Inside Asian Gaming

22 We believe that the likely winner of li- censes may be some kind of consortium featuring local and foreign companies. For- eign companies with credentials and a track record include Las Vegas Sands, Melco/PBL, Genting,MGM andWynn.Of the local compa- nies, Sega Sammy, Konami, real estate devel- opers such as Mori and also Denstu are being mentioned as being part of the consortiums. Aruze’s relationship with Wynn could also put the company in the picture. We have no doubt that casinos will be a success in Japan (although this depends on the level of government interference). Looking at the experience of Las Vegas, we can see that new developments attract visi- tors – i.e. supply will create the demand. The same story is seen in Macau where tourist ar- rivals have increased by around 50% in the past two years while gaming revenue has in- creased by 140% in the past four years. Don’t discount the impact This sounds like a lot of speculation that could easily be ignored. Stock prices of companies with exposure to other poten- tial gaming jurisdictions, such as Macau and Singapore, increased significantly (up to 10x) and in very early anticipation of companies securing the licences. For example, Melco’s share price went up 20x times before it announced its first casino. The company subsequently announced fur- ther developments, secured a full gaming license and sought a US listing.The company has been completely transformed into one of the world’s leading gaming operators, from what was very originally Macau’s electricity company. Genting International’s shareprice soared 2.5x on news the company secured the Sen- tosa licence in Singapore. Las Vegas Sands andWynn have also done well. It is very difficult to determine the po- tential earnings impact of the casino devel- opments. Assumptions need to be made on ownership share, number of gaming tables, number of hotel rooms, retail, food and bev- erage, invested capital, gaming taxes – the list goes on. However, as a starting point, we can re- view the Ebitda contribution from a number of casino projects in Macau and Singapore. The average Ebitda contribution per year is around ¥40,000m. This would boost 2011 Ebitda estimates by between 30-80% for a sample of Japanese leisure companies that we have selected. Our numbers appear reasonable. Accord- ing to a study completed in late 2002 by the Tokyo Metropolitan Government on the ben- efits of a casino in the capital, a casino with hotel and entertainment facilities would earn ¥91bn a year, rising to ¥224.6bn in associated revenues, and generate 13,785 jobs. We are ¥m Casino Ebitda 40,000 2010CL Ebitda Earnings impact Aruze 60,000 66.7 Konami 55,000 72.7 Namco Bandai 75,000 53,3 Sega Sammy 125,000 32.0 not sure what is included in these calcula- tions, but applying a typical Ebitda margin of 20% to the revenue base equals around ¥20- 45,000m. Either way, our estimates represent a starting point for further analysis. Casino stocks trade at high multiples giv- en predictability of earnings stream, strong cash flow generation and high returns on invested capital. During the current environ- ment when casinos will open all over the globe over the next few years, many of the casino stocks are trading at very high earn- ings multiples. Average PE is around 100x. We are not suggesting that Japanese companies with casino exposure would in- crease to 100x.We are saying that increasing to 20-30x from 10-15x is possible. We believe stocks associated with Japan’s casino legalisation will significantly outper- form the market given a) previous run of stocks during casino deregulation; b) the po- tential uplift in earnings; and c) the expansion of the valuation multiple. A 50% increase in earnings and a doubling of the earnings mul- tiple would cause the stock to increase 200%. For those investors who are prepared to take a long term view, we would recommend building a basket of casino-related stocks. It is worth noting that many Macau-related stocks saw a significant period of outperformance in the run up to the license issuance.At this point, we believe it is not yet as critical to select the ultimate winners – time for this will come later when valuation multiples expand and start pricing in too much expectations. Within the leisure sector, we would rec- ommend including Sega Sammy, Konami and Aruze. PE (1yr fwd) Gaming stocks PE (one-year-forward) Wynn Genting Intl Melco Intl Las Vegas Sands MGM Harrahs 0 50 100 150 200 250 300 Earnings impact from casino