Cotai Plot Five and Six

When will Cotai, the wannabe extension to Macau's traditional downtown gaming industry, really come of age? The moment could be as significant in Macau history as when the centre of gravity in Las Vegas entertainment shifted from the Downtown area to the Las Vegas Strip.

Both the Cotai Strip and the Las Vegas Strip are essentially inventions of the human imagination rather than 'real' places. The latter was built out of desert not already conquered by Las Vegas' creeping urban sprawl. The former was literally dredged from the waters of the Pearl River Delta—not so much terra incognita as terra ad absurdum. Both places set out to challenge the status quo of the existing traditional gaming zones in the world's two most famous gambling cities because they have the space for the industry to grow outward not just upward. They have already provided integrated resorts—one stop shops for legal adult entertainment—everything you could ever need; from gambling, hotel accommodation, restaurants, shopping, theatres, nightclubs and sports events, all under a single roof. And there's a lot more to come—especially on Cotai.

In late May, Sands China, the local unit of Las Vegas Sands Corp, announced a deal for a 30,000 square foot Playboy Mansion Macao as part of the company's next phase of development on Cotai. That next phase, known as Parcels Five and Six, or 'Cotai Five and Six' is currently scheduled to have a first phase opening in the third quarter of 2011, says Sands China.

Toddler stage

As to whether Cotai as a whole could currently be called a 'mature' tourism destination depends on how we define the term. One could argue that Macau itself isn't yet a 'mature' gaming market, given that around 75% of its entire revenues are dependent on high roller baccarat. Last year the casinos on the predominantly massmarket Cotai Strip—The Venetian Macao, The Four Seasons and City of Dreams, the resort from the joint venture Melco Crown Entertainment (Nasdaq: MPEL), between them recorded gaming revenues of US$2.46 billion. That's only 16.5% of the US$14.9 billion gross gaming revenues recorded by Macau as a whole in 2009. (CoD only opened in June that year.)

Given the VIP-skewed nature of Macau's gaming market, a more reliable indicator of the business health of Cotai may be the numbers of people arriving from mainland China via the Lotus Bridge, just a few hundred yards from The Venetian, and via the Pac On Ferry Terminal at neighbouring Taipa. In the first four months of 2010, arrivals to the Taipa ferry terminal rose 24.9% to 1,107,183, according to DSEC, the territory's Statistics and Census Service. By contrast, arrivals by ferry to the Outer Harbour next door to Casino Oceanus on Macau peninsula rose by only 4.6% during the period to 2,160,671.

Visitor arrivals by land (including the Border Gate on Macau peninsula as well as the Lotus Bridge) increased by 13.9% year-on-year to 4,261,467 in the first four months of 2010.

In appearance, Cotai still has a raw, unfinished look—rather like those vintage photographs of Hollywood from the early 1920s. Cotai doesn't yet have the 'stickability' of the Las Vegas Strip in terms of offering a place for people to stroll and take in the sights and the lights. That's what Dr Ambrose So, the Chief Executive of Stanley Ho's casino operating company SJM, meant earlier this year when he told Inside Asian Gaming that Cotai doesn't yet have "critical mass".

SJM has been adopting a 'wait and see' approach to Cotai. It doesn't currently have any land gazetted for casino use there, but there is a piece of land on Cotai that if developed will depend on a gaming sub licence purchased from SJM. That's the MGM site to the east of the Strip behind Sands China's plots five and six.

SJM—no foothold

SJM itself was supposed to have had land on Cotai at a rock bottom price following a land swap deal in 2006. In the deal, the Macau government indicated it would allow Shun Tak Holdings—a shipping and property conglomerate providing most of the ferry services from Hong Kong to Macau that Pansy Ho leads as Managing Director and Dr Ho chairs—to exchange a 1.1 million square feet piece of land it acquired in Taipa in 2002 for a plot on Cotai by paying HK$500 million. Following the arrest, trial and imprisonment for corruption of Ao Man-long, a former Macau secretary for transport and public works, land swap deals went out of fashion in Macau, and public tender for land sales at going market rates became all the rage. SJM was pretty vague in its IPO prospectus in 2008 regarding its plans for Cotai, referring only to "preliminary plans for two mixed—use developments".

