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Killer Whales

Any new price war over VIP junket business could come back to bite the Macau operators

Friday, 01 October 2010 16:29
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Remember the price war that started in the Macau VIP baccarat trade back in December 2007, when Crown Macau offered a junket aggregator 1.35% rolling chip commission? It seems the price wars are back, but this time in the form of competition over profit sharing.

As our Asian Gaming Intelligence e-newsletter reported first last month, at least one concessionaire, in a drive to build its share of the vital VIP market, is said by reliable industry sources to be dangling in front of junkets the carrot of a 57% share of profit (profit in this context denotes the ‘win’ or gross revenue) generated by the junkets’ VIP players. With the government’s share accounting for around 40% of profit (35% as direct gaming tax, the rest as mandatory social and welfare payments), that only leaves a 3% share for the casino operator.

Anecdotal

News of a 57% deal offered by a particular operator first began circulating in the industry three weeks ago. It has not so far been confirmed on the record by that operator’s management. But the arrangement has been confirmed off the record within the industry. It has also been suggested to Inside Asian Gaming that three SJM satellite casinos—i.e. casinos licensed by SJM but owned by third parties—have been on a 57% deal for several months.

A possible reason for the reluctance of operators to discuss the topic openly is its sensitivity in relation to two regulatory issues. The first is that the government has already acted once (if somewhat belatedly) to curb cutthroat price competition in the VIP trade. The second is that in order for an operator to go as low as 3% on its own share of profit, many industry observers assume it would need to pass on all or most of the running costs associated with VIP room operations to the junket operators. That is what SJM, Dr Stanley Ho’s casino operating company, did when it shifted some of its satellite casinos from a 40:40:20 model initially to a 40:55:5 model. Anecdotal reports suggest the three SJM satellite casinos alluded to were then moved to a 40:57:3 deal to allow them to pass more incentives to high roller agents and bring in more VIP customers.

But any shifting of VIP operational costs to the junkets naturally raises questions about how much oversight the concessionaire or sub-concessionaire retains over that VIP business. Dr Ho has certainly been accused in the past by some Western regulators of allowing a ‘casino within a casino’ situation to develop in some of his properties because of an arms-length approach to VIP room management.

The advent of a 40:57:3 model is seen in some quarters as an attack principally on Wynn Macau. Wynn reportedly offers a 42% profit share to its junket partners. While Wynn is retaining significantly more of the profit (18%) from its VIP baccarat operation than reportedly does the competitor mentioned in our newsletter, it’s important to point out that Wynn retains responsibility for the staffing costs and other overheads associated with its VIP rooms.

Loophole

“As a result of the rolling chip cap, a notable portion of Macau’s junket business has shifted to win-rate (aka profit share) deals in order to circumvent [commission] caps,” said Union Gaming Research in Las Vegas in a recent note to the investment community regarding Wynn Resorts.

“This loophole once again allows for ‘price-base’ competition in Macau, and it appears that three casino operators with varying motivations are temporarily capitalising on the dynamic. This is creating profitability concerns for all concessionaires, and particular market share concerns for Wynn Macau who will not likely chase commissions higher,” added the research company. It stated, however, that Wynn should benefit when what Union thinks will be a temporary price war comes to a halt—possibly through government action.

“Wynn should benefit from a quick unwind of win-rate commission increases and the eventual gazetting of win-rate commission caps in our view,” said the research note.

Changing picture

The competitive landscape certainly seems to be shifting in Macau. According to unofficial figures from Portuguese news agency Lusa, Melco Crown Entertainment (Nasdaq: MPEL) leapt from fourth place in the Macau revenue share league table in June when it had 13.5% of the market, to third place in the list in August, with a market share of 16%. That meant it overtook Wynn, which fell back from 17% in June to 14% in August. MPEL initiated the first VIP price war back in 2007 when it offered 1.35% commission on rolling chips at Crown Macau (now Altira).

MGM Macau has also shown signs of stepping up its game in the VIP segment. MGM Macau has been the runt of the concessionaire litter in terms of share of gross revenue (mainly on account of its VIP performance) since it opened in December 2007. At one stage part way through August, some analysts were predicting MGM Macau was going to fall to an all time record low of 6% of market share for the month. In the end, it recovered to end on 8% for the month—a gain of 1% on July’s performance. One obvious incentive for MGM Macau to seek a rapid improvement in its performance is that within months it is likely to float a local unit—MGM China Holdings Ltd—on the Hong Kong stock exchange. It submitted the first round of paperwork to the local regulator last month, and sources familiar with the deal say the joint venture between MGM Resorts International and Pansy Ho hopes to raise at least US$500 million via the offering. That task will be easier if investors are convinced that the US$1.25 billion property is moving forward in the Macau market, not merely treading water.

War, what is it good for?

