"You cannot prevent the birds of sorrow from flying over your head, but you can prevent them from building nests in your head…" Old Chinese Proverb
From the way scared money has been fleeing China related gaming shares you'd think we were entering the Year of the Rabbit, not the Year of the Monkey-which according to my Chinese friends, augurs a much happier state of affairs in 2016. And when there's scared rabbit money out there to the degree that has shown up so far in the 1,000 point hit the Dow took last week, it tells us this: It may not be the wisdom of crowds moving the needle in this case, but perhaps, it's madness.
Whether you believe in the Efficiency of Markets Hypothesis or not is of course a matter of personal conviction. I don't, particularly in the case of Las Vegas Sands (NYSE:LVS) and the battering its shares have endured over the past trailing twelve months: $36.63-$61.59. The operating assumption here was that there was so much gloom and doom about Macau sloshing through the media, followed by the recent plunge in Asian markets that there was little positive sentiment to buck up believers in Las Vegas Sands. So is the market telling us that everything there is to know about the stock, is known, micro, macro and the color of the tie Sheldon Adelson will be wearing on Monday?
Is the market saying that its price dipping as low as $39 at the Friday close is efficient because there's nothing out there hidden beneath some metric mushroom that proves we don't indeed know everything?
Since along with the Dow, nearly every sector on the market came in for a drubbing last week, we need to attribute at least some of the selloff of LVS to the general jitters occasioned by China perceived woes metastasizing globally. The shares will rebound this week when and if, cooler heads, prevail. But how far? If LVS regains its pre-Asian flu price in the low 40's is it then a better exemplar of efficient markets at work?
The efficient markets theory or not, we think the current jangling of nerves about China offers almost a historic entry point low for conviction buyers of this company. I've written in SA for months now that even at higher prices, I still thought the stock was cheap on fundamentals. At the same time bearish market sentiment about Macau in many quarters kept LVS suppressed and I got my share of na, na, na, na, na shame on you comments on my optimistic take along the way. Fair enough, point taken, but I held my ground at $70 and still do. My thesis was simple:
There is never a time when you can know everything there is to know about a company operating in China or under its auspices. Almost by definition, it's an opaque prism where decisions and policies, often in conflict with each other, pour out of government daily. So to me, believing that the price of LVS shares was indicative of the efficient market hypothesis at work at any level in its 52-week trading range was dead wrong. And I believe that now more than ever as the shares have sunk to a bargain basement price that tells me - while there is lots known, it's become a question of not what the market does see, but what it wants to see.
I believe the market has bought into a flawed narrative on LVS now exacerbated by the shaky market we witnessed last week.
Forget it Jake, it's Chinatown
Trying to figure out what officialdom is up to in Macau evoked an image in my mind of the 1974 movie "Chinatown". In the last scene, as an inexplicable act of police corruption that even stunned the hard boiled private eye Jake Gittes (played by Jack Nicholson) we see him pulled away from the scene of a murder with the memorable line of a friend saying, "Forget it Jake, it's Chinatown…"
Nowhere is this clearer than in the crazy quilt monetary policies of the Chinese government, which has caused the normal currency fluctuations to move from a long time stabilized average of 2% to a more recent 8%. On top of this, the foreign reserves of the country are shrinking at a rapidly increasing rate, causing some moneyheads around the world to speculate that if that reserve number ever drops close to $2 trillion - we're all in the veritable crapper. China is learning the hard way that currency moves and stimulus packages can only go so far, bump into each other, and send conflicting signals. The takeaway: China has yet to learn Capitalism 101 given the gyrations in its monetary and economic stimulus policies of late.
The irony here is this: The Chinese economy isn't anywhere near as challenged as its markets jitters tell us. The real economy may indeed have lost some steam, but it's far from a basket case. In fact going by the recent prices of commodities and disposable income numbers, the 7% to 6.5% GDP growth range projected earlier this year seems a lock.
These confusing and fumbling attempts by China to manage its economy through its current trough gives us pause to believe that no, we don't know everything and that the price of a China sensitive company like LVS may reflect all that we can know, certainly not all that we should know to make smart calls on timing buys and sells on LVS.
What we know, but perhaps don't really see
1. The great GGR collapse in Macau. Triggered by the junket crackdown, the market tanked a staggering 48.6% last February. And each successive month the y/o/y gap continued to decline at an alarming, but narrowing rate from the high to mid and eventually, low 30s, ending the year, for the month of December at a 21% y/o/y downside. For the entire year, we saw a 34.3% plunge bringing 2015's total GGR in at $28.9 billion.
Moreover, as mass play increased its percentage share of total GGR, we saw the huge room inventory of LVS acting as a potential safety valve against even more staggering losses of revenue.
