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Macau's gaming industry faces two disruptions
MACAU, a city with an area of only 30 sq km and a population of 650,000 but with a gross domestic product (GDP) per capita of US$122,500, is the second-richest city in the world, according to data from the International Monetary Fund (IMF).
The industry market capitalisation has more than doubled since bottoming in January 2016. The six listed companies' combined total gaming revenue was US$33 billion in 2017, and market cap was US$120 billion, as at June 30 this year.
However, Macau's gaming industry is about to face two unprecedented disruptions for the first time in 20 years. The first is licence expiry, and the second is competition from Japan and the Chinese province of Hainan.
Without these disruptions, Macau should trade at a long-term average forward EV/Ebitda (enterprise value to earnings before interest, taxes, depreciation and amortisation) of 12.5x.
On the basis of consensus Ebitda for 2020, industry market cap in the next 12 months could be as high as US$146 billion in our base case, implying a 42 per cent upside.
To arrive at our bull case, we assume that the sector transforms itself from a high-growth industry into a combination of growth and yield, as the capital expenditure cycle effectively ended in 2016, and the resulting dividends are rising meaningfully.
If we remove licence renewal uncertainty, the sector could trade at as low as 5.5 per cent FCFE (free cash flow to equity) yield; applying this to our 2020 estimates would mean a market cap of US$186 billion (82 per cent upside).
However, before we achieve so much upside, we need to quantify and understand the impact of the disruptions mentioned earlier.
Licence renewal is due as early as March 2020 for two of the concessionaires, SJM and MGM.
The consensus is generally not too concerned about this disruption, since the land lease extends beyond the gaming licence - that is, the operators are generally going to keep their non-gaming amenities and hotel assets, even if they lose their gaming licence.
We have quantified several scenarios, including a one-time payment of the annual Ebitda generated by each of the concessionaires (roughly US$6.7 billion for the industry), a potential increase in annual revenue tax rate of 300 basis points (bps) from 39 per cent to 42 per cent, entrance of the seventh concessionaire, or forced sale of half of the stake to have more local representation.
We would highlight that the last scenario is not the most likely one, but certainly the most disruptive. In this scenario, the existing concessionaire would have to share 50 per cent of its profit with the new entrant and be compensated with 50 per cent of the book value.
This would be value destructive for the existing players, due to the high return on invested capital (ROIC) nature of the business.
In case of competition, previous openings of casinos in Singapore and the Philippines have had limited impact on Macau, since Chinese gamblers have remained loyal to Macau, due to its proximity.
However, Hainan (if casinos were to open there) and Japan could change this by shrinking the pie meaningfully.
Macau's market share of China's outbound tourists was 17 per cent in 2017, but it captures around 90 per cent of all gambling by Chinese citizens. Macau accounts for 70 per cent of total global land-based casino revenue, but 90 per cent of all casino spending by Chinese citizens.
We estimate that the legalisation of gambling in Hainan (not our base case) could chip off 15 per cent of Macau's gaming revenue by 2025.
In 2017, about 55 million Chinese tourists visited Hainan, and 18 million of them visited the key city Sanya in Hainan island.
In the case of Japan, we expect that high-net-worth domestic individuals, as well as limited reliance on junkets, would mean less cannibalisation of Chinese gamblers coming to Japan.
Thus, we estimate the impact on Macau would be to the tune of 5 per cent of its gaming revenue in 2025.
In an extreme bear case scenario of Japan and Hainan opening, and Macau's existing concessionaires losing 50 per cent of their Ebitda, we think that the industry market value could decline by US$60 billion from our base case of US$146 billion.
That would imply 17 per cent lower than current market value.
Singapore, the fourth-richest city in the world, according to the IMF data published in 2018, opened its first casino in 2010, but the market matured quickly, with gross gaming revenue reaching US$4.6 billion in 2017.
Singapore's gaming market is somewhat protected from the above disruptions - its 30-year licence expires in 2026, and competition from Japan and Hainan is limited for Asean customers.
However, Singapore will have to manage to find growth amid rising competition from Asean casinos - such as in Vietnam, Cambodia and the Philippines - and tighter local regulation.
Growth is also constrained by limited supply addition, unlike other gaming destinations. If Singapore allows its two casino operators to deploy their excess cash/return into additional entertainment offerings, it could differentiate itself and achieve growth, despite the challenges from the competition.
- The writer is head of Asian Gaming & Lodging and Real Estate Research at Morgan Stanley