Strategic Allies

SJM has its forces spread across Macau

SJM produced HK$760 million (US$97.6 million) profit attributable to shareholders, according to its unaudited results for the first quarter of this year. That’s a 451% increase on the HK$138 million profit achieved in the year earlier quarter.

The improvement was due to a number of factors. One is SJM’s low level of debt relative to its Las Vegas rivals. It had HK$4.9 billion (US$630 million) of debt excluding convertible bonds as of 31st March this year. On the same date, LVS’ global debt stood at US$10.46 billion. Another factor likely to be favourably affecting SJM’s profitability is that the company’s share of the bigger margin mass-market segment has been rising, according to a conversation IAG had recently with Dr Ambrose So, Chief Executive of SJM. But more than half of SJM’s gross revenues in Q1 2010 came from satellite casinos, where SJM doesn’t own the full economic benefit of that revenue. As a result, SJM’s adjusted EBITDA for the quarter was HK$1.1 billion, providing an EBITDA margin of 8.6%.

The satellite properties aren’t owned by SJM, but give a share of their revenue to SJM in return for access to the SJM gaming licence. Four new satellite properties have been added to the SJM family since 2005. There is no official limit to the number of satellites that SJM can cover with its licence; however, in practice the Macau government regulates the number of satellites allowed into the market.

In the first quarter of 2010, the satellite properties contributed more revenue to the SJM balance sheet than the company’s flagship Grand Lisboa and the company’s other directly managed properties (known as self promoted casinos within the SJM group, including Casino Lisboa, Casino Oceanus and Jai Alai) combined.

The arms-length operations produced revenues of HK$6.6 billion (US$850 million) in the first quarter, compared to Casino Lisboa’s HK$3.2 billion and the self-promoted casinos’ contribution of HK$3 billion.

The satellites include some of Macau’s most famous ‘legacy’ casinos, such as the Golden Dragon, as well as newer properties, such as The Grand Emperor Hotel & Casino that opened in January 2006. What they all have in common is that they are predominantly VIP-focused operations that appear to have been able to ride the tidal wave of VIP revenue growth seen in Macau in the first five months of the year.

Profitable

The percentage of the gross contributed by the satellites to the SJM operation amounts in some cases to almost 100% profit for SJM, depending on whether SJM is contractually required to offer marketing support and table dealers as part of the satellite agreement.

Some of the casinos in this satellite grouping pay five percent of their gross to SJM. Those using a more traditional arrangement common prior to market liberalisation in 2002, when Dr Ho had a monopoly, operate on a 40:40:20 model (i.e., 40% to the government in tax, 40% to the property owner and 20% to SJM.

SJM has been steadily switching its profit sharing agreements from the 40:40:20 model to a 40:55:5 arrangement (40% for the government in tax, 55% for the owner and five percent for SJM). The benefit of this latter system for SJM is that the property owners must assume all of the labour costs, which have been steadily rising in Macau, with the median wage for a casino dealer in the first quarter of 2010 now standing at 13,000 patacas (US$1,600) a month, according to data from Macau’s Statistics and Census Service.

So why with so many apparent structural advantages accruing to SJM in the Macau market isn’t more foreign investor money piling into SJM? The answer is probably transparency—or rather, concern there isn’t enough of it. Foreign investors fret that despite SJM’s listing on the Hong Kong Stock Exchange, they don’t know exactly what they’re getting exposure to—particularly in relation to VIP room operators in SJM casinos. That point has been reinforced by the recent report from the New Jersey Division of Gaming Enforcement finding Pansy Ho an ‘unsuitable’ partner for MGM MIRAGE in Macau because of her father Dr Ho’s long-standing relationship with junket operators, some of whom the US federal authorities suspect have connections with criminals.

As Sun Tzu points out: “We cannot enter into alliances until we are acquainted with the designs of our neighbours.”

Given the low gearing of his company and the healthy returns currently being generated for shareholders, Dr Ho is in less need of fresh equity investors than his Las Vegas rivals. But SJM is an investment play that cannot simply be ignored ad infinitum. Eight years after market liberalisation, SJM shows no signs of going away, and indeed actually seems to be getting stronger in market share terms. When a succession plan for the company’s management becomes clearer, it could potentially lift the regulatory cloud lingering over SJM from the days of its parent company STDM’s casino monopoly. Once that happens, the world may come knocking on SJM’s door for some lessons and, more importantly, for some of the profits that can be made from fighting casino wars.