Buried in the crepe, hanging monthly GGR numbers - was a less evident truth. By last fall, the most blatant chunk of corruption sourced VIP business had been wrung out of the market. The VIP to mass ratio had brought GGR into a 50/50 balance - encouraging news for LVS. And visitation, encouraged by a small change the government put into VISA regulations, began showing results. No hallelujahs for certain - a small, but defined arrow pointing upwards. And more on the way.
2. The Union-Pay hysteria
The government knew since 2010 that launderers were using their Union Pay credit cards to do a three-card Monte shuffle that moved money out of the mainland, into cash in Macau with fake jewelry shop sales, among other sleight-of-hand activities. When officials acted last year in an order that put government controlled Union Pay on notice to either shape up or ship out, it fed into the Macau narrative: Another death blow to Macau casinos dealt by officialdom. But how much? We worked the phones to our Macau sources. They agreed this was indeed another direct strike on gaming revenue. So determined were officials to stamp out the abuse that it was widely believed, and in many cases reported to us, that government informants were even taking cellphone photos of Union Pay players at the baccarat tables and sending them to the police.
But, just how much total impact could the crackdown on Union Pay have on GGR? We sifted through our information sources in an attempt to put a realistic number beside the news and kept checking back with marketing executives we knew. Was it as bad as all the prognosticators thought? Worse? Was this the final nail in a Macau coffin that was already being lowered into the ground? Last October the picture started to emerge as a photograph in a tray of developer.
My sources both in the industry and among groups of players I knew believed that thus far the effect on gaming revenues due to Union Pay shenanigans had proven overblown. "Yes it has shrunk some play, mostly I think in the premium mass area," one marketing executive told me. "Look we can't afford to lose any play in this crazy market. But this will be a lot less than people think." She clocked her estimate at around a "worse case 3% to 4%" of mostly premium mass sector play. No cause to cheer naturally, but no signal to keep digging the Macau grave.
Now almost three months later, her estimate was confirmed to a great extent, by Grant Govertsen, of Union Gaming Securities of Asia, whose report estimated the hit as somewhere in the area of 2% to 3% of GGR, agreeing that most of it would indeed come out of the premium mass sector, who his research showed, were the largest users of Union Pay cards of any Macau market segment.
He estimated total illegal Union Pay transactions last year would reach $153 million - no tsunami was advertised when the crackdown began. A grand total, according to his estimate (my sources put it a bit lower) is that 10% of premium mass GGR originates from Union Pay players. Here's the lesser known number: the government has under 100 cases of UP fraud under investigation - not much to show for all the heat generated. The government wants loud, clear poster child cases - for certain. The chilling effect was there, but hardly arctic.
Whether this says more about their law enforcement smarts or the overkill applied to the problem, we can't say. But our point here is this: The Union Pay news broke as a shock wave and sent jitters into the trading of Macau gaming shares. Why? Because it, along with other continuing negative news about GGR fitted the media narrative of the great global gaming giant tottering on the edge of the abyss.
This view is in no way meant to diminish the seriousness of the beating Macau took last year. Yet it continues to prove that the efficiency of markets theory doesn't really work. Negative events that shake share prices may feed into traders and short seller strategies, but their long-range impact too often proves far less damaging and that among other perceptions is what has contributed to the battering of LVS.
3. Small short term facts sometimes foretell larger ones to develop long term in unstable markets.
Amid all the forecasters of long-term Macau gloom, this year was a very real fear among some analysts that the core gaming proclivities of the Chinese had changed. They no longer believed that the long held cultural affinity for gambling had dissipated and that the younger demos of the Chinese populace had nowhere the gaming inclination of their parents and for certain, their grandparents. This may well be correct. Millennials are pretty much cut from the same cloth all over the globe. And if Las Vegas was seeing a decline in the gaming to non-gaming ratios of young people there, it just made sense that their Asian demographic brethren would echo that inclination. Pop culture tropes and habits among millennials cross national and cultural borders these days via social networks as never before.
With this in mind, we wondered about the attitudes of younger Chinese people toward gaming and threw out our own net again. We got lots of raised eyebrows, some confirmation, yet for the most part, disbelief that it was a major demographic threat to the industry. In figures published last week by Macau regulators, we learned that in 2015 the casinos had denied entry to 236,000 underage people who'd arrived either with fake IDs or with other means to talk their way into the casinos.
Our sources also added that despite militant monitoring by the operators, they were certain there were still kids finding their way inside and getting ejected after the fact, which would add to that number. It's a small fact and we really don't know how many of these young people came prepared to gamble, sneak into a show or restaurant, or even how many came to commit petty crimes. Again, our source reported with a smile, "No no, these kids did not try to fake their way in to eat a bowl of noodles they could get on any street corner. Or even see a show, or meet friends. They mainly came to gamble, and of course, have a good time in general."
Our takeaway on this tiny factoid: Despite widespread adaptation of online gaming options, dozens of entertainment diversions now available to millennial Chinese young people, casinos still remain a powerful draw. Is it just the moths to a flame effect? A primal need of the young to be where the action is? Perhaps that is part of it. However, over time as long as gaming can be conducted in a single location as it is in China, it will draw people who want to gamble. And as they age and their disposable income increases, so will their patronage of Macau's casinos. So our news for the demographic death prognosticators is simple: Not so fast.
The still great case for LVS
Here's the basics as of this writing:
52-week range: $36.53-$61.59
Market cap: $32.05 billion
P/E (TTM): $14.49
Dividend & yield: 2.60 (5.93%)
2014 Asia revenue base:
Macau: $7.95 billion
Singapore: $2.57 billion
Total for Asia: $10.52 billion
Here's a Xanax dose for a scared market that traded LVS below $40:
1. Adjusted EBITDA Margin as of Q3 2014: 36% of revenues
2. LVS owns 52% of the hotel rooms in Macau before its new properties, The Parisian and St. Regis open late this year.
3. Dividend forecast for 2016 $2.88. Take it to the bank now. Preserving the dividend is Sheldon Adelson's second religion. LVS has a compounded annual growth rate in dividends of over 30%.
4. LVS had $3.7 billion in cash flow for the trailing 12 months ending last September.
5. Capex is narrowing: During the same period capex was $1.5 billion leaving an annualized cash flow at $2.2 billion.
6. Sands China. Despite the battering of the market gained 2.1% of market share to 23.7%
Peering into 2016
Our estimate for Macau GGR this year remains in a range between $31 to $35 billion. Our low call is anywhere between $1.5 to $2 billion above analyst consensus and our high the same. If LVS sustains its current market share and later adds to it when the Parisian and St. Regis properties open for part of the year, it could move its market share up to 25% in our view. That puts its Macau revenue number against our $31 billion low side forecast of $7.75 billion, to which you add Singapore, Las Vegas and its surging gains in its US regional at Bethlehem, PA. A solid performance for a stock currently priced around $40.
These are the numbers which in our view, also support the 2016 $2.88 dividend call and the price target of $70 by the end of Q2.
What to watch for now
1. We are a bit less than a month away from Chinese New Year. We believe the results for February GGR will be an excellent barometer to measure the degree of recovery the market will be looking at going forward into Q1 and Q2. Bear in mind that last February bore the initial brunt of the junket earthquake that shook the market, with GGR falling 48% from its 2014 number. Our take now is that the narrowing comps we have seen since then will continue and bring y/o/y GGR in the range of 18% to 22% for February and continue to move toward flat by April. Naturally, the lousy 2015 numbers will be easier to beat - but in the stock market it's as often the message that propels stocks, as much as the events.
2. Opening in late June of Wynn Palace and later in the year LVS Parisian and St. Regis. Recovery momentum should continue.
3. Publication of Macau's concession renewal policies, which we believe will continue to press for militancy against grey area practices, but which will also have elements supportive of industry growth. And even as we have suggested, the possibility of a new wrinkle: The government buying an equity position in the US casinos.
4. The GGR gains will come from mass and premium mass, from expanded room capacity market-wide to accommodate more tourist/gamblers and mostly from a change in sentiment. Q1 this year will be telltale. LVS is sitting very pretty in such a scenario.
What we can't nor can anyone else state at this point, what the Chinese economy will look like going forward. As we've stated in this article, we believe it's neither as strong as it was, nor as bad as many prognosticators have forecast. However, if they stay in the 6.2% to 6.9% GDP number for the year, we see no dramatic downside for the Macau casino sector.
Longer term, we looked at the behavior of US gaming jurisdictions before, during, and after recessions between the years 1987 to 2007/2008. In all cases, the revenue hits taken were for the most part restored in full or close enough to pre-recession levels to provide confidence that the basic business model of jurisdictions comprised of integrated casino resorts worked. And we see no reason why this history won't be replicated in Macau beginning this year.
And because the negative Macau narrative still seems to overhang the shares of solid performers like LVS, we believe the entry point for conviction buyers has never been better. And that those investors who have come in higher this past year can also expect to be rewarded.
Compare LVS's yield at near 6%, its cash flow, its core business, its margins, against most other shares selling at similar levels and its apparent mispricing due to what we see as an overreaction - understandable as it is - to events this year and ask yourself: Just how efficient has the market been?
About the author: Howard Jay Klein is a 25+ year c-level executive veteran of the casino industry including properties like Caesars, Ballys and Trump Taj Mahal. He is now a consultant to that industry in marketing, operations and development. He is the author of Mastering the Art of Casino Management available as a Kindle ebook. His opinions are not standard security analysis though some of its metrics are employed to give context to his views. His objective is to provide investors with a 360 degree view of gaming companies with insights not readily available through regular financial media as much of it comes from his personal experience, network of friends, former colleagues and associates inside the industry.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.