Private equity firm buys 20% stake in Galaxy

The $840 million deal marks Permira's first direct investment in non-Japan Asia, but more are likely to follow as the firm plans to open an office in Hong Kong.
UK-based private equity firm Permira has agreed to buy a 20% stake in Macau casino operator Galaxy Entertainment Group for a total cost of $840 million in what will be its first direct investment in Asia outside Japan.

The investment will leave Hong Kong-listed Galaxy with a substantially improved balance sheet and enough funds to provide a foundation for the future development of phases two, three and four at its Cotai Mega Resort, the company said at a press conference yesterday.

Coming from EuropeÆs largest buy-out firm with a long history of gaming-related investments, the strategic acquisition is also a notable endorsement of GalaxyÆs growth strategy in Macau where it is up against competition from US casino magnates, Sheldon Adelson and Stephen Wynn.

The investment, which is subject to shareholder approval, comes after Galaxy last month said its first half operating results improved significantly from a year earlier, with sales up 385% and Ebitda increasing by 300%. The gains were supported by strong growth at its flagship StarWorld hotel and casino which was opened in October 2006. Yesterday, the companyÆs CFO Nigel Morrison also said that Galaxy has lifted its share of MacauÆs gaming market from less than 7% in March 2006 to over 20% this March.

Permira noted that aside from having shown that they can run casinos, GalaxyÆs controlling shareholder, the Lui family, also has a strong background within construction and 20 yearsÆ experience of developing and operating hotels, including the Stanford Hotels Group whose hotel brands include the Sheraton, Hilton, Marriott and the Intercontinental.

ôHeritage and the experience of this family in construction projects of this size is a significant factor in our decision to invest,ö says Martin Clarke, a partner and head of the global consumer sector investments at Permira. ôWe think they have the ability and expertise to develop the next phase of growth which will happen at the Cotai strip.ö

The first phase of GalaxyÆs Cotai Mega Resort, which is due to open towards the end of next year, will feature two five-star hotels and the worldÆs second largest casino after the Venetian Macau that is run by Adelson.

In connection with PermiraÆs investment, Galaxy last night launched a placement of at least HK$1.3 billion ($163 million) worth of new shares to prevent its free-float from falling below the required 25%. Since PermiraÆs stake wonÆt count as being held in public hands, this would otherwise have been the case. Following the placement and the transaction, the Lui family and connected parties will hold about 52% of Galaxy.

The placement comprised 150 million shares that were offered to investors at a price between HK$8.42 and HK$8.82, which represents a 2%-6.4% discount versus GalaxyÆs latest closing price of HK$9.00. Because the deal wasnÆt launched until after PermiraÆs investment was announced at about 7:15pm Hong Kong time last night, sources say the offer will stay open for Asian investors until mid-morning or noon today.

Interestingly, Permira will make its investment on an unleveraged basis, but says it still expects the same size returns that it would target from a leveraged deal elsewhere in the world. Typically, those returns would be in the 20%-25% range. Martin Clarke, partner and head of global consumer sector investments at Permira, noted that the firmÆs returns are ôconsistentlyö in the upper quartile when compared with the private equity industry as a whole. A source said the firm would not have invested in Galaxy if it wasnÆt comfortable that the returns generated would keep it in that upper quartile.

ôOne of the remarkable things about this deal is that the growth profile can actually generate adequate returns on the basis of an unleveraged position, which certainly says something about the growth in Macau,ö Clarke says. ôI doubt that this growth is representative of what is available elsewhere in Asia, but certainly this is a very compelling transaction even on an unleveraged basis.ö

Macau registered 50% growth in gaming revenues in the second quarter of this year and surpassed Las Vegas as the worldÆs largest gaming hub in 2006.

The fact that Permira is buying the Galaxy shares at a mere 6.4% discount to the market price further emphasises its optimistic views on the company.

The private equity firm does intend to work for its returns, however, and Clarke stresses that the firm will not be a passive investor. Rather it will be involved in all major strategic decisions and aims to apply the experiences and lessons it has learnt from its more than 10-year collaboration with Gala Coral in Europe, as well as its extensive work with family-run companies to help Galaxy realise its full potential.

Gala Coral is EuropeÆs largest integrated gaming group with significant interests in casinos, sports betting, bingo and online gaming. Permira is also invested in Sisal, which is the second largest lotto operator in Italy.

Since its inception in 1985 under the name of Schroder Ventures Europe, Permira has raised about $30 billion through 19 funds and has completed over 180 private equity transactions. It made it quite clear yesterday that it views Galaxy as a significant first step into Asia and intends to make more direct investments in the region as it sees ôabundant opportunitiesö here and particularly in China.

To support this effort, the firm will open an office in Hong Kong in the first half of next year.

The private equity firm will get two seats on the Permira board, which will be occupied by Clarke and Guido Paolo Gamucci, who is the Tokyo-based chairman of the firmÆs operations in Asia Pacific.

Aside from the capital injection, the investment will also help clean up GalaxyÆs shareholding structure as it will reduce K. Wah InternationalÆs stake in the company from 18.6% to around 4%. Observers say this should remove a long-standing overhang on GalaxyÆs share price and note that it makes a lot more sense for the casino operator to have Permira, with its expertise within gaming, as a strategic investor than to retain construction company K. Wah International on the shareholdersÆ roaster.

Galaxy and the K. Wah group, which was set up in 1955 as a small construction materials supplier but has since grown into a multinational group with core businesses within construction materials, property development, hotels, entertainment and leisure, were both founded by Lui Che-woo who remains chairman of both entities.

Permira will buy 452 million existing shares from K. Wah International at a price of HK$8.42 apiece û the same price as the bottom end of the price range for the placement launched by Galaxy last night û and 323 million new shares issued by Galaxy at the same price. This will result in a cash injection of HK$2.7 billion ($351 million) into Galaxy.

The casino operator will use HK$1.3 billion of that money to repay 50% of its outstanding fixed-rate notes that are held by entities linked to the Lui family. The other 50% of the notes will be converted into 157 million ordinary shares in Galaxy, again at the same HK$8.42 price.

Together with the cash raised from the share placement, the transaction will result in a net cash injection of HK$2.7 billion for Galaxy, a debt reduction of approximately HK$2.6 billion and a HK$250 million net saving on it annual interest costs. The company estimates that its net gearing will fall to 20% from 31%, even after completing all the funding for the first phase of the Cotai resort project in 12-14 months.

This should help eliminate the drag that interest costs have had on the companyÆs bottom line following its massive land acquisition on the Cotai strip and result in another boost for the Hong Kong-listed stock. Even though the groupÆs Ebitda improved to HK$737 million in the first half from HK$186 million a year earlier, and more than doubled in the second quarter from the first, the company still reported a net loss of HK$267.8 million for the first half.

The share price too has been sluggish, hovering for the most part between HK$7 and HK$8.50 over the past 12 months. Since the earnings release on September 17, the stock has jumped 15%, however, and it is up 40% from a low of HK$6.43 in late August in connection with the opening of the rival Venetian casino resort. The shares have been suspended since last Friday pending the announcement of PermiraÆs investment.

Permira was advised by Deutsche Bank, while Galaxy was advised by Merrill Lynch. Merrill is also the sole bookrunner for the share placement.

¬ Haymarket Media Limited. All rights reserved.
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