|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||1,450||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
At less than 3x run-rate free cash flow, I believe Emperor Entertainment Hotel (EEH) presents an opportunity to buy a premium Macanese gaming property at less than one-fifth the valuation of any other casino stock in the world. Since EEH also trades for less than the liquidation value of its net assets I also believe it is the safest way to gain exposure to
For those of you who couldn’t say what a Pataca is to save your life, Macau is a special administrative region of
Prior to 2002 the market was a regulated monopoly controlled for 40 years by Stanley Ho’s Sociedad de Jogos de
Enter market liberalization. Three original licenses were auctioned (to SJM, Galaxy and Wynn) and subsequently several more sublicenses were spun off. Las Vegas Sands became the first major new entrant with the Sands Macau in May 2004. The Sands was a nine month payback, and continues to be the most phenomenal casino I have seen from an ROI perspective.
Fast forward to today. Several large casino projects have sprouted up since the Sands, and with the flood of investment has come a flood of gamblers. All of the development to date has been in downtown
Long-term Cotai will become a threat because casino real estate is obviously reflexive as we’ve seen in the migration from downtown Vegas to the Strip. However I believe it will take many years before Cotai builds enough critical mass. Besides, paying less than 3x free cash flow I believe we’ll make our money back and then some by then, plus we’ll have the residual value of the real estate, worst case. But then it’s also possible that Cotai and downtown will survive in harmony as Cotai catches the spillover from downtown. Many also believe that Cotai will attract a different demographic – e.g. the difference between Gold Coast and Excalibur in
Because we’re all conservative value guys the whole time you’re reading this write-up you may labor over the very real risk of win per table plummeting. Through intensive research I’ve become a convert to the Adelson/Wynn school of casino economics (i.e. supply-driven market expansion). I believe that new developments can still stimulate incremental demand in this early stage of market development in
The Grand Emperor Hotel
EEH owns and operates the Grand Emperor Hotel in the heart of downtown on the
That SJM pays operating costs is an important stipulation. Labor inflation in
The Emperor is situated in a very valuable location, a two minute walk from the historic Casino Lisboa and the newly-opened Grand Lisboa (next door to the old Lisboa), and a five minute walk from Wynn, and not much further from the Sands. The Pharaoh is also close. The Pharaoh is an underappreciated early-mover casino that still generates phenomenal traffic. There’s also a mall going up right next door to the Emperor. When I was there last it was still a skeleton so it’s probably several months from opening. I believe it will be the only mall in
Prior to 2006 EEH was a junket operator for Casino Lisboa. A junket operator is a liaison between high rollers and casinos. The junkets maintain the relationships and take a percentage of the gaming revenue. Most casinos don’t maintain their own VIP rolls in
The Macanese VIP business differs from the Vegas high roller business in many ways. Namely, the VIP business is much bigger than in Vegas. There are simply many more high rollers in
If you’re imagining newly-minted Chinese millionaires hopping over to
The point I’m getting at is this is not a crowd that you can read about in the papers and know that their credit is good, it takes years of relationships and getting to know this crowd. The Macanese VIP business operates 100% on credit, and lots of it. It isn’t unusual for a gambler to have $1 million in credit outstanding.
The foreign casino operators – and more importantly the Nevada Gaming Commission – are uncomfortable granting credit to these guys without mandatory thorough research. The Sands – magnificent casino that it is – is a VIP wasteland. A visit to their VIP floor will turn up halls and halls of emptiness. In the entryway is a desk with computers linked to a 24 hour office in
The Emperor VIP hall is by far the fullest and liveliest and I believe most of the gamblers enjoy that; I think when some Macanese casino operators say otherwise they are playing to our western naivete. Portfolio managers may enjoy sitting quietly in seclusion for hours on end, but not gangsters.
Because Emperor operates their own junkets their cost structure is lower since they don’t have to pay a third party junket, so Emperor can afford to pay their gamblers higher rolling commissions. Rolling commissions are paid to high rollers for bringing new gamblers to the junket. As you can see, this is a somewhat reflexive business.
Emperor’s VIP franchise is possible because they junketed for the only casino in
To shift gears, Emperor’s mass market business is frankly unimpressive but profitable. The concourse is small and unexciting compared to the massive halls at Grand Lisboa and Sands, but the tables are full. If not for the gargantuan LEDs on the exterior, beefeater guards armed with automatic weapons at the door, and $2 million of gold bars set into the lobby floor, the casino itself is undistinguishable from an office building. Given that the VIP business contributes more than 3x the EBITDA that the mass market business does, I can live with average.
The ugliness is a virtue though. It’s obvious that management built the Emperor for ROI. Were the Emperor to be at the far end of Coloane I would be very concerned for its weak mass market offering.
