By Howard Jay Klein
"Gossip as usual, was one third right and two thirds wrong…"
L.M. Montgomery 1874-1942
Last week, the Government of Macau issued its long-awaited Mid-Term Review on the economic, financial and regulatory performance of the six gaming operators. Many gloomsters about the industry in general and the den of Macau bears on SA and elsewhere had long growled that the report would issue at best a C and very possibly D to F failing grades. The shorts had nursed this possible negative news as further proof that Macau shares were headed south in a death spiral.
The review, commissioned by the government and produced by the University of Macau's Institute for the Study of Commercial Gaming, took over a year to complete. It is mind numbing in its detail, economic statistics and clarity. The report was published in Chinese and Portuguese, but its key conclusions were released in English at a press conference last week chaired by the Secretary of Economy and Finance, Mr. Lionel Leong Val Tac.
In his remarks to the press Mr. Tac stressed that the report implied "no guarantee that the six operator's licenses would be automatically renewed" when the reconcession decisions come down in 2020 and 2022. Understandably, the Secretary has the mainland government hovering behind him. He must keep his public utterances in line with policy issues he well knows will likely be decided in Beijing, not Macau four to six years from now.
Yet, undeniably the 254-page report clearly had a strong positive tone toward the industry. And our sources in Macau feel confident it will support a renewal thumbs up in four to six years. No one can ever be certain about anything. This is China and nobody can read the minds of Xi and his top cadres now no less in the future. As with everything in China, there is often more to read between the lines than in the lines themselves.
Realizing the nuances of languages could mislead, we asked an industry friend, a native of Brazil, to translate the report from Portuguese for us. (He is a businessman interested in the effort next month to move casino gaming legislation in that country). What is digested for you here are the most salient points of the report that relate to the shares. We believe they will be good news to holders of Macau-centric gaming stocks: Las Vegas Sand (NYSE:LVS), Wynn Resorts (NASDAQ:WYNN) and MGM Grand Resorts (NYSE:MGM).
We aren't including Galaxy only because due to certain technical issues relating to finance, the report hesitated to give the company the same clear signals about its compliance. It's being worked on.
Taking language nuances in translation into account, we've boiled down the main points of the report we believe to be supportive of the six operators' efforts to build, finance and operate a vital, growing and diverse Macau gaming industry. Our view is that it will serve as further support for the stability of the industry and by extension, add a bullish tone to the shares.
There were nine key issues the report dealt with including: finance, compliance, diversity of non-gaming offerings, human resources, the relationship between the operators and local businesses, impact on Macau society in general and of course, the junket problem.
1. Finance. The report unequivocally confirms the financial stability of the operators, their investments in building the industry and their continuing commitment to growth. "All have fulfilled their capital commitments as promised."
2). The report noted that the trend of non-compliance with various regulatory issues was on a rapid, downward trend and cited this as a positive. It concluded that the industry was sensitive to the regulatory issues and reacted quickly to respond to problems.
3). That the concessionaires had an overall positive impact on the Macau economy, attracting foreign investment and improving the overall welfare of the public by creating a strong environment for robust employment growth.
4). That the operators had, as promised, sustained a policy of promoting local citizens to positions in middle and upper management.
5). As has been stated, the report stressed that there was "no direct relationship between the report and the gaming concession renewal process to come." However, a broad consensus of analysts as well as key individuals in our industry source network believe that the report cannot do anything but enhance the rationale for concession renewals.
6). The Macau government is closely watching ongoing casino development in other Asian jurisdictions. This expression of understanding that the industry could be facing increasing pressure tells us - between the lines - that they're not operating in a gaga land vacuum. They're not taking their success for granted and understand that Macau's incredible success has been compelling for other Asian entities to move ahead on gaming development.
Their grasp on reality is a positive for the operators. And they clearly grasp how the crackdown has devastated the VIP sector.
7). The negatives. As expected the report card, as do all such evaluations, had its fails, expressed here as expected, with the junket business and its structure. Here the report stated that it was not the government's intent to seek "a systematic reduction in Macau gaming revenue." But newer, stiffer rules needed to be put in place to assure tighter control on junket system abuses associated with money laundering and other ills.
The report, as expected, had this to say about junkets:
a) The excessive bargaining power of junket representatives was disturbing.
b). The management of credit in general, as a process needed stiffening.
c) The number of junket operators who had been closed down due to financial weakness, questionable practices, like side betting, etc. tell their own tale. This is all old news. Yet it also made it clear it expected to beef up enforcement considerably. Over 150 junket operators have already closed. The government will take strong steps to assure that the remaining companies comply with new regulations and financial stability controls.
The report expressed concern about the rise of inflationary trends and crime since the industry first blossomed. It must be noted here that similar worries always surface in such studies in gaming jurisdictions all over the globe. In context, facts are facts but increases in inflationary pressures always accompany rapid economic growth.
Rising crime rates are directly related to the confluence of new masses of people in resort areas and the presence of cash. Yet over time, as other studies have proven, once law enforcement and on property security matures in gaming cities, crime rates tend to go down. And they will in Macau as both operators and government work together to reduce the threats of rising crime.
The report has an amazing 120 tables of figures. That gives you just a sense of the immense scope of the review and how serious the government took up the challenge to provide as accurate and detailed a picture of the industry as possible.
Having plowed through the entire report, we see it on balance as a highly positive assessment of the industry that is realistic and comprehensive. To us it's at the least, a report card of Bs with a single, key, but nonetheless single, grade of D or F in the arena of junkets. Interestingly, the report did not lay heavy blame on industry neglect for the junket problem, but largely confined its assessments to the system. Nobody really got off unscathed of course. The recommendation for stronger regulation speaks for itself.
Overall, the report was received positively by analysts and operators, some of whom issued press releases expressing satisfaction that the report was mostly positive for the industry. The broadest consensus we were able to tease out of our conversations with our sources was that despite the floodtide of government crackdowns, scoldings and threatened policy moves, that facts are facts. And the facts clearly support the economic powerhouse that has been created in Macau. And at this point anyway, it's hard to make the case that the concession renewals will face tough headwinds.
To current and would be holders of Macau-heavy shares, we believe the report is a bullish event in that it removes much uncertainty about how the government views the industry, its productivity and most of all, its adherence to the original promises made when the concessions were first granted.
Meanwhile the industry has ahead of it, four to six years under the present concession to adapt and create the new normal. We'll see less singular dependence on VIP business, yet a VIP business that will nonetheless survive. It will be a smaller percentage of overall Macau gaming revenue, but will provide more than enough of its share of high margin revenue for the operators.
The Premium Mass business will grow as the macro economic conditions in China recover from down cycles and produce an ever-growing flow of a newly affluent patron base. The Mass business will expand as room inventory increases and transportation infrastructure projects come on line. Casino marketers will reach ever deeper into the populations of inland China provinces and beyond that, to global tourism.
For Macau-centric gaming shares to reach previous highs and in fact, exceed them, we now have the first positive news in a long while. The long awaited Mid-Term Review - it's on balance, a positive for Macau shares.
Here's what we need to keep seeing as we move forward:
1. A continuing narrowing of yoy GGR declines from the disastrous 2015 crackdown impacted numbers. We'd like to see those revenues begin trending flat by summer and in full recovery mode by fall.
2. A steady absorption of the new capacity coming on line from Wynn, LVS and MGM. Will the expanded room inventory draw the expected increase in peak period tourist/gambler visitation? We think it will take some time, but it will.
3. Will the conversion of the heavy leverage of the operators mentioned in this article to EBITDA contributions from new properties meet expectations? We think they will.
As with all report cards, we issue this commentary in the space at the end for teacher comments:
Good work, please keep it up. You've got to work lots harder to pick up some grades. Pay attention, don't be late for class and have a nice summer. See you in the fall.
About the author: Howard Jay Klein is a 25+ year c-level casino executive and consultant in the gaming industry. He is the author of Mastering the Art of Casino Management. His own gaming investments are held in a blind family trust so as not to pose conflict of interest problems with his consulting assignments in 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.