CLSA’s Aaron Fischer believes the Japanese government will legalise casinos in the next couple of years, with Okinawa a frontrunner for the first license. Mr Fischer discusses the approval process currently in progress, and considers what form future casinos in the country could take
Casinos have been legalised in 120 countries and Japan is the only G8 country not yet to have joined the party. Casinos are no longer considered a hive of illegal or immoral activity but rather a major drawcard for domestic and international tourists and business visitors and a generator of taxation revenue. Along with a few other Asian governments, the Japanese government recognizes the potential lost opportunity and is currently framing policy for the introduction of casinos in the coming years.
We understand that the Liberal Democratic Party (LDP) and opposing parties have agreed in principle to make a proposal to the Diet for the legalisation of casinos. The LDP Policy Research Council established a Special Committee on Tourism Casino Entertainment Study Group, which published a draft paper titled the Basic Policy for the Introduction of Casino Entertainment into Japan on 16 June 2006.
The policy recognises that “casino entertainment is currently being introduced in many locations around the world based on the Las Vegas model of an entertainment complex which can be enjoyed by all ages and sexes and even families, comprising not only casinos but also theme parks, theatres, cinemas, shopping and restaurant malls, sports facilities, international conference centres, hotels and so on.”
While casinos have been banned by the Penal Code in Japan since the Meiji period, the prevailing view in other developed countries is that ills from casinos do not derive from the casinos themselves but from those who use casinos to conduct improprieties or become addicted to gambling. On the second point, it is recognised that non-casino gaming such as suburban clubs create more problems with respect to gaming addictions.
The policy document outlines several benefits to be derived from introducing casinos, including: increasing tourism; increasing government revenues; subsidising and boosting the entertainment industry; and benefiting the Japanese public through economic ripple effects. These are discussed below.
The policy document also recognizes that legalised casinos decrease the funds flowing to illegal casino activities, which are often associated with underground organisations and other illegal activity such as loan sharking, drugs and prostitution. However, we would note that the policy does not explicitly state that illegal casino activity is a major concern in Japan. We agree that this is more of an issue in other Asian countries such as Thailand.
The direct beneficiaries of an increase in tourism include hotels, airlines and retailers, while indirect ones include food producers and cleaning companies. Global tourism is a high growth industry, particularly in Asia – incomes are increasing at a rate that is triggering a disproportionate growth in spending on leisure activities. This is particularly true in China, India and other developing Asian economies. Easing visa restrictions, increasing leisure time and shifting demographics are also driving growth in these countries.
In the past 15 years, outbound tourism has increased by around 300 million trips to 694 million per annum. Over the next 15 years, the World Tourism Organisation expects absolute growth to be three times as great; increasing by 900 million to 1.6 billion by 2020.
In terms of originating countries, the Chinese are likely to become the most prolific travellers. We estimate that Chinese outbound travellers will reach around 115 million by 2020 based on a compound annual growth rate of 9.6%. Opportunities to gamble, particularly for Chinese, would clearly increase the attractiveness of Japan as a tourist destination.
Currently, the number of outbound Japanese tourists is three times the number of inbound tourists to Japan. Since 2002, the Japanese government has been working to achieve a “Japan that is open to the world as a tourist destination”, promoting strategies which will increase the annual inbound tourists to 10 million by 2010.
Japan, as the dominant Asian country over the past few decades, economically and culturally, is an obvious candidate for travelling Asians. According to the policy document, “Japan’s extremely attractive tourism resources, typified by its history, traditions and culture, as well as the richness and beauty of the natural environment that forms the basis of Japanese culture and exhibits changing faces with each of the four seasons, are highly acclaimed worldwide and constitute a large motivation for foreign tourists to visit Japan”.
The committee will be looking to leverage these existing resources but recognizes the need to develop new tourism resources to cater for the diversifying needs of overseas tourists including business people, and the changing lifestyles of Japanese citizens.
