 1999 happened with far less fanfare than the handover of Hong Kong by Britain two years earlier.

However, global gaming operators, attracted by the opportunity to participate in the rapid economic growth of China and the rest of Asia, are now trying to alter the landscape of Macau. It remains to be seen whether they will be successful in charting this new course.

If casino operators devote resources to both developing clientele and capacity and stagger their expansion plans, Macau will probably do well in the long term, explains a banker. But a sudden glut of capacity, be it shopping, hotel rooms, recreational facilities or casinos, could be harmful for everyone.
¬ Haymarket Media Limited. All rights reserved.
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