Senior gaming analyst Bill Lerner tells Inside Asian Gaming why some overseas investors are turning more bullish on Macau
Union Gaming Research, described as the only Wall Street financial research firm based in Las Vegas, took gaming investors on a tour of Macau earlier this month. Bill Lerner, one of the founders of Union Gaming and formerly Managing Director—Senior Gaming & Lodging Analyst at Deutsche Bank Securities, led the visit. He tells Inside Asian Gaming some of what he learned.
IAG: From an investor’s perspective, what, if anything, has changed in Macau from your previous visit in the spring?
Bill Lerner: “The willingness to pay for future growth is more evident now. That’s certainly reflective in the multiple that the market is assigning to Wynn’s Hong Kong listing. I think the market believes that structural issues in Macau are truly transitory and that this is a market that will continue to achieve excess returns.”
Some Hong Kong-based securities analysts are questioning the long-term sustainability of Wynn’s initial public offering (IPO) pricing. According to Bloomberg data, Hong Kong equities trade on average at 17 times company earnings while Wynn was priced at double that.
BL: “Using earnings multiples for casino operators is nonsensical. These are typically appreciating assets. But their non-cash depreciation and amortisation has the effect of understating earnings. That’s why multiples on an earnings basis look inflated. So what we [at Union Gaming Research] and what all gaming investors globally use is an enterprise value to EBITDA [earnings before interest, taxation, depreciation and amortisation] multiple. I would never talk about or publish a valuation for a casino operator using an earnings multiple. That said, the valuation for Wynn in Macau—in Hong Kong—whatever you want to call it—is certainly at a premium to the gaming industry multiples globally.
“I can’t compare it [Wynn’s trading value on the Hong Kong stock market] with the general Hong Kong equities market. I can compare Wynn’s trading though on a metrics basis and it’s at a material premium to where SJM and Galaxy are trading [on the Hong Kong index].
“I think investors assign a lot of value to Wynn’s brand and to Wynn’s execution in this [Macau] market. They are certainly willing to give credit to Wynn for continuing to execute on Encore Macau, as that opens perhaps in the second quarter of 2010. The market likes how he [Steve Wynn] has redeployed capital.”
Do you see any role for bonds in terms of raising project capital in Macau?
BL: “Let’s put it this way, if the market is telling us vis-à-vis the Wynn Hong Kong data point that it is willing to pay a mid-teens multiple of cash flow, then I would raise capital that way [via equities], as opposed to using credit, all day long.
“The cost of capital on the debt side for new projects—if it’s even available—is much more expensive than raising capital via equity. We certainly saw however an oversubscription of demand for exchangeable debt—effectively to convert, if you will—for Las Vegas Sands in Macau.
“In the US, we’re starting to see project finance for gaming projects come to fruition again. And whether it’s projects in Pennsylvania or Kansas or another regional market, we are starting to see interest from credit providers—not cheap credit¬—but it’s there nonetheless.
“I’m not sure how much demand there will be for new supply in this market vis-à-vis debt financing. I suspect we’ll know in the next 12 months. I suspect [in Macau] Las Vegas Sands will want to restart [Cotai] plots five and six after raising fresh capital early next year and there’s going to be some component of debt associated with that, I guess.”
When it comes to Hong Kong IPOs for gaming companies, is there such a thing as first mover advantage, or is it more about underlying company value?
BL: “I think it’s more to do with underlying value. That includes operating track record, growth profile, management, capital structure, etc. If it were first mover advantage then Galaxy and SJM would be trading at a much higher multiple. So I would suspect there will be good demand for a Las Vegas Sands listing out here [in Hong Kong]. The dramatic amount of demand for Wynn was not filled. I don’t know if those people will follow on in the open market or not. Certainly a lot of those folks will have an opportunity with Las Vegas Sands. But it’s a different growth profile, a different cap[ital] structure.”
Do you expect to see an additional share allocation being made available to institutions following Wynn’s IPO?
“There will be 15% greenshoe, but we won’t know about it for a little while. On the institutional side, Wynn [Hong Kong IPO] was at least 20 times oversubscribed. I know one institutional investor that only got 1.5% of his requested order for Wynn, so that greenshoe will be filled.”
Do you think Macau gaming companies already listed in Hong Kong will try to take advantage of the local bounce in equities and issue more stock?
BL: “I was with Galaxy [Entertainment Group] senior management, and I think with regard to Galaxy the answer is ‘No, not a chance’.
