Inside Asian Gaming

ournalists have a handful of attention-grabbing figures to draw on in describing Macau’s potential. There are the one billion people who reside within a three-hour flight of the city. The more than US$12 billion in investment being carried out by the likes of Las Vegas Sands,Wynn Resorts, Galaxy Resort and Casino, SJM and MGM Mirage to create a “critical mass” of tourism and gaming attractions in the city. And of course, then there are 16.7 million visitors who last year descended on the once “sleepy enclave” with a mere 476,000 inhabitants.But perhaps the most attractive figure for investors is Macau’s gaming revenue, which is on the verge of overtaking that of the mighty Las Vegas Strip. Some journos jumped the gun by reporting that Macau had already unseated the Las Vegas Strip in 2004, although the final gaming revenue tally for the year came to US$5.1 billion in the former and US$5.33 billion in the latter. From January to August 2005, the Las Vegas Strip recorded US$3.91 billion in gaming revenue while Macau hit US$3.85 billion. With gaming revenue growth in both places running at around 13%, the battle for the year-end number one slot will be even more closely followed than the perilous twists on the Guia circuit of November’s 52nd Macau Grand Prix. If Macau does come out ahead, will it mean it is the biggest market? Not by far, since non- gaming revenues have a big part to play. Taking these into consideration, Las Vegas would close to double Macau in terms of total revenue. Non-gaming’s gaining fast CLSA forecasts Macau’s gaming revenue to increase by 17% CAGR (compound annual growth rate) over the next five years, while non-gaming revenue is expected to increase by 57% CAGR. Non-gaming revenue will be the more exciting side of the race, not only in terms of growth, but also as there seems no real consensus across operators — local and western included — as to what style of non-gaming activities will appeal most to visitors from the Chinese Mainland and Hong Kong. Will the Chinese trade up to five star hotels? Will there be huge demand for Cirque du Soleil type attractions? Will French cuisine be the most popular? The answer to these questions is probably no, therefore there are barriers yet to overcome. Short Stay Macau The first challenge is to increase average stay. The Macau market is a day-trip market, and despite 50% of visitors staying overnight in 2004, only 24% used a hotel room. Average length of stay is critical to casino operations, given the positive correlation of time spent in a casino to money wagered (and lost) and expenditure on other non- gaming activities. The average stay in Macau is 1.2 days, compared to more than three days in Las Vegas.Any increase in the number of days stayed would have a disproportionate impact on hotel rooms – at an Non-Gaming Revenue The Other Side of the Revenue Race Although Macau could soon inch past the Las Vegas Strip to become the world’s leading gaming market, it will still trail far behind Vegas in terms of hotel, dining and entertainment revenues. CLSA’s Aaron Fischer sees potential for Macau’s non-gaming revenue to accelerate dramatically over the coming years average stay of three days,the number of hotels in LasVegas is 15 times higher than inMacau.Despite the relatively high number of hotel rooms in Las Vegas, the occupancy rate has been averaging more than 80% in the past few years. Disproportionately higher number of rooms in Las Vegas than Macau Source: Macau Government, LVCVA, CLSA Asia-Pacific Markets Taking into account developers’ expansion plans, there are likely to be more than 30,000 hotel rooms in Macau by 2010, or three times the current supply. Our estimate appears reasonable from a top-down perspective, based on our projection that the number of tourists will jump from 16.7 billion in 2004 to 36.6 billion in 2010, and the average length of stay will approach two days. Last year saw an increasing strain on hotel capacity, and with barely any rooms added in 2004, the occupancy rate shot up from 64% to 76%. However, with the start of a rapid expansion in rooms available this year, Macau’s hotel occupancy rate has been dipping again. Macau occupancy rates surging as supply is tight Source: CLSA Asia Pacific Markets,DSEC Mainlanders favour cheap digs Demand for rooms in Macau is likely to be felt by both the three/four and five-star hotels. In Hong Kong, the rollout of the individual travel scheme for Mainland Chinese travellers wishing to visit China’s two Special Administrative Regions has seen strong demand for affordable accommodation and as a result, three and four- star hotels have seen the greatest benefits. In Hong Kong, Mainland Chinese spend only 12% of total spend on hotels versus around 35-40% for Americans and Western Europeans. We also note that in Macau in 2004, around 58% of Mainlanders stayed in four or five-star hotels compared to 74% of other tourists. As a result, we expect to see stronger demand for affordable accommodation in Macau. However, with footfall so critical to the financial success of casino operations, we expect to see operators offer four and five-star rooms at two and three- star room rates, at least over the short run. We do believe that Mainlanders will trade up, but this is going to take some time. Mainland Chinese spend less on hotels Source: Hong Kong Tourist Board,CLSA Asia Pacific Markets Mainland Chinese less inclined to stay in 4/5 star hotels Source: Macau Government,CLSA Asia Pacific Markets Movingupthe foodandbeveragechain We estimate that 90-95% of revenue in Macau is derived from gaming activities, with