Last week I headed across the Zhujiang River Estuary east from Hong Kong, to the island of Macau, for a kick-the-tyres session of what is the largest gambling centre in the world by a very large margin.
It has been a while since I looked at this fascinating scene. Shepherding me through it was an old friend and former colleague from way back. A banker, he is now deeply involved as a shareholder and board member of one of the major listed gaming companies focused on the Macau market. So he has deep knowledge and insights into what is going on in this huge industry.
Helping him was Grant Govertson, the founder of a unique boutique research and advisory business, Union Gaming, that specialises in the Macau gaming sector. Seven years of deep immersion in this industry in Macau, following years of work in the sector in the U.S., has given him a huge knowledge base and highly tuned insights into the industry, the Macau real estate scene, and the policy morass that drives the industry in Macau.
A high-stakes game
The first thing to realise, if you did not know it already, is that Macau's gambling business is almost totally driven by money and gamblers from China. It does not attract plane-loads of punters from around the world like Las Vegas does. Gamblers flock from up north (China), and across the water from Hong Kong about thirty miles away.
This makes the industry totally at the mercy of Chinese government policy. Macau, like Hong Kong, is a Special Administrative Region of China, operating under the principle of “one country, two systems”. But we should be under no illusion about who is really pulling the strings in the Macau gaming industry. A prime example of this is the large anti-corruption drive instigated by Chinese President Xi Jinping in 2014 – which stopped a lot of Chinese high rollers from heading into Macau and flashing their cash, and crippled the industry.
Second is to realise the scale of the industry. It is huge. It dwarfs that other big gambling centre, Las Vegas. Total gaming revenue in Macau is almost six times that of Las Vegas, amounting to around US$32 billion, compared with around US$5.5 billion for Las Vegas.
Macau has always been a gambling hub. But in the early days gambling was controlled by one family, headed by Stanley Ho, through SJM Holdings and related companies. As recently as 2004, SJM's market share of gaming revenue was close to 100 percent.
About twenty years ago, the industry was opened up with the issue of a brace of new licenses and sub-licences. This was when the legends of Vegas showed up in force – Steve Wynn, Chairman and CEO of Wynn Resorts, and Sheldon Adelson, Chairman and CEO of Las Vegas Sands, most notably. This opening began the radical transformation of what was a sleepy, lower-end monopoly, into the top of the global gambling league table that it is today. Billions of dollars have been invested in massive new hotels and gambling palaces.
Our tour took us to the two gambling hubs in Macau. And we need to bear in mind that Macau is a TINY place. At 30.5 square kilometres, it is half the area of Manhattan. Its population is a little over 600,000. But it receives more than 30 million visitors per year. And those visitors drop a lot of money on the local economy. Or more specifically, on the owners and investors in these hotels and gambling houses.
The first hub is in the core of the “old” town, known as Peninsula Macau, the part of Macau that is attached to China. The other is the new area located to the south on reclaimed land between the Islands of Taipa and Coloane called the Cotai Strip. Peninsula Macau has significantly more valuable real estate. It is a few minutes’ drive from the Chinese border (northern), and is in the centre of a “real” town of real restaurants, shops and local life.
Source: Union Gaming
The Cotai Strip, to the south, is a totally new, modern (and some would say soulless) place. And getting there from the Chinese border across the bridges can be a challenge with Macau’s almost dysfunctional traffic system.
During our drive around the city, Grant punctuated his conversation with, “See that building there, total investment $3.5 billion… $3.2 billion… $4.5 billion” and so on. Big numbers for sure.
But the growth has been electric. Gambling tables (gambling licences specify the numbers of tables allowed) have grown from 1,269 in 2005 to 6,128 in 2016. The total number of slot machines has grown from 2,933 to 14,494 over the same period.
But the experience of the past three years has clearly demonstrated how China’s government really has the whip hand here. President Xi Jinping's ascendancy to the top of China’s government in 2012 was quickly followed by a nationwide anti-corruption campaign. This has continued to the present. The campaign battered Macau’s gambling business. From a peak gaming revenue of around US$46.2 billion in 2014, revenues slid by almost 39 percent to US$28.6 billion in 2016. It’s still many multiples of Las Vegas, but the decline was a big shock to the system. The VIP sector, which caters to high-end gamblers and is the biggest money spinner, was particularly hard hit.
However, it seems from recent figures that the worst may be over. The VIP high rollers, as well as the mass market players, are coming back, and the tables are starting to do better. So far revenues are reportedly up about 19 percent year to date. VIP gamblers are back with a vengeance, up approximately 30 percent. The mass market is up around 15 percent.
And the share prices of Macau’s gambling companies have recovered from recent lows. Sands China (Hong Kong Stock Exchange; ticker: 1928) has increased 121 percent and Wynn Macau (Hong Kong Stock Exchange; ticker: 1128) has risen 221 percent since their lows in January 2016.
Meanwhile, returns in the industry have shrunk dramatically through a combination of lower top line revenues in the past few years and higher construction costs. Today, new developments can expect a cash on cash return of around 9 to 10 percent per annum. Still not too bad. But this has come down from somewhere between 30 to 50 percent since the “golden days” of a few years ago. However, these returns are heading north again as the punters return and revenues rebound.
This has been reflected in the stock prices of the main gaming companies. But some are clearly differentiating themselves from others according to Grant’s analysis. So far in this recovery it has been good enough to simply bet on the sector. Looking ahead, it will be important to figure out who are the winners, who has the competitive advantage and who are the also rans. Our new friend Grant has a very firm finger on the answers to this question.
Other developments will add to the Macau mix. Like Las Vegas, Macau development is increasingly focusing on non-gaming tourism. Family holidays, conventions, and exhibitions. Also, external transport links are adding to the accessibility through the very large Hong Kong - Macau - Zhuhai bridge development due to open in 2018.
On top of all that is the so-called Greater Bay Area initiative that is aiming to integrate the whole Hong Kong, Shenzhen and Zhuhai area more effectively as a single economic unit. It already comprises the second-largest port in the world, the third or fourth-largest financial centre, the largest gaming centre, the largest manufacturing conurbation in the world, and a growing tech centre of global significance.
My advice? Keep an eye on Macau, and in particular the Greater Bay Area (encompassing Macau, Zhuhai, Hong Kong, Shenzhen and Dongguan). The sector looks broadly positive right now, but as I mentioned earlier we are focusing our efforts on stock selection and will publish any specific company recommendations in The Churchouse Letter, our flagship investment publication.