I don’t think I can overemphasize the value of Emperor’s location. I believe it sits on some of the most valuable property in
You Worry Too Much
The risk, defined as what we don’t know, to incremental buyers of EEH is markedly lower today than before the opening of Grand Lisboa in February. You must understand how big a threat Grand Lisboa posed – I’m embarrassed to say I didn’t until it was already built.
Grand Lisboa is simply an impressive casino built by the smartest operator in
It’s my opinion that if Grand Lisboa couldn’t destroy the Emperor, that the single casino risk is unlikely to be a material risk going forward. The Grand Lisboa is the best evidence I have that win/table won’t easily be whittled away. Other evidence abounds.
Monthly market statistics (apologies for the spottiness):
Seats Rev1 Rev/Seat Notes
June 2006 16,248 489 30,090
July 2006 16,322 557 34,107
August 2006 18,335 572 31,197 Sands expansion
Sept 2006 19,959 558 27,972 Wynn opens
Oct 2006 21,890 715 32,650
Dec 2006 23,118 734 31,763
Feb 2007 25,750 696 27,020 Grand Lisboa opens
Mar 2007 25,169 778 30,911
1Millions of USD
It seems that the market is absorbing the capacity comfortably. Or another way to look at it is that the new developments are generating their own demand, and carrying their own weight. The middle ground, which is supported by the data, is that the growth of the market is meeting pent-up demand. Visitor growth isn’t keeping up with capacity growth and probably won’t in our time horizon. Instead, spending per visitor is growing rapidly. When I think about my own gambling habits, my gambling budget is going to be much higher if there are 20 casinos nearby than if there is only one because I get bored and want to try another casino, or I pop into a casino on the way to dinner, etc. I think it’s clear that some market expansion is good for everyone. Grand Lisboa may take some spend away from the Emperor in the short-run but it’s just as likely to draw gamblers into the area. Most importantly, long-term the Grand Lisboa helps strengthen the neighborhood.
Lastly, as always, one has to seriously consider what a number really tells you. It’s easy to fall into the trap of assuming that because an average declines that all boats fall with the same tide. It’s possible, and likely in some cases, that the incremental table has a much lower win than the previous average and so pulls down the average with little to no deterioration in existing tables.
Prediction: When the April and May market numbers come out we will see a healthy decline in revenue per position coinciding with the opening of Crown Macau’s (Melco) 2,200 gaming positions. I am certain this won’t be because of any material shifts in market share. It will be because Crown will put up pathetic numbers. Crown is situated squarely in the armpit of Macau, built I suspect more to bilk Americans out of their investment dollars than to bilk Chinese out of their gambling dollars.
I believe market revenue per seat will grow nicely over the next several months. There will be a lull in promising launches until Q4.
2007 Launch Schedule:
Project Date Positions Notes
Crown April 2,200 See above
Wynn Exp. July 1,484 Terrible VIP offering
Venetian Q4 9,200 Cotai
MGM Grand Q4 3,105 Nice addition to Emperor’s neighborhood
Greek Mythology Exp 4,650 In the Crown armpit, run-down & declining traffic
Pier 16 725
The only remaining project in 2007 that remotely concerns me is MGM, but again I don’t consider it nearly as concerning as Grand Lisboa. I think it’s good for nearby property values.
2008 Launch Schedule:
Project Date Positions Notes
Four Seasons Q1 1,180 Cotai
Galaxy Mega 4,600 Cotai
MGM Expansion 1,565
Sheraton/St. R.Q3 3,700 Cotai
Shangri-La Q3 3,700 Cotai
Basically by the end of 2008 there will be nearly as many seats in Cotai as in the whole market today.
2009 Launch Schedule:
Project Date Positions Notes
Hilton/Conrad Q3 3,700 Cotai
Fairmont/Raff. Q3 3,700 Cotai
Prior to last week EEH also operated a gambling boat. EEH sold the boat for HK$175 million. The price isn’t juicy relative to $30 million of free cash flow. It should be emphasized however that the business was deeply flawed in my view. For starters it was a cruise out of
EEH is also a 50% partner in a mall project in
It makes no sense for a casino operator to develop malls in
I’m going to break this discussion into impossibly granular detail that can only be reconciled by speaking to management. Company reports will not provide this level of detail unfortunately. The company does have a thorough presentation confirming most of the details. I’ve posted the IR contact info at the end of the writeup. Note that EEH reports on a March fiscal year. Also note that EEH effectively owns 45% of Grand Emperor Hotel with minority investors owning the other 55%. As such EEH is entitled to 45% of the concourse, slots and hotel EBITDA. VIP doesn’t count as part of the hotel, so EEH keeps 90% of VIP EBITDA. EEH doesn’t pay income taxes since they elect to pay gambling taxes instead.
