Numbers Game

What price would make it worth LVS’s while to sell off Cotai plots five and six?

How would an SJM bail out of LVS on Cotai work in practice? In theory nothing can happen without the approval of the Macau government, though given a choice between LVS’s Macau project potentially imploding and Dr Stanley Ho getting a cut price entry into the Cotai market, it seems clear which way the government would jump.

Taking the notion of a 40 US cents on the US dollar buy out by Dr Ho of LVS’s Cotai plots five and six as a starting point, can we put any metrics on that possible deal? We know that in January this year Kenneth Kay, Senior Vice President and Chief Financial Officer of LVS, told analysts at a conference call to discuss the company’s Q4 2008 earnings: “The amount spent to date [on plots five and six] is probably, I’m going to guess, in the range of US$350 million.”

Valuation

Using the 40 cents on the dollar formula, that would give a potential valuation (on bricks and mortar only) for plots five and six of US$140 million. One doesn’t need to be a cynic to understand that the valuation of a project when presented to financial analysts as a cost is likely to be significantly discounted compared to when that same project is presented to a potential buyer as an asset. Nonetheless unless other suitors come to LVS’s table, Dr Ho can reasonably expect to drive a hard bargain.

The cost pro rata of the 25-year land lease granted by the Macau government to LVS for its Cotai site is also likely to be factored in to the calculations. So in all likelihood would a premium to reflect the fact LVS has already done significant spade work and above ground work in developing plots five and six.

In the same earnings call, Mr Kay said a worst-case scenario for LVS’s financial commitments on plots five and six was US$880 million. Using the 40 cents on the dollar formula that would present SJM with a price tag potentially of US$352 million.

Given though that LVS’s long term global debt stood at US$10.8 billion as at 31st December 2008, even an asking price of US$500 million might not be enough to help LVS stave off debt default risk long term, unless general trading conditions in LVS’s markets improve quickly.

Market signals

And what also would be the effect of any buy out of plots five and six on LVS’s dreams of monetising real estate from the shopping mall at The Venetian Macao and from the apartments at Four Seasons Macao? Some commentators already regard the monetisation path as a fading dream, given LVS’s expectations on price. No one is likely to pay a premium for the assets of a company facing significant challenges in a bearish market to its very existence.

The general impression recently has been that potential equity suitors of LVS or potential purchasers of LVS assets in Macau are simply biding their time in the hope of a bargain. They may have been encouraged by the recent decision of several international hedge funds including Och Ziff and TPG-Axon, to accept a heavily discounted buy out of US$400 million-worth of debt securities they committed to in 2006 for the HK$2 billion Fisherman’s Wharf project. The shopping centre-cum-theme park scheme near Macau’s Outer Harbour had Dr Ho as an equity partner with Macau businessman and legislator David Chow.

Fisherman’s Wharf was spectacularly misconceived and a financial time bomb from the day it opened, so no sensible comparison can be made between it and The Venetian Macao, save for a fondness at both properties for architectural pastiche. The notion though that LVS may have been unrealistic with the asking prices for some of its Macau assets has been a recurring theme in the financial sector.

Leaseback backlash

An example is the idea reported in The South China Morning Post recently that LVS might seek to sell title to the bricks and mortar of its Sands Macao casino in return for cash up front. LVS would then in effect buy back its own property by paying the investor a yield from its gaming revenue stream, rather in the manner of the yield paid on a treasury or commercial bond.

The predominantly mass market Sands Macao has been a money box for LVS in Macau. It was relatively cheap to build (US$285 million) by the standards of the more recent megabucks integrated resorts and it reached pay back on project costs within 12 months of its 2004 opening. On that basis the opportunity for third party investors to be offered exposure to Sands Macao’s gaming revenue stream in return for money up front could be tempting. The SCMP quoted analysts mentioning figures between US$1.3 billion and US$1 billion to be raised up front based on yields of 7.5 percent to 10 percent respectively

Investment sources spoken to by IAG think a figure closer to US$400 million might be more realistic, given Sands Macao’s recent performance. Last year, Sands Macao recorded US$213 million of earnings before interest, tax, depreciation and amortisation—significantly lower than the US$372 million profit realised by the property in 2007.

Sources told IAG that even leaving queries about market valuation of a lease and buy back scheme to one side, there could be some regulatory hurdles to overcome.

“In regulatory terms that might count as gaming participation on the part of the leaseholder,” one investment manager told IAG.