There’s no silver bullet to deal with table hold volatility
Macau’s VIP gamblers may love baccarat, but it’s a game that can occasionally give casino executives sleepless nights. It’s likely to give them even more hours of restless sheep counting in 2009.
This is because of baccarat’s well-documented volatility. Volatility does, though, work both ways. It can hugely benefit casino operators at times, but it can also put a severe crimp on the bottom line if the house has a run of bad luck.
In Las Vegas, Harrah’s got out of the high roller baccarat market after losing money in that segment. CEO Gary Loveman was quoted as saying “it didn’t make sense” to have 10,000 to 12,000 people enjoying themselves in your property but be nervous that one ‘whale’ in the high limit room could undo it all.
A shellacking
In light of Las Vegas Sands Corp’s recent troubles in Macau, a losing streak in VIP baccarat is probably the last thing on its executives’ minds. Nevertheless, the US$48.5 million net loss recorded by LVS in Q3 2007 was attributed in part to a run of bad house luck on its VIP tables in Macau.
“We got shellacked. It is what it is,” is how LVS President and Chief Operating Officer Bill Weidner memorably put it.
One of the reasons the non-negotiable chip system was introduced to VIP table gaming was to deal with the potential threat to junket operator liquidity posed by high-rollers walking away after big wins. Too many of those runs on the bank in a short space of time can threaten not only the working capital of the junket operators, but also wipe out casino profits.
Rolling chips do not, however, deal with the wider issue of smoothing table hold volatility. To achieve that effect, other mechanisms are needed. In that context, Deutsche Bank analyst Karen Tang found things to praise in Melco Crown Entertainment’s Macau strategy in a recent report on the outlook for the territory’s economy in 2009.
By special arrangement
Ms Tang mentioned in particular that MPEL had “mitigated” volatility risk to high-end table games by signing a “volatility hedge arrangement” with Hong Kong-listed A-Max Holdings Ltd, the junket aggregator that feeds MPEL most of the VIP players that attend Crown Macau.
In case ‘volatility hedge arrangement’ sounds like a silver bullet for dealing with VIP volatility risk in the baccarat-heavy Macau market, it’s worth making a few points.
The first is that one cannot change the laws of probability or the laws of mathematics. If a game of chance has a certain theoretical house edge, that house edge ‘will out’ in the long run. As IAG has said enough times to risk boring our readers, the mitigation of volatility risk in table games such as baccarat is to a certain extent an illusion designed by casino managements to smooth returns and placate the mood particularly of institutional shareholders who tend to prefer quick and smooth returns over short investment cycles.
School of hard knocks
A second point worth making is that if the recent meltdown in the financial markets proves anything, it’s that there is no such thing as complete mitigation of risk in any market. Some of the financial derivatives products sold to Hong Kong’s high net worth community as hedges against equity price volatility were themselves so oversold that they created a mini bubble that burst spectacularly when the markets crashed in the fourth quarter of 2008. These ‘accumulator’ derivatives have now been bitterly nicknamed ‘I’ll kill you later’ products by some of those who lost out.
A third point to make is the ‘volatility hedge arrangement’ mentioned by Ms Tang isn’t exactly an innovation. Simon Dewhurst, MPEL’s Executive Vice President and Chief Financial Officer, was talking about volatility management as long ago as MPEL’s Q1 2008 earnings conference. He pointed out that hedging against volatility is standard practice for casinos with high-roller operations.
Here’s what Mr Dewhurst said: “In our business, risk mitigation straddles a wide array of concern, including table hold volatility. There are a number of things that we can do to mitigate the impact of table hold volatility and we believe that this is especially important for us given that we have one property [Crown Macau] that currently delivers the vast majority of our revenue and earnings. And that property caters to the most volatile segment of the market [the VIP sector] with respect to luck.
Pump up the volume
“The most effective way to reduce table hold volatility is to increase volume. Since the commencement of operations by AMA in mid-December [2007] and the commensurate increase in rolling chip volume, the volatility and our daily rolling chip table hold percentages dropped as expected,” added Mr Dewhurst.
So there we have it from the horse’s mouth. A ‘volatility hedge arrangement’ with a junket consolidator is only the second best way for a casino operator to mitigate volatility risk in high stakes baccarat. It will have to do for the time being though.
Maintaining high volume of play to create a smoothing effect in liquidity doesn’t look such an easy option when the Macau government has effectively outlawed a price war on VIP commission. It was, after all, the headline-grabbing offer of 1.35% rolling chip commission that helped Crown Macau grab around 18% of Macau’s entire VIP baccarat business by the end of the first quarter of 2008. Maintaining or building VIP play volume is also going to be tough at a time of global recession and when visa restrictions are still in place for visitors from China.
During the Q1 2008 earnings call, Mr Dewhurst went into more detail about MPEL’s hedging arrangements with AMA.
“We’ve also always offered a revenue shared base junket compensation model, which shares the impact of table hold variation between the casino and the junket operators,” explained Mr Dewhurst.
“Some of the tables allocated to AMA have recently been included in this programme,” he added.
RelatedPosts
“Last we have constructed a win rate sharing arrangement that allows us to smooth the peaks, and [that] rallies the table hold within our commission based junket business with AMA. All this is designed to make our cash flows and earnings more stable and predictable.”
This is all good stuff, but a fourth point worth making is that MPEL and A-Max are a lot closer than is typically the case in a conventional customer-supplier relationship. Ted Chan, the current President of Crown Macau, was until November 2008 CEO of A-Max Holdings. And before joining A-Max, which started trading in December 2007, Mr Chan was head of Mocha Clubs, the Macau slot club unit of MPEL.
There is nothing illegal about all of this, and Inside Asian Gaming and its publishers would like to point out we make no suggestion of impropriety in the arrangement. This closeness between customer and supplier does, though, arguably make it harder for investors to assess the effectiveness of MPEL’s VIP gaming business model as set against its competitors, and to judge how transparently the volatility hedge arrangement will be implemented.
One thing seems clear. Table hold volatility will remain a topic of intense interest for all operators as long as Macau remains a baccarat focused market. Global recession, regional economic slow down and a mini-credit crunch among Chinese high rollers may all work to make it harder for those operators to smooth the effects of this volatility on behalf of their investors, but it won’t stop them from trying. After all, many of them are likely to have searching questions posed by analysts on the hunt for upside in what’s likely to be a challenging 2009.
