Scientific Game

Value Proposition

While high-end VIP players looking for a gambling getaway in Asia will naturally gravitate to Macau and Singapore, their low- and mid-tier counterparts may find Cambodia’s NagaWorld a better bet

Friday, 25 May 2012 18:51
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In many respects, NagaWorld is an improbable operation. It’s in Cambodia, still one of the poorest nations on the planet, with nominal GDP per capita under US$1,000 per person. The country’s neighbor to the west forbids gaming and has a strict Buddhist tradition supporting that official policy. To the east is a communist country, relatively poor and long wary of games of chance.

Worse yet is the fact that the nearest relatively wealthy country, Malaysia, has an incumbent casino giant, Genting. And then of course there’s Macau—arguably the global geographic center of gaming—which lies less than three hours by air to the north. It would be very easy to write off NagaWorld or just file it away with the other Cambodian casinos, which are small, semi-legal border operations.

But in the 17 years since it got its start, famously on a barge on the Mekong River in the capital city of Phnom Penh, NagaWorld and its corporate entity NagaCorp have proven again and again that what at first didn’t seem to make sense may actually be one of the better gaming propositions in this part of the world, or anywhere for that matter. Through a combination of luck, solid management, a modicum of humility and a keen understanding of the market it serves, the company has built an operation that is not only successful but also uniquely positioned, set to grow nicely into the future and structured to survive any economic shocks that may come its way.

In fiscal 2011, net profits more than doubled, margins remained the highest for a casino group in Asia, near 50% on an EBITDA basis, and hotel occupancy was about 80%. NagaCorp’s stock price has more than tripled in two years and the company now has a market capitalization of over US$1 billion.

It turns out that the location was far more an asset than a liability. Being in Cambodia gives the company advantages that no one else can match. Costs there are very low—Cambodia’s basic wage is less than US$100 per month. Land and other essential inputs are also quite cheap given the relative lack of wealth in the country. While billion-dollar-plus facilities pop up regularly in Macau, NagaWorld spent in total so far about $230 million on its complex.

Given the fact that the country is essentially just starting out after the horrors of the 1970s and the troubles of the 1980s, the government is keen to do business and has gained a reputation as one of the easiest to deal with in the region. Visas are simple and granted on arrival, and for some countries not required at all, while red tape is minimal. As an early mover and committed investor, NagaWorld received good terms from Phnom Penh. It has a 70-year gaming license, through 2065, and a 41-year gaming monopoly, ending 2035, for activities within a 200 kilometer radius of the capital. The company also has a concessionary tax rate. It pays a lump sum that rises by a scheduled amount every year.

“We pay a monthly fixed tax of US$370,000, and that covers everything: corporate tax, gaming taxes and even the GST. That is only about 2% of revenue,” says Philip Lee, chief financial officer and executive director, NagaCorp. “If you compare that with 39% in Macau and 16 or 17% in Singapore, we have a huge cost advantage.”

But more importantly, Cambodia is quite a good place to situate a casino. The country of just 14 million attracts 3 million visitors a year and those numbers are increasing rapidly. In the first quarter of 2012, arrivals were up 28% year-on-year, compared with the 15% growth of 2011. By 2020, forecasts put Chinese visitors numbers at 1 million. Many of these so-called footfalls find their way to NagaWorld, which is conveniently located downtown next to the National Assembly and the Foreign Ministry.

Vietnam is a particularly interesting source market for visitors. As in China, the lack of casinos in the country prompts its residents to travel to neighboring jurisdictions to get their gaming fix (while MGM Grand Ho Tram is set to become Vietnam’s first casino resort when it opens next year, the casino portion will be, by law, strictly off limits to local players, as are the slot clubs currently located at hotels around the country).

About 18% of visitors to Cambodia, more than from any other country, come from Vietnam and arrival numbers