Inside Asian Gaming

9 8 Analysts argue for the continued rise of Melco’s share price by pointing out that the company is trading at a substantial discount to its US peers, Las Vegas Sands Corp (LVS) and Wynn Resorts, which have enjoyed big run-ups in their share prices on the back of optimistic forecasts for revenue growth from their Macau operations. Those expectations are based on the view that theMacau gaming market will repeat the Las Vegas experience of supply-creates-demand – a view shared by Deutsche Bank’s Karen Tang on page 16. With Melco’s share price at such lofty altitudes, however, it’s not surprising that some analysts are getting cold feet. Dow Jones Newswires reported the views of an unnamed analyst who fears Melco’s shares now look a tad overvalued when considering the potential risks, and offers a sum-of-parts valuation of the shares at about HK$16.3. While Citigroup and Credit Suisse may be ex- cessively bullish because of their likely par- ticipation in the Nasdaq IPO, the bearish view of the anonymous analyst could also have ulterior motives. Dow Jones quoted the analyst with no name as saying the opening of Wynn Resorts’ first property in Macau on September 5 (full story on page 18) could result in “cannibaliza- tion” of some of LVS’ market share. Most ana- lysts view Macau’s gaming industry as supply driven, although they agree that the coming huge expansion in capacity – from1,648 gam- ing tables at present to close to 10,000 by the end of the decade – will naturally result in a significant dilution of win per table.Only three of Macau’s six casino licensees – Stanley Ho’s SJM, Las Vegas Sands Corp and Galaxy En- tertainment Group – are currently operating tables, so their respective shares of the over- all market will also likely decline as the other licensees – Wynn Resorts, the Melco-PBL JV and the MGM-Pansy Ho JV – open shop. If supply continues creating demand, however, although LVS could lose some of its market share going forward, its revenue growth will continue. Compounding fears that demand will be unable to match the huge increase in supply are concerns about tiny Macau’s straining in- frastructure, even though casino operators claim they are confident the city will have the facilities and workforce in place to host the projected 35 million visitor arrivals in 2010 Light Background Melco International Development Limited was originally incorporated as “The Macao Electric Lighting Company Limited” in 1910, and has been listed on the Hong Kong Stock Exchange since 1927. It was only in 2001 that Melco adopted its current form. In addition to its core gaming business, Melco owns an investment banking firm, the Jumbo Kingdom floating restaurant in Hong Kong and a gaming technology arm called Elixir, which this year announced a 20-year alliance with Shuffle Master Inc to jointly develop localized gaming technologies in Asia, as well as distribute Shuffle Master’s existing products in the region. On June 1, Melco was added to Morgan Stanley Capital International’s Asia Pacific ex-Japan indices and its Hong Kong index. This should raise holdings of its shares by international funds,many of which use MSCI’s indices as performance benchmarks and maintain the bulk of their portfolios in any given region with MSCI constituent stocks. Melco’s JV partner, Publishing and Broadcasting Ltd (PBL), owns Melbourne’s Crown Casino and Perth’s Burswood International Resort, Western Australia’s only ca- sino, for which PBL paid A$715 million (US$535m) in September 2004. PBL is one of Australia’s largest diversified media and entertainment companies. Its market capitalisation of more than A$8 billion places it among the top 25 compa- nies in Australia. PBL will rely heavily on its gaming operations to drive earnings growth. Profit at PBL’s gaming unit jumped 60% year-on-year in the six months ended December 31, while its television profit declined 13% as the company’s Nine Network struggled to maintain its five-year lead as Australia’s most viewed network. – almost double the 18.7 million visitor ar- rivals logged by the city with a mere 488,000 residents in 2005. Bubbly Valuation? As with the technology companies that dom- inated the Nasdaq during the Internet boom, the value of Melco’s share price is based largely on its future earnings prospects. At the start of this year,Melco’s price to earnings ratio was a heady 120, but it declined con- siderably following a nine-fold year-on-year jump in the company’s profit in 2005. Melco’s P/E ratio was 40 as of June 1,but that is based on an artificially high 2005 profit figure – the HK$548.7 million profit for the year included a one-time gain of HK$514.4 million from PBL’s purchase of its JV stake. The bulk of Melco’s revenue currently de- rives from the company’s six Mocha Slot out- lets, which account for about 30% of Macau’s slot machines.Slot revenue in Macau is grow- ing rapidly,albeit froma negligible base.Slots earned US$29 million in 2003, accounting for 0.8% of total casino gaming revenue, and US$152 million in 2005, when they provided 2.7% of total revenue.Slot revenue in the first quarter of 2006 stood at US$53 million, or 3.4% of total gaming revenue. Melco’s slot revenue will likely continue posting strong growth, but absolute gam- ing revenue will only seriously take off after the Melco-PBL JV starts operating tables at the two casinos it is currently building, and a third for which it recently announced it would acquire land. Melco formed its JV with PBL in 2004, and in March this year purchased the last of Ma- cau’s six casino licenses from Wynn Resorts for US$900 million. Melco and PBL will share profits from all future projects in Macau and Asia on a 50:50 basis. Melco is headed by Lawrence Ho, son of Macau’s legendary king of casinos,Stanley Ho. PBL is headed by James Packer, son of recent- ly deceased Australian media and gaming mogul, Kerry Packer. The JV’s projects under construction are the US$256 million Crown Macau hotel and casino, slated to open in April 2007 (delayed from the original Sep- tember 2006 opening) on Taipa island, and the US$1 billion City of Dreams resort on the Cotai Strip, expected to open in mid-2008. In May, the Melco-PBL JV widened its fu- ture geographic presence inMacau by agree- ing to purchase a site along the peninsula’s Friendship Avenue – where SJM’s flagship Casino Lisboa and LVS’ Sands Macau current- ly sit,andWynn Macau,Galaxy StarWorld,and MGM Grand Macau are being built. The land purchase will cost HK$1.5 billion (US$193 million), and pending government approval, is expected to be completed in the first quar- ter of 2007. The JV’s third casino project could open as early as 2009, and will include a hotel and a block of serviced apartments. Construction costs are expected to bring the project’s total cost to an estimated HK$3.5 billion (US$449 million). Melco’s June 1 share placement, which was handled solely by Credit Suisse, raised HK$1.21 billion (US$157 million), the bulk of which will go towards the land pur- chase,with the remainder earmarked for debt repayment and other corporate purposes. With Melco’s major gaming operations yet to commence, its share price is subject to the vagaries of sentiment towards Macau, and moved by news about the city’s casino revenues and visitor arrivals. Analysts regard project delays as one of the major risks to the share price. With Crown Macau’s open- ing date having already been pushed back six months without grounding Melco’s me- teoric rise, the bias thus far has clearly been on the upside.