Recognising the prolonged boom expected in global, and in particular, Asian tourism, other countries within the continent are moving quickly and aggressively to tap into the growing pool of international tourists. This includes countries or regions such as Singapore or Macau that are not blessed with any major natural attractions and are successfully overcompensating with entertainment and business convention facilities. Both these countries have legalised casinos and are expected to see significant growth in inbound tourist numbers. However, it is worth noting the differences between the two regions and the implications for Japan.
Macau: More gaming focused in short term
Macau will be primarily focused on targeting tourists from China and Hong Kong. In the short term at least, the emphasis will be on gaming with low levels of revenues generated from other entertainment activity, retail, hospitality and conventions. This is expected to change over time, particularly as construction of larger complexes are completed in the Cotai Strip.
Singapore: Targeting tourists and business visitors
The more conservative Singapore government is seeking a more balanced approach with a greater focus on business visitors and other entertainment.
Two ‘integrated resorts’ have been approved, with Las Vegas Sands Corp securing the site at Marina Bay, which will be more integrated into the CBD and focus more on the convention market and overseas business visitors. The development at Sentosa, which was recently awarded to Genting International, will focus more on attracting tourists with a Universal Studios theme park being a feature of the development. The government is also taking more strides to minimise the negative side effects of gaming – examples include implementing entrance fees for Singaporeans.
It seems clear that Japan will take a more similar approach to the Singaporean government, particularly with respect to regulations, taxes and restrictions that will be implemented.
There is also talk of other Asian countries seeking to legalise casinos. In particular, we believe that Thailand could eventually be a major player in this industry as the country offers so much for tourists – a stunning natural environment including islands, beaches and jungles. One might also argue that Thailand is more culturally interesting than Macau or Singapore. However, corruption and the current political environment might prevent Thailand from becoming a player in the near term.
We expect that operators in these regions will be able to generate significant returns on investment given the huge demand for such facilities. Should other countries legalise and establish casinos in the short term, there might potentially be less interest for overseas visitors. Nevertheless, we believe the local market is sufficient to generate material returns for casinos established in Japan.
The future Marina Bay Sands in Singapore
New source of revenue for government
The policy document recognises that revenues obtained from gaming can be utilized in a productive manner. The document highlights that revenues can be used “as a funding source for education, welfare, regional development and so on, and significant employment has also been generated”.
Further, the committee recognises that “by using the revenue generated from the casinos that form part of the complex, and undertaking integrated operations with other facilities, casino entertainment can provide visitors high quality services such as shows, restaurants and accommodation at low prices. The provision of low cost services at a casino entertainment complex is of great appeal for visitors, and this is why casinos are key facilities, extremely useful in boosting the entertainment industry as a whole.”
An estimate from the Japan Casino Academy suggests that up to ¥120bn in tax revenue would be generated per year if six public casinos were to open in Odaiba.
Economic ripple effects are hard to measure but include direct beneficiaries such as the casinos, casino suppliers and employees and less direct benefits such as greater government revenue and employment created in the local areas. Petrol stations and convenience stores in surrounding areas will also prosper.
The indirect benefits could be huge – tourism represented 10.6% of 2005 global GDP with 3.8% direct and 6.8% indirect. In terms of employment, the tourism industry directly employs 2.8% of total global employment but 8.3% if we include indirect employment.
Purpose of legislation
The objectives of the legislation shall be:
• To realise a globally competitive tourism sector by increasing the numbers of overseas tourists and promoting domestic tourist attractions that encourage visitors to spend time there and stay overnight;
• To provide casinos as a new form of entertainment for the Japanese public and visiting tourists, in order to contribute to the growth of entertainment-related industries, the generation of employment and regional development and revitalisation; and
• To use the revenue obtained to contribute to financial resources of the regions and the country as a whole (casinos as a form of entertainment will be referred to by the terms “games” and “gaming”).
Further, when establishing the system, consideration shall be given to the issues of minimising the potential negative impact of gaming on society, eliminating negative influences on young people, preventing improprieties and wrongdoing, eradicating similar underground activity, ensuring safety and order in public places, and providing a safe and sound gaming environment for the Japanese public as well as tourists.