If a VIP price war has commenced, does it even matter when the market is so buoyant? Some analysts estimate Macau gross revenues for 2010 could reach MOP180 billion (US$22.5 billion). That’s a 50% increase on 2009, which was already an all time record year.

To place the debate in the context of the recent rolling chip commission war, Union Gaming estimates a 57% profit share arrangement is equivalent to 1.625% in rolling chip commission.

“In this case, for every hundred dollars in roll, EBITDA contribution is just six cents assuming normal hold,” says Union Gaming.

If an operator snatches market share by fierce competition on VIP business, can the operator then make a decent profit out of that business, and sustain the commercial model? The evidence from the experience of Crown Macau (now Altira Macau), MPEL’s high roller-focused property on Taipa south of Macau peninsula, is ‘No’.

South side bubble

In the short term, the rolling commission hike certainly helped MPEL, Co-chaired by Lawrence Ho. Within months, Crown Macau had grabbed 18% of the Macau VIP gross. But the market as a whole paid a high price. It led casinos and junkets to act like factory ships in a bid to compete, trawling the sea of VIP players and sucking up any they could find—even those they might normally have thrown back in the water. Some of those smaller fish went rotten on them, creating a bad debt problem for all the operators (except Wynn Macau, which declined to join the whale war). It all ended rather messily with the Macau government eventually imposing a cap of 1.25% on rolling chip commission deals. When that happened, the rationale for junkets to use Altira disappeared almost overnight. In the third quarter of 2009, when the commission cap came into effect, Altira’s VIP rolling chip volume fell 31% year on year (from US$14.2 billion in Q3 2008 to US$9.8 billion in Q3 2009). Junkets, no longer lured by the possibility of top rate commission, deserted the property en masse. Net revenue at Altira Macau fell 31.4% year on year in Q3 2009 to US$182.6 million.

So what makes operators think a price war on profit share will be any more sustainable than Altira’s rolling chip commission-induced bubble? Union Gaming Research certainly doesn’t sound optimistic.

“Simply put, we don’t believe this activity is sustainable for any relevant period of time,” it stated. A gaming industry source spoken to by IAG put things slightly more colourfully.

“The answer isn’t for operators to drop their pants to try to lure junkets,” said the insider.

“They would be far better served making sure they have the right, visionary, leadership so that they can strategically build their businesses to work properly. What they need is new ideas, a different approach, not just more of same old baiting of junkets that failed so badly in the case of Crown Macau.

“Market share is one thing, true profits are the real aim. Turnover is great, but if you don’t hold enough of it at the end of the day, you still can’t pay the bills,” added the source.

“Where does the auction stop when you try to outbid the next guy? Junkets will simply move to the highest bidder again, starting more price wars, and still the poorer performing casinos won’t make enough money.”

Wiggle room

Union Gaming Research points out that a 57% profit share leaves little room for manoeuvre by the casino operator if its actual hold is below theoretical hold.

“At this 57% level, there is virtually no room to under-hold,” states Union Gaming.

“In fact, we estimate a minimum of just 2.72% hold (versus a normal 2.85%) to be the break-even threshold below which casinos would actually lose money when offering 57% commissions on a win-rate basis to junket operators.”

Profit share is the term used locally in the Macau industry to describe this particular form of junket incentive, but win-rate commissions as Union Gaming refers to it might be a less confusing and more helpful phrase. That’s because the level of house ‘profitability’ in baccarat can be quite volatile, compared to the generally accepted theoretical house win rate of 2.85%. A casino’s actual win rate can fluctuate by plus or minus 50 basis points, which is what managements and analysts mean when they refer to ‘bad luck’ or ‘good luck’ in relation to casino win rates during a particular reporting period. And by having in mind the theoretical win rate, one can more easily assess from actual win rates just how narrow or wide a casino’s margin is going to be if it gives more of its house win to its junket partners.

In a free market system, and barring the Macau government stepping in to act as referee in the manner mooted, an operator is of course entitled to offer to junkets whatever deals it thinks will bring in business. Often when a price war starts in an industry, those most critical of the alleged aggressor are those participants with a vested interest in maintaining a cosy status quo. But equally the sustainability argument seems a very powerful one, reinforced all the more strongly by the Crown (Altira) experience.

Union Gaming estimates if a shooting war has indeed broken out over prices, the maximum win rate commission possible before losing money (EBITDA) is 1.68% for rolling chip deals and 59% for win-rate arrangements.

Junkets and high rollers may be happy to move from one Macau VIP room and one casino venue to another in pursuit of the best pricing deal, like potentates touring a kingdom. But the banks and shareholders who risked billions to build the place will probably be less sanguine. Consumer power is a good thing, but not at the expense of rational competition. That’s the challenge for the industry, and that’s the question upon which the Macau government may ultimately be required to adjudicate.

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