Will Melco Hit The Jackpot In Macau?

There is no question that, in the long term, Macau has the potential to be a very lucrative gaming market, but Melco PBL (MPEL) is betting heavily on explosive growth in the short term. When I saw this IPO down a road a month ago, I thought for sure it would be one of the hottest of the year, rivaling Nymex (NMX) . But so far it hasn't turned out that way. So is right now a good buying point? Well it depends on what you think of the risks presented in the IPO prospectus

1. Politics. Melco has not hammered down a land lease agreement for their City of Dreams complex with the Macau government yet, even though they're already committed financially to its construction. When you throw in the additional factor that commercial land in Macau is white-hot right now, I would guess Melco does not have too much leverage in these negotiations. City of Dreams is expected to come on line in 2008 and provide a large bulk of Melco's earnings, so any delay would be very detrimental, especially considering how leveraged Melco is.

2. Infrastructure risk. I was in Hong Kong this year and decided to visit Macau. Unfortunately the only methods of transportation available were expensive and likely inaccessible to the mass market ("high-speed" jetfoil, helicopter, or plane). I took the jetfoil. The ride was 45 minutes long and extremely turbulent. When I got off the boat I was definitely not in a gambling mood. The jetfoil was also about 20% full. On the other hand, all you need is a car to get to Las Vegas. So the question is: will foot traffic increase at a fast enough rate to give Melco a decent return on its massively leveraged investments?

3. Competition. The huge Wynn (WYNN) and Sands (LVS) projects are expected to come on-line at around the same time City of Dreams does, not to mention two big casinos have just opened up (Galaxy StarWorld and another one that I can't remember the name of). All promise high-end amenities and full entertainment suites. Where is Melco's moat?

4. Weather. Macau isn't located in the middle of the desert where every day is sunny and there is no risk of anything damaging infrastructure, save terrorism. Macau is comprised primarily of two islands - two very small islands. Typhoons are common in the Pacific, and we all saw what happened to Harrah's (HET) properties in Mississippi when Katrina hit. But Harrah's was diversified enough to recover from that damage, while all of Melco's revenues are derived from Macau. Should a natural disaster occur, the results on Melco would be devastating.

But then again, if I were to put all my eggs in one basket, Macau is definitely pretty high up on the list of baskets. So, as long as you feel the risk/reward is favorable, take a shot at it. It is after all one of few IPOs in the latter half of the year to fizzle even with a compelling story and great potential for growth.

Disclosure: Author has no position in MPEL.