Other interesting elements of the proposed framework include:
• Casinos shall be designed as multi-functional tourism centres and not just gaming entertainment facilities.
• Other similar activities such as internet gaming shall be prohibited.
• Casinos will be phased in; increasing over time as the effects are evaluated.
• Preliminary operation will be restricted to 2-3 locations, with priority given to regions with high policy needs whereby casino establishment would give rise to beneficial promotional effects from a national and international perspective. However, we believe it is possible for there to be multiple casinos operating in any one location. We therefore, believe that a total of 7-10 casinos could be operating in Japan across 3-4 locations eventually.
• The Government shall retain exclusive rights regarding the licensing of casinos. In order to guarantee that operation will be performed safely, soundly and fairly, the government shall establish unified rules and a framework concerning the details of operation, regulate all facets of operation, as well as supervise and monitor operations. A new government body shall be set up under the competent Minister to perform the abovementioned tasks.
• Entities able to receive licenses to operate casinos shall be local government authorities or associations of local government authorities sharing a particular administrative function.
• A local government authority, which is the legal casino licensee, may select a designated private contractor based on public process to perform the planning, development, funds procurement, construction or maintenance and administration of a casino (gaming) facility, and by means of contractual agreement, such contractor may be entrusted with the practical administration of a casino (gaming) facility. The selection of a contactor responsible for administration shall be carried out by the local government authority by means of a competitive process, publicly seeking proposals.
• Issues of revenue and expenses, risks and benefits are shared between the local government authority and private contractor responsible for administration, and shall in principle be left to the local government authority and private contractor to decide through consultation and negotiation.
• However, it is appropriate that the contractor responsible for administration bears the risks associated with game outcomes and casino related investments and loans, and it is important that the risks accompanying operation and financial risks should not impact on local government authorities. Further, operators are under no obligation to themselves own the facilities and assets accompanying casino operation, and the nature of ownership may be arranged appropriately between the local government authority operators and contractors responsible for administration.
• After determining its total earnings (before deduction of expenditure) obtained from customers though games (this can be referred to as the gross gaming revenue and equates to the sales amount), the operator shall pay a levy to the government body, being a fixed ratio of its total earnings calculated as a graduated rate.
• Levies received by the government body as described above shall be spent on activities furthering the legislative objectives, such as promoting international and domestic tourism, and contributing to the financial resources of the regions and nation, and uses shall be limited by the legislative objectives.
• Local government authorities may voluntarily enact bylaws to implement measures restricting demand that go further than national rules (in this case, measures restricting demand may be based on the need to suppress demand among domestic users, and may include limiting business hours, restricting the days and hours facilities can be used by customers other than overseas tourists, imposing set entrance fees and so on, as well as setting own minimum and maximum bets and overall measures to suppress demand for casino facilities).
• It shall be prohibited to install ATMs of banks or credit card companies in casinos or designated area surrounding casinos. Similarly, it shall be prohibited in principle to lend money to persons in casinos or in the designated area surrounding casinos, for use in casino games. However, it is possible to grant credit to pre-registered important overseas customers and high roller customers as part of their customer service activities. Such debts owed by customers shall be legally enforceable.
• It is considered that at least to begin with, it is appropriate to suppress the effect of casino facilities from fuelling excessive passion for gambling among the Japanese public. Thus certain regulations shall be implemented preventing excessive advertising and active promotion of casinos domestically.
Most of the document makes sense
Having reviewed similar documents and government commentary for Macau and Singapore, the draft policy document appears straightforward and fairly logical – the benefits of legalizing casinos, the misperception about casino ills, operational framework, taxation, revenue disbursement, etc.
I guess what is slightly strange is that the local government is the official operator of the casino, but in practice the private contractor will assume total responsibility aside from transferring the taxes to the government. Even so, we believe it might be difficult for some local governments to even manage the administrative functions. It seems more likely that a new central government department would need to be established to manage the various casino operations across the country.
The policy document does also suggest that ATMs will not be allowed in the casino or nearby – I have not heard of a casino without ATMs and I am not sure that this would make a huge difference in preventing gaming addictions.
Location, timing and foreigner involvement are the big unknowns:
One of the big unknowns is the locations of the future casinos. Discussions with various industry participants suggest that Okinawa and Tokyo are the most likely options.
Okinawa would appeal to Japanese and the development would provide an added economic boost to the area, which continues to be negatively affected by the downsizing of the US armed forces. As an island off the mainland, Okinawa represents a good testing ground for casinos. Kyushu and Hokkaido have also been mentioned as areas which urgently require regeneration and new economic tools to boost both tourism and employment.
Early casinos could just be placed in areas such as Okinawa, Kyushu and Hokkaido. Okinawa, and especially Kyushu, is very well placed to develop new international tourism; whereas, with respect to Tokyo, a casino would be just one more attraction in an area where there is already probably too many attractions.
According to Hakubun Shimomura, the chief secretary of a Diet panel called the Study Group to Promote International Tourism, “More than 20 local governments have already expressed an interest in hosting the first multi entertainment complex and I myself spoke with the Okinawa Chamber of Commerce in July. Personally, I believe Okinawa would be the ideal place for the casino because around 5.5 million tourists visit the prefecture every year – but we could very easily double that number.”
A casino based in the heart of one of the world’s largest and wealthiest cities would attract huge demand from locals. No other major city in the world – including New York, Paris, London, Shanghai, etc – boasts a major city casino. London does have casinos, but they are much smaller than the casino that would be expected in Tokyo.
Tokyo would be by far the most successful casino operation in the world, but for the past two plus years there’s not been any energy out of the Tokyo administration for a casino. We understand that the focus is on the 2016 Olympics.
There is some debate about the location within greater Tokyo – Yokohama and Obaida are among the various locations discussed. We understand that the government has sufficient land available for the casino development. However, we understand that the land is being reserved should Tokyo secure the 2016 Olympics.
We believe the bill seeking the legalization of casinos could be proposed for approval in the next 12-18 months. Using Singapore and Macau as a guide and factoring the pace of change in Japan, casinos would not likely be operational until post 2010.
Although Hakubun Shimomura stated “in the best-case scenarios in which a new law is passed in 2007, we believe we could have the first two venues operating by late 2008.” We believe this timing is too aggressive and unlikely.
We understand that most local and even prefecture jurisdictions are not geared at the moment to move the process forward. Interestingly we understand there has never been an independent feasibility/economic study produced by any jurisdiction in Japan, although we understand that Nagasaki is in the process of completing a study.
Without a casino industry in Japan at present, it is difficult to imagine a Japanese company securing the rights to manage a casino. However, as casinos with limited competition generally generate reasonably high returns, there may be some political backlash should only foreign operators be awarded the rights to manage the casinos. We therefore expect some consortiums consisting of local and foreign companies to bid for the rights. Possibly, local companies would secure the official casino rights and be responsible for dealing with the government, while foreign companies would be responsible for casino management.
We understand that the model could be different for Tokyo and other regional casinos. We expect the government would have greater involvement in the Tokyo casinos – where the returns would be very significant. The government would be expected to finance the development and outsource the management of the casino to an experienced operator – a similar structure to the hotel industry.
With respect to operator selection, in areas other than Tokyo the one selected will be the one who became “embedded” early in the process and gave the jurisdiction the tools and funding to help them put together their presentation. Finally there’s the consensus. Without consensus the government will not grant licenses, and that’s another reason for gaming companies to be “embedded” in order to provide the economic facts which help in building a consensus.
Who could win the mandate?
We believe the local government will consider the following factors when deciding on which companies are most appropriate to manage the casino developments:
• Iconic developments – as the casinos will be major developments for Japan, we expect the government will go for the contractors and architects with impressive track records. We would expect a development that encompasses modern design but leverages Japan’s rich culture and long history.
• Strong drawcard for international and domestic tourists – using Singapore as an example, we believe that Genting International was favoured due to the impressive track record of attracting tourists in Malaysia along with the incorporation of Universal Studios.
• Rejuvenate local economy – in the case of locations such as Okinawa, Kyushu and Hokkaido an objective of the casino development will be to rejuvenate the local economy. Therefore, we expect the government will favour operators that have a track record of working with the local community and adapting to local cultures.
• Overall positive for Japanese residents – we believe the government will be looking for operators that minimise social implications by effectively managing any potential “ills” of the casino industry including addressing problem gaming.
• Generate revenues for local community – we believe the government will be looking for an operator with a history of successful developments, more likely operators from the US, Australia and other parts of Asia. Successful operators will generate more tax revenues 22
We believe that the likely winner of licenses may be some kind of consortium featuring local and foreign companies. Foreign companies with credentials and a track record include Las Vegas Sands, Melco/PBL, Genting, MGM and Wynn. Of the local companies, Sega Sammy, Konami, real estate developers such as Mori and also Denstu are being mentioned as being part of the consortiums. Aruze’s relationship with Wynn could also put the company in the picture.
We have no doubt that casinos will be a success in Japan (although this depends on the level of government interference). Looking at the experience of Las Vegas, we can see that new developments attract visitors – i.e. supply will create the demand. The same story is seen in Macau where tourist arrivals have increased by around 50% in the past two years while gaming revenue has increased by 140% in the past four years.
Don’t discount the impact
This sounds like a lot of speculation that could easily be ignored. Stock prices of companies with exposure to other potential gaming jurisdictions, such as Macau and Singapore, increased significantly (up to 10x) and in very early anticipation of companies securing the licences.
For example, Melco’s share price went up 20x times before it announced its first casino. The company subsequently announced further developments, secured a full gaming license and sought a US listing. The company has been completely transformed into one of the world’s leading gaming operators, from what was very originally Macau’s electricity company.
Genting International’s share price soared 2.5x on news the company secured the Sentosa licence in Singapore. Las Vegas Sands and Wynn have also done well.
It is very difficult to determine the potential earnings impact of the casino developments. Assumptions need to be made on ownership share, number of gaming tables, number of hotel rooms, retail, food and beverage, invested capital, gaming taxes – the list goes on.
However, as a starting point, we can review the Ebitda contribution from a number of casino projects in Macau and Singapore. The average Ebitda contribution per year is around ¥40,000m. This would boost 2011 Ebitda estimates by between 30-80% for a sample of Japanese leisure companies that we have selected.
Our numbers appear reasonable. According to a study completed in late 2002 by the Tokyo Metropolitan Government on the benefits of a casino in the capital, a casino with hotel and entertainment facilities would earn ¥91bn a year, rising to ¥224.6bn in associated revenues, and generate 13,785 jobs. We are not sure what is included in these calculations, but applying a typical Ebitda margin of 20% to the revenue base equals around ¥20- 45,000m. Either way, our estimates represent a starting point for further analysis.
Casino stocks trade at high multiples given predictability of earnings stream, strong cash flow generation and high returns on invested capital. During the current environment when casinos will open all over the globe over the next few years, many of the casino stocks are trading at very high earnings multiples. Average PE is around 100x.
We are not suggesting that Japanese companies with casino exposure would increase to 100x. We are saying that increasing to 20-30x from 10-15x is possible.
We believe stocks associated with Japan’s casino legalisation will significantly outperform the market given a) previous run of stocks during casino deregulation; b) the potential uplift in earnings; and c) the expansion of the valuation multiple. A 50% increase in earnings and a doubling of the earnings multiple would cause the stock to increase 200%.
For those investors who are prepared to take a long term view, we would recommend building a basket of casino-related stocks. It is worth noting that many Macau-related stocks saw a significant period of outperformance in the run up to the license issuance. At this point, we believe it is not yet as critical to select the ultimate winners – time for this will come later when valuation multiples expand and start pricing in too much expectations.
Within the leisure sector, we would recommend including Sega Sammy, Konami and Aruze.
Genting’s upcoming resort in Sentosa, Singapore