Cotai—the Building Site

It's still a little rough around the edges

About the nearest thing to a Cotai Strip 'stroll' at the moment is the short walk from City of Dreams, Melco Crown Entertainment's resort on the north eastern side of the Cotai Strip, due west across the Strip, to the Campanile tower of The Venetian Macao. It's only recently that a pedestrian crossing was added to that part of the Strip. Previously, walkers took a chance dodging six lanes of traffic populated by Macau's sometimes erratically driven taxis and minibuses.

A big part of the reason for the lack of 'strollability' is that around half of Cotai is still a giant building site. 'Cotai 1.0' would have been at or near completion were it not for the global credit crisis of late 2008. That led to Galaxy Entertainment Group mothballing its nearly completed Galaxy Macau IR to the west of the strip behind The Venetian Macao. The crisis also caused Las Vegas Sands Corp (LVS) to suspend construction of its Cotai Five and Six plots on the eastern side of the Strip across the road from The Venetian Macao and the Four Seasons. In April, Galaxy announced it had the funding to start fitting out Galaxy Macau with the aim of opening in the first half of 2011. In late May this year, LVS announced it had completed a US$1.75 billion syndicated loan deal to allow it to recommence work on Cotai Five and Six. That cash complements the US$2.5 billion LVS raised from a listing of its local unit, Sands China, on the Hong Kong Stock Exchange in November 2009. LVS said in a filing to the United States Securities and Exchange Commission (SEC) in May that the first phase of Cotai Five and Six would be completed by the end of the third quarter 2011. Doubts still remain, however, over the completion date for the whole project. It's not clear whether Sands China will be able to recruit enough of the 10,500 workers it will need as quickly as it will need them, because of possible restrictions on migrant labour caused by the Macau government's desire to placate a small but vocal group of the local long-term unemployed.

Parcels Five and Six

The term 'Cotai Five and Six' to describe LVS's Cotai extension is convenient shorthand for writers and analysts. But it's somewhat misleading, making the project sound like the equivalent of a granny apartment built onto the family home, rather than what it actually is—a truly gigantic project costing almost twice as much as The Venetian Macao. When finished, it will have more than 6,000 hotel rooms—twice as many as The Venetian Macao—shared between four major brands: Sheraton, St Regis, Traders and Shangri-La.

In its first quarter 2010 results filing to SEC, LVS also said it had been given a two-year extension to complete the development of Parcel 3 on Cotai, next to The Venetian Macao, on condition the site was finished by April 2013. That looks distinctly ambitious, given the time it took to organise recommencement in Cotai Five and Six. The company added in its filing, however, that it might be possible to get a further extension on the deadline, but added: "If we are unable to meet the April 2013 deadline and that deadline is not extended, we could lose our land concession for Parcel 3, which would prohibit us from operating any facilities developed under the land concession. As a result, we could forfeit all or a substantial portion of our US$35.6 million in capitalised costs, as of March 31, 2010, related to our development on Parcel 3."

Cotai for Petrolheads

Getting there involves a road trip

The ferries serving Cotai directly are getting fuller by the month, but passengers still require a transfer by road to the actual doors of the casino properties. There's none of the convenience of the monorail serving the Las Vegas Strip. That's due to change—possibly within four years with the arrival of a light rail system; Macau's first ever railway. And within six years, Cotai is expected to have other links feeding from mainland China.

The first phase of the light rail system, including four stations serving Cotai, is likely to cost US$1 billion. In October last year, the government said the first stage could be open by 2014, though the scheme has been put back several times already. A further US$11 billion is being spent on a 31- mile long bridge across the Pearl River Delta to link Macau to neighbouring Zhuhai in mainland China and onward to Hong Kong.

That could be ready by 2016, but it is likely to be reserved for freight and commercial vehicles such as buses, because of the lack of space for parking private cars in Macau. China's ongoing railway modernisation programme has already halved the rail journey time between Beijing and Shanghai and is expected to do something similar for journey times from these major cities into the mainland cities next door to Macau.

Critical Mass

Cotai in the next five years

What are the prospects for Cotai 2.0, following on from Galaxy Macau and LVS' Cotai five and six? Steve Wynn said in April when he visited Macau for the opening of Encore at Wynn Macau, that construction on a Wynn Cotai project could begin as early as next year, for a possible opening before the end of 2013.

But the piece of land currently reserved for Wynn could hardly be described as the best position on Cotai. While it has the benefit of being close to Macau International Airport, it is well off the Strip, tucked behind City of Dreams, MGM's plot and LVS five and six.