hotel, food and beverages often thrown in for free to attract visitors.This is in stark contrast to Las Vegas,where gaming revenue represents only around 50% of the casinos’ total takings, with hotel, food and beverage and entertainment making a positive contribution. Macau’s current revenue mix is similar to that of Las Vegas in the 1960s, when the emphasis was also on gaming, with only a marginal contribution derived from non-gaming activities. Las Vegas moved on and so will Macau. Estimated%age of casino revenue by division Source: CLSA Asia-Pacific Markets. We expect to see a continued shift towards non- gaming revenue, particularly as the Cotai Strip develops and casinos attract visitors for business conventions and family entertainment as seen in Las Vegas. We believe non-gaming revenue will increase to at least 25% of total revenue by 2010. Given the inherent love of gaming in Asia, this will still be below the 50% of revenue derived from non-gaming activities in Las Vegas. Increasing importance of non-gaming revenue Source: CLSA Asia Pacific Markets Good for group margins The effect of moving into non-gaming activities on group operating margins is likely to be positive. In Las Vegas, we note hotel operations typically generate an Ebitda (earnings before interest, taxes, depreciation and amortization) margin in excess of 70%, while food and beverage and entertainment is narrower than the gaming activities’margin of closer to 50%. 2004 Ebitda margins by division for Las Vegas Sands and MGM Mirage Source: Las Vegas Sands 10-K,MGMMirage 10-K Nobody to serve right now Currently,casinos/hotels offer very little in the way of quality non-gaming activities such as family entertainment and food and beverage, largely because there is not the demand in the market right now. However, we expect this to evolve over time as the visitor profile shifts from hardcore players to general holidaymakers. In time, Macau will begin to have a similar entertainment offering to Las Vegas, including concerts by both Asian and Western popstars, sporting events such as boxing, trendy nightclubs, and so on. However, shows like Cirque du Soleil have not performed incredibly well in Asia. Asians are looking for an experience, but the entertainment needs to be relevant to them. Similarly, we see potential for a significant upgrading of the variety of restaurants that are available in Macau. However, we do believe that there will be continued strong demand for noodle shops and Chinese fare. For example, Wynn Macau’s largest restaurant will be Chinese, not French or American. The current retail offering in Macau is average at best. The majority of those visiting Macau for shopping look to acquire antiques, furniture and other home products. At the high end, there are a only a small number of luxury-goods stores located at the Mandarin Oriental hotel including Louis Vuitton, Burberry, Dior, Zegna, Emporio Armani, Dunhill, Hermes, Omega, Hugo Boss and Salvatore Ferragamo. This is a very low number relative to Hong Kong, where there are multiple sites for each of the major brands. Snatching shoppers fromHong Kong We believe there is significant potential to tap the Mainland Chinese visitors that are currently travelling to Hong Kong to shop. According to the Hong Kong Tourism Board, a high level of total spending is allocated to shopping – 82% for same- day visitors and 59% for overnight visitors, with Mainlanders allocating a greater level of spend to shopping compared to other tourists.The most popular items acquired are ready-made items such as garments, jewellery and watches (50% of total), snacks and confectionary (28%), cosmetics (22%), footwear (17%) and handbags and other leather goods (14%), all of which can be offered in Macau. We believe Mainlanders and other tourists will divert their trips from Hong Kong to Macau for shopping because over time there will not only be a similar retail offering in the latter, but also because Macau will offer a wider variety of entertainment choices and better quality and less expensive hotel accommodation. Many of the casino resorts recognise this opportunity and are allocating a significant area for retail.We believe themajor retail developments will be located at the Venetian (Las Vegas Sands), Wynn Macau, City of Dreams and Oceanus Grand Canal Shoppes in the Venetian, Las Vegas Source: Pictures copyright (c) Las Vegas Sands Corp.2005 We believe the development of resorts in Cotai is likely to be the key catalyst to increase the level of non-gaming activity in Macau, by making available significantly more space for conventions, entertainment halls and retail. Macau LasVegas Ratio Average daily no.of tourists 45,683 102,435 2.2 Average length of stay (days) 1.2 >3.0 2.5 No.of hotel rooms 9,168 131,503 14.3 Occupancy rates (%) 76 90 8,200 8,250 8,300 8,350 8,400 8,450 8,500 8,550 8,600 8,650 2001 2002 2003 2004 50 55 60 65 70 75 80 Hotel rooms Occupancy rate (RHS) (%) (No.) 0 5 10 15 20 25 30 35 40 45 50 USA Europe Australia North Asia South Asia Mainland China % of total spending spent on hotels 20.7 37.5 37.2 36.9 28.7 18.8 10.1 4.2 3.2 2.6 0 10 20 30 40 50 60 70 80 90 100 Mainlanders Other Guesthouse 2 star 3 satr 4 star 5 star Macau Las Vegas Gaming/casino 92.5 50 Hotel rooms 5.0 25 Food and beverage 2.5 15 Entertainment 0 5 Retail 0 5 Total 100 100 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 2004 2005CL 2006CL 2007CL 2008CL 2009CL 2010CL (US$m) Non gaming revenue Total gaming revenue (%) LasVegasSands MGMMirage Gaming/Casino 52.0 50.3 Hotel rooms 75.2 72.9 FoodandBeverage 46.8 44.8 Entertainment na 31.9 Retail na 34.1 31 30