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Las Vegas bets big on Macau
The gambling industry on the Chinese island could triple in five years, propelled by companies like Las Vegas Sands and Wynn Resorts. Investors can get in on the action, too.
By Michael Brush
With so much concern about Chinese imports flooding Wal-Mart Stores, its refreshing to know we are shipping at least one big export back to China: the Las Vegas Strip.
For months, a U.S. casino company has been busy creating a replica of Las Vegas on Macau and a patchwork of other islands just south of China between Hong Kong and Hanoi. The venture -- along with other separate casino projects in the area -- makes up one of the biggest construction projects in history.
Its like a dust cloud, there is so much construction going on there. It is mind-boggling, says Joe Fath, a gaming and lodging analyst with T. Rowe Price Group (TROW, news, msgs). Fath is an investor in the U.S. casino companies responsible for the development -- Las Vegas Sands (LVS, news, msgs) and Wynn Resorts (WYNN, news, msgs).
If it pans out as hoped, gaming and tourism revenue in the region could double or triple over the next five years, lining the pockets of developers. If it fails, investors who have recently bid up shares of two companies behind the gambit could lose big.
Which way will it go?
As with any casino bet, it could go either way. But the odds favor the house, even if plenty of obstacles stand in the way. Nobody knows how strong the market will be, says Fath, whose T. Rowe Price fund group is one of the biggest holders of Wynn Resorts, just behind Chairman and Chief Executive Steve Wynn himself.
Related news and commentary on MSN Money
Safe bet?
There are a several reasons to think this wager will pay.
By any measure, Macau is already a huge success. Growth in the casino business there has been spectacular since China took it over from Portugal in 1999 and designated it the unofficial gaming resort for the mainland.
Annual gaming revenue shot up to $5.6 billion last year from $2 billion in 2000. The annual take now rivals that of Las Vegas. The number of visitors increased to 18.7 million in 2005, from 9.2 million in 2000. There are several factors behind this rapid expansion -- factors that should continue to spur more rapid growth ahead.
China is cracking down on illegal gambling on the mainland. It has also loosened travel and currency restrictions on Macau. This is driving a steady flow of high rollers to the island. China didnt want gaming on the mainland, so they decided Macau would be the gaming center, says Fath.
Avid gamblers. They love to gamble there, says Fath. It is absolutely packed, even the middle of the day. Fath describes the level of play -- which includes back betting, or the practice of standing behind players at tables and betting on their hands -- as more intense and intimidating than what you find in Las Vegas. It is a different gambling experience.
Chinas economic success. It is broadening out the middle class and making some people rich. Other changes in the financial system free up income, points out Jefferies & Co. gaming analyst Lawrence Klatzkin. Above all, the countrys mortgage, lending and insurance industries are developing. This means many Chinese no longer have to tuck away large sums of money to save for a big purchase, or to be prepared in case a large medical bill hits, says Klatzkin.
Access to Macau will improve. High rollers now come in by helicopter or ferry from Hong Kong. There is also a bridge to the mainland. But the government is building a network of rail lines and superhighways, including a planned 37-mile bridge to Hong Kong, expected to be completed in 2011.
Outside help
Why do U.S. companies play such a big role? Its part of Chinas effort to keep the Macau gaming sector clean.
For years, Chinese gamblers would reportedly get to the island with assistance from underworld clans who organized junkets and helped people get around travel and currency restrictions.
China has since eased travel and currency rules -- so Chinese dont have to rely on the junkets. Knowing that U.S. casino operators are strictly barred from association with the underworld, the Chinese turned to them as a way to keep organized crime out of Macau.
Low rollers
To date, the high rollers have driven Macau's gambling. To grow now, the region has to draw the mass market -- regular tourists, conventioneers and shoppers.
Skeptics argue that Macau and the nearby Cotai Strip, also a target for gambling development, cant make the conversion to family traffic from high roller. But developers respond that critics had the same doubts about Las Vegas decades ago. If they are right, that leaves two questions for potential investors.
How big could Macau get? Klatzkin thinks annual gaming and tourist revenue could more than double to $12.9 billion by 2008. Morgan Stanley analyst Celeste Mellet Brown believes gaming revenue alone will hit $11.6 billion by 2010. Shes less certain about the timing of nongaming revenue -- like income from hotels, shopping malls and condos going up in the area.
Who wins? Because they have the most exposure to the biggest projects, Las Vegas Sands and Wynn Resorts are the two best U.S.-listed plays on the growth. MGM Mirage (MGM, news, msgs) does have a 50-50 joint venture with a local operator. But it has such a huge casino business in the U.S. that Macau will only ever be a small piece of its operation. Here's a look at the players.
Las Vegas Sands
Like Wynn Resorts, Las Vegas Sands runs a casino on Macau -- the island where the gaming business is already well established. But Las Vegas Sands is also making a huge, if risky, side bet.
What is the bet? Las Vegas Sands hopes to recreate the Las Vegas Strip on the Cotai Strip, an undeveloped site off Macau. With help from partners, Las Vegas Sands is putting in a casino and more than a half-dozen resorts. It also hopes to replicate its winning approach in Las Vegas by putting in a big convention center -- to keep hotel room rates up during the weekdays. There will also be a huge shopping mall.
They want to get a concentration of hotels and gaming and retail all in one place, says Brian Summers, associate portfolio manager at Thornburg Investment Management, which holds a position in the company. They are trying to replicate the Las Vegas Strip.
The projects could be finished in phases over the next 18 months.
Will it work? They have to be able to pull the business in, says Fath. There is nothing down there now. Unlike Macau, the site is just a barren piece of land. It is like building a casino on some landfill in New Jersey. They are taking a lot of risk.
Las Vegas Sands may hedge its bet by selling off the retail space -- a maneuver the company carried out while developing properties in Las Vegas. Some analysts speculate Las Vegas Sands could get as much from a sale as they are putting into the entire Cotai Strip development project, or about $5 billion to $6 billion, essentially getting the Cotai Strip bet for free.
Wynn Resorts
Compared to what Las Vegas Sands is doing, the Wynn Resorts' plans are fairly simple. It is opening a casino on Macau called the Wynn Macau -- probably this September. It will likely announce a new project in the region soon. Stateside, it is opening a casino called Encore in 2008 and has a golf course near its Wynn Las Vegas casino in Las Vegas it could redevelop into a casino and hotel complex.
The gamble
One big risk is oversupply. Merrill Lynch analyst David Anders estimates the number of gaming tables on Macau and the Cotai Strip will increase more than fivefold to 5,908 in 2009, from 1,176 last year. He predicts the number of hotel rooms will go up nearly five times to 28,908 in 2009, from 6,320 last year. Thats a lot of growth, and it could be too much capacity.
But bulls arent worried. People have made the same argument about Las Vegas for 30 years, says Summers. It is worth monitoring, but it is not keeping us out of Las Vegas Sands. Jefferies Klatzkin thinks the new casinos will steal business from the older, threadbare casinos on Macau, ultimately forcing them to close down. The existing capacity is in the dark ages of gaming and should have a hard time competing, he says.
Next, theres always the risk that the Chinese government might change course abruptly and put limits on foreign operators. But Summers calls that unlikely.
Maybe the biggest risk lies in the stocks themselves. Las Vegas Sands and Wynn Resorts trade for more than 11 times the cash flow they are projected to earn in 2006. Thats pretty rich for casino stocks.
The issue for Las Vegas Sands and Wynn Resorts is not the amount of opportunities, but when it is appropriate to price these opportunities into the shares, cautions Goldman Sachs analyst Steven Kent.
If you buy now for the long-term promise of Macau, you may have to weather a few downdrafts along the way. But if you believe in Macau over the next five or 10 years, then you want to own these stocks because they will be home runs, says Fath.
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