In an obviously underappreciated announcement made at the time of the gambling boat sale, EEH announced the opening of four additional VIP tables. It’s possible that the market believes the new tables will simply cannibalize the older tables. What management didn’t publicize is that these new tables don’t address the same market as the older ones. The new tables will be mega high roller tables. It has been intimated to me that the existing roll of VIPs won’t even know about these new tables. The new hall will have its own secret entrance in an obscure part of the hotel garage and will not be accessible from the rest of the casino. I believe this is a substantial step toward strengthening the Emperor’s already solid VIP franchise, as I believe no other casino in
1H 2007 win/table day was HK$676,000 (not a typo – that’s about US$85,000/day). Management feels that 2H win/table will increase sequentially. As Grand Lisboa didn’t open with any VIP tables there would’ve been no drag on win/table.
If you want to get more granular, gross roll per month is about HK$5 billion – apply a 2.7% net win percentage and divide by 30 days then divide by number of tables and you’ll get your net win per table day, give or take.
To arrive at net revenue for a period apply the following formula:
Win/table day x Days x Tables x 40%
Rolling commission is officially .85% of gross roll, but I’ve short-handed it by making it 78% of net revenue.
1H 2007 Run-Rate
Tables 6 10
Win/Table 655 700
Net Rev. 288 1,000
Oper. Costs 9 30
Rolling Comm. 225 780
EBITDA 54 190
EEH’S 90% Share 49 170
Capex 2 5
FCF 52 185
EEH’S 90% Share 47 165
The Emperor also leases out several VIP tables to junket operators, which generates about HK$35 million in rental income per year with no associated expenses. This income is reported in the hotel segment.
Mass Market Concourse
In 1H 2007 win/table day in the mass market concourse was HK$28,000. After the Grand Lisboa opening I’m told that win/day bottomed out at about $26,500. Since then win/day has set a new record in March – win/day recovered to previous levels after about 45 days. Net revenue is 40% of gross win.
1H ’07 Run-Rate
Tables 48 52
Win/Table Day 28 29
Net Rev/Table 11 11.6
Net Revenue 94 220
Oper. Costs 58 120
EBITDA 36 100
EEH’s 45% Share 16 45
Capex 6 12
FCF 30 88
EEH’s 45% Share 14 40
Slots 1H ’07 Run-Rate
Seats 340 348
Win/Seat Day 940 1,000
Rev/Seat Day1 290 400
Net Revenue 18 51
Maint. Cost 16 32
EBITDA 2 19
EEH’s Share 1 9
Capex 5 10
FCF -3 9
EEH’s Share -1 4
1Note that the revenue share arrangement with SJM was increased subsequent to the first half from 31% to 40%.
Hotel 1H ’07 Run-Rate
Rooms 291 291
Occupancy 81% 85%
Avg. Rate 805 800
Room Rev. 35 72
F&B Rev. 30 60
VIP Rental 17 34
Mkt. & Prom. 43 86
Other Rental 8 16
Total Revenue 133 268
Operating Exp1100 180
EBITDA 33 88
EEH’s Share 15 40
1Management believes that marketing costs were about HK$10 million per half higher in 1H than current run-rate because of launch costs.
Note that hotel operating expenses include a negligible amount of capex, so EBITDA is the same as free cash flow.
1H Gaming/Hotel Est.
Total Rev. 533
1H Ship & Corp.
Total Rev. 61
Total Est. 1H Actual
Revenue 594 593
EBITDA 136 133
Stock Price 1.56
Market Cap 1,450
Land 600 HK$350 mill cost basis, 25% tax rate
So shorthand we can see EEH is trading for 2.5x 1H RR EBITDA. We know that current earnings power is considerably higher given that they’ve expanded their VIP capacity by 67% with little addition to overhead.
Base Case FCF Mult. EV
VIP 165 10 1,650
Mass Mkt. 40 8 320
Hotel 40 9 360
Corporate -10 10 -100
Total 235 2,230
Equity Value 3,000
Shares Outstanding 929
Stock Price 3.25
Best Case FCF Mult. EV
VIP 180 13 2,340
Mass Mkt. 44 11 485
Hotel 44 12 530
Corporate -10 13 -130
Total 258 3,225
Equity Value 4,400
Shares Outstanding 929
Stock Price 4.75
Keep in mind that these numbers are run-rate, not 2008 or 2009 as other
Downside (or lack thereof)
EEH and the minority shareholders put about HK$1.4 billion into the hotel property. The most recent appraisal valued the property at about HK$2 billion. EEH’s 45% share would be worth HK$630 million at cost, and HK$900 million at market. An adjacent lot owned by SJM is empty and could be used to develop a larger casino.
Shanghai JV Put 485 HK$530 put, $350 basis, 25% taxes
Net Cash 180
Net Asset Value 1,565
Current Market Cap 1,500
It would seem harder to get downside as a going concern – how much would win/table have to go down before we’re at a respectable multiple?
Vanessa is sort of the COO of the casino business, but she also works with 163 as well.
Company Web site: www.emp296.com