Description

SJM Holdings (0880-HK)

Current Price: $12.18 HKD

Target Price: $17.00 HKD (40% Upside)

Industry: Asian Gaming

Market Cap: $66.4 bn HKD / $8.5 bn USD

SJM Holdings ("SJM") is one of the six companies authorized to operate casinos in Macau

• - SJM is the incumbent gaming operator in Macau, having operated with the monopoly license for 40 years prior to the Macau government opening up the market to others in 2004
• - SJM remains the largest casino operator in Macau, in terms of gaming revenue, number of tables, and number of casinos, with market share of approximately 32% (based on gaming revenue) in 2010E
• - SJM is controlled by billionaire Stanley Ho, the founder of the Macau gaming industry, and as such, has excellent relations with both the Macau and Chinese governments. Mr. Ho owns 7% of the company directly and controls an additional 56% through a holding company
• - SJM owns 4 of its casinos outright (most notably, the Grand Lisboa) and collects a management fee of approximately 4% of gross revenue in the 14 other casinos that it operates
• - In 2011, Grand Lisboa will account for approximately 65% of SJM's EBITDA, with 12% coming from other owned casinos, 18% coming from the management of third party owned casinos, and 5% from non-gaming activities

Macau is the largest and one of the fastest growing gaming markets in the world and continues to have strong long-term growth prospects

• - Macau is expected to generate over $23 bn USD of gross gaming revenues in 2010, or approximately 3.5x what the Las Vegas Strip did at its peak in 2007 (~4.0x 2010)
• - The market has grown at a CAGR of 30% since 2004 (when it was first opened to outside operators)
• - The Macau gaming market has significantly outperformed expectations in 2010 and is now expected to post gaming revenue growth of 55% for the year, relative to expectations of 15%-20% at year end 2009
• - Current expectations are that the market will grow an additional 15%-20% in each of 2011 and 2012
• - This sustained level of growth is supported by (i) continued high single digit growth in China's real GDP and (ii) the Chinese government's commitment to increase visitation to Macau through various infrastructure improvements, including:
• o Expansion of the primary Macau border gate from an annual capacity of 11 mm to 25 mm (expected to be completed within the next 40 days)
• o Completion of a high speed rail network that will link Guangzhou (the capital city of China's most populous and highest GDP province) to Zhuhai (the bordering Chinese city to Macau). This rail line will reduce travel time from Guangzhou to Zhuhai from 3 hours by bus or car to 47 minutes. The rail line is expected to be 70% complete by the end of 2010 (resulting in a 30 minute train ride plus a 30 minute bus ride to get to Macau) and 100% complete by the end of 2011
• o Expansion of Guangzhou International Airport (already China's 2^nd busiest airport) from a capacity of 37 mm annual passengers in 2009 to 65 mm annual passengers in 2010 to 80 mm in 2011, making it larger than JFK, La Guardia, and Newark airports combined. Guangzhou is a significantly less expensive air destination than Hong Kong for mainland Chinese residents as it is not an international location
• o Construction of a high speed interstate connecting Guangzhou to Zhuhai that will reduce the current driving time from 3 hours to 1 hour (expected to be completed by year end 2012)
• o Completion of a new ferry terminal on Cotai that will double the existing terminal's capacity (currently 25% complete, expected to be 100% complete be year end 2012)
• o Construction of a light rail network within Macau that will connect the ferry terminal to 20 stops on both the Macau Peninsula and Cotai, making travel throughout Macau much easier (expected to commence operation in 2014)
• o Construction of a bridge connecting Hong Kong to Macau that reduces driving time between the two cities from 4.5 hours to 20 minutes and provides a more comfortable alternative to the 1 hour ferry (expected to be completed by 2015)

2010 has been a break-out year for SJM, with a number of factors leading to EBITDA growth of +115% (from $2.3 bn HKD in 2009 to $4.9 bn HKD in 2010) Key drivers include:

• - Strong performance at SJM's flagship Grand Lisboa property, which is expected to grow revenue by 72% (vs. market growth of 55%), driven by an increase in number of VIP tables and increased win per table in the mass segment. EBITDA at the property is expected to increase by 60% in 2010, from $1.6 bn to $2.6 bn HKD
• - The opening of SJM's Oceanus casino (a mass focused casino located directly next to the Macau peninsula ferry terminal) in December 2009, which is expected to contribute $200-300 mm HKD of incremental EBITDA in 2010 (not separately disclosed)
• - Renegotiation of the management contracts with its third party owned casinos from being profit sharing agreements to revenue sharing agreements. SJM now receives approximately 4% of gross revenue and effectively created $1 bn HKD of incremental EBITDA overnight

We believe consensus EBITDA estimates for 2011 and 2012 are still too low.  Key drivers of our higher estimates include:

• - In October 2010, SJM moved 30 VIP tables from the Old Lisboa to the top two floors of the Grand Lisboa (a significantly better location) concurrent with an agreement with the Golden Junket (Macau's largest and most powerful junket) that its players would move an incremental $5 to $10 bn HKD of betting volume per month (above what they were already betting at the Old Lisboa) to Grand Lisboa from non-SJM properties. The Golden Junket is partially owned by Stanley Ho (SJM's controlling shareholder) and his wife, so there is little risk of the Golden Junket reneging on its agreement or moving the business elsewhere
• - We believe the market is not only underestimating the revenue impact from this agreement but also management's ability to maintain Adjusted EBITDA margins in the 16% range
• - We also believe there is upside to EBITDA margins at SJM's other owned casinos, which we believe can improve from 7.5-8.0% in 2010 to approximately 10% by 2012   

- We would note that despite expected market growth of 15-20% in 2011 and 2012, our projections include revenue growth rates that are below this range due to (i) our estimate that SJM's older, third-party owned casinos will grow at a rate that is slower than the market and (ii) the opening of the Galaxy Macau resort in Q1/Q2 2010 should result in some share loss for all existing casinos

• - We would also note that due to minimal maintenance capex requirements, a strong net cash position, and the absence of a corporate income taxes, SJM's Free Cash Flow is approximately 95-96% of its EBITDA

Despite SJM's strong operational performance in 2010 and robust growth prospects (both organically and through expansion into Cotai), SJM trades at a discount to its Macau gaming peers even before taking into account our higher than consensus estimates and potential value from its future Cotai project

SJM's $15 bn HKD ($2 bn USD) Cotai project could add $2.00 to $3.00 of value to the share price.

• - SJM is currently negotiating with the Macau government for a parcel of land in Cotai
• - Identification of the piece of land that SJM will build on is expected to be announced in Q4 2010 / Q1 2011
• - We believe Phase 1 of the project (the casino and primary hotel towers) will take approximately 3 years to build and begin operation in 2015

 At a 14x multiple of 2012 FCF, we believe the stock should be worth $17, excluding $2-3 of value for the present value of a project on Cotai, discounted back at a 10% cost of capital and assuming a 25% ROIC (vs. 53% for Grand Lisboa)

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