What about Macao Studio City?

Potentially a pivotal issue for Cotai 2.0 will be what happens to the Macao Studio City site. This is the 32.3-acre plot in the southwest quadrant of the Cotai Strip nearest to the Lotus Bridge Gate to and from mainland China. The MSC project has been the main loser so far from the global credit squeeze. The project is currently stalled and mired in litigation, including some between two of the consortium partners—New Cotai LLC and Hong Kong-listed eSun.

Macao Studio City was originally scheduled to open in mid-2009 at a cost of US$2 billion, and was billed as Asia's first leisure resort property combining theatre, television and film production facilities and retail, with gaming, entertainment and worldclass hotels. MSC was to have featured 1,902 hotel rooms and suites, a 2,300-seat theatre, a 4,000-seat multi-purpose arena, a 40,000 square feet Playboy Mansion and a 500,000 sq. ft casino operating under the licence of Melco Crown Entertainment Ltd (which itself operates on a sub licence bought from Steve Wynn for US$900 million). MSC should also have had a 1.4 million sq. ft Studio Retail™ complex, created in partnership with Taubman Centers, Inc.

Because of the apparent deadlock between the partners, there have been rumours that the Macau government will take back the land assigned for MSC. That could in turn open up a new round of bidding for the prime site from existing operators, including SJM. Interestingly, SJM likes to refer to its property Casino Oceanus on Macau peninsula as 'Macau's first casino'. That's because it's the one nearest to the Macau Maritime Ferry Terminal. Were it to make a bid for the Macao Studio City site, it could then claim to have 'Cotai's first casino', because of the site's proximity to the Lotus Bridge Gate.

Were the MSC site to become available, it would be unlikely to attract operators new to Macau. The government said that Macao Studio City was the last deal where a sublicence of a sub-licence would be allowed (i.e., a gaming licence granted by an operator that is itself already working via a subconcession from a main concessionaire).

Back in the pot?

A person with knowledge of the financing of Macao Studio City has told IAG, however, that the rumours the government will take back the land may be overplayed.

The source said: "It is correct that a letter was recently sent to the partners by the government explaining that the return of the land was an option, but my understanding is that there were 30 other letters sent at the same time to companies in similar positions.

"The whole exercise may have been more geared towards residential properties rather than gaming, Cotai and MSC in particular. A big issue at the moment in Macau is the provision of social housing. Some developers have land for residential projects on the understanding they would include social housing. In some cases the government is saying: 'Where is the social housing?'

"I'm not saying that the government is not looking at the issue of the lack of movement on MSC, or that the government won't take back the land. But I certainly don't think it's going to happen imminently as suggested in some media reports," added the source.

New Cotai LLC certainly has access to money. Its financial partners are Oaktree Capital Management and Silver Point Capital, both big hedge funds in the United States. Oaktree is one of the biggest hedge funds in the US, controlling US$76 billion in assets. Oaktree also appears to have credibility with the central government in Beijing and was recently invited to work with the China Investment Corporation, a wholly owned state company with RMB1.55 trillion in working capital.

But if MSC were out of the equation, who would be the most logical suitors for that prime site? SJM already has a gaming licence it could use to develop the property. LVS has its hands full with Cotai Five and Six. Wynn might be another possibility. MGM already has a site reserved behind Cotai Five and Six and currently has its hands full tidying and strengthening its balance sheet following the major spending on CityCenter in Las Vegas. MPEL doesn't want the land taken away from MSC because technically that's an MPEL project. It's part of MPEL's future story to sell to the company's investors.

Looking ahead

With around 800 tables due to come onto the Cotai market before the end of next year and more than 4,000 new hotel rooms, it seems the only way is up for 'The Strip'. The issue may be not so much whether the Cotai Strip can reach critical mass in terms of numbers of properties, but whether Macau's centre of gaming gravity as a whole can be shifted any time soon. Currently, that centre of gravity involves a statistically tiny number of baccarat-loving VIPs providing most of the revenue on low margins for the operators because of the necessity to team up with junkets.

Only the sheer volume of roll makes it a profitable business for the operators, and a healthy 40% tax rate makes it a profitable business for the government. Time and the growth of a genuine, deep, middle class stratum in Chinese society with a real appetite for other pleasures aside from gambling is ultimately what will make the difference for Cotai. Bunnies alone won't get the joint jumping.