“It’s more a function of what happened with their last offering, where Permira [a European private equity firm] bought a stake in the company at a significant premium to where the stock is trading right now. That would be the reason why they [Galaxy] wouldn’t raise equity capital down here [Hong Kong].
“I can understand the sentiment if you will from the Galaxy guys on that one. If the market wanted to pay up for Galaxy, it wouldn’t need an equity offering to do it. You can buy the shares in the open market. But right now it just seems that investors aren’t giving credit for Galaxy’s Cotai project, in that there’s capital in the ground without cash flow being generated. So the stock is more expensive on 2009 numbers than it really should be. Assuming they open the Cotai project and based on conservative assumptions about market share on Cotai, then Galaxy’s trading at about a third of the price at which it listed in Hong Kong. That tells us the market doesn’t believe they are going to open the project any time soon, or that they won’t execute. Execution [on Cotai] is the path to increasing the share value of Galaxy.
“From Galaxy’s perspective, the timing on the opening of Cotai has to be managed very very carefully in order to capture recovery in the market. I think they’ve been real smart about it. But the market’s not willing to give credit to that [Cotai] development for Galaxy, while they are willing to give credit to Wynn for Encore Macau.”
Did you get a chance to tour Encore Macau?
BL: “No. But I believe the room product for Encore will be somewhat similar to Encore Las Vegas. That involves more of the residential feel than traditional Wynn [hotel] product. We got a little bit of a peek at what the public space looks like from a distance.”
Was there any discussion by Wynn about a project on Cotai?
BL: “No. I want to stress we didn’t meet senior [Wynn] management on this trip. Prior to the IPO they weren’t allowing investment analysts to spend time on the ground here with senior management. But I think it will be a very very long time before Wynn puts a shovel in the ground on Cotai.”
Why is that?
BL: “I think that’s because of the desire to generate returns that are acceptable for that company. Encore Las Vegas has been relatively problematic for Wynn Resorts. They haven’t generated a return on that project yet, unfortunately, because they opened into a recession. So it will take some time, and now there’s lots of supply coming online in Vegas [such as CityCenter] to compete with it. So that project [Encore Las Vegas] for the time being has been a disappointment for Wynn and for investors.
“But Steve Wynn is a developer and operator who is in it for the long haul. It’s just that the timing [on Encore Las Vegas] wasn’t ideal. When it comes to transposing that on Macau, we’re starting to see a recovery here, we think. I think it is sustainable. I think it has a lot to do with the flow of credit and the cycle of money here at the high end [VIP player market].
“It’s certainly something to do with visa restrictions easing. But if you subscribe to the notion that Beijing will only allow a metered level of growth [in the Macau gaming market]—maybe [Mainland China] GDP plus—that may translate into 10% [annual gross gaming] revenue growth. And with some extra [casino] supply coming online, it will take quite some time to absorb the capacity that’s in the market. That means it will be some time before it makes sense to commit massive amounts of additional capital to this market.
“So I think Wynn will enjoy his Encore [Macau] expansion for some time.”
Is this ‘GDP-plus’ growth rate view on Macau a Union Gaming view or a consensus view in investment circles?
BL: “That’s a Union Gaming view rather than a Wall Street consensus. People look at September’s preliminary numbers [on Macau GGR] and think: ‘Oh my gosh, this is a market that’s going to explode again to the upside with 50% plus revenue growth’.
“I just don’t think that’s what Beijing has in mind.
“Maybe we’ll see a month or two [growth] here and there that’s outside of the comfortable band for central government, but I think if I were a concessionaire in this market I would certainly not want to see 50% growth for a few months in a row.”
What sorts of investors were on your trip?
BL: “Purely institutional—mutual funds, long/short hedge funds—a thoughtful group but a cross-section for sure.”
What was the feedback from the investors?
BL: “There was a very very positive response from investors. These included people who hadn’t been here for some time. Some of them have been to the market many times—some even 30 years ago. These are some experienced investors, some of whom have a lot of history here in Macau. They’re aware of the structural challenges that have existed here.
“All the meetings—whether it was with junket operators, the concessionaires themselves or other folks associated with the market—were very positive. I think the investors feel—if this group is a proxy for other investors—good about the recovery story here and the sustainability of growth. Outside of our small sample, that’s what the market—such as Wynn etc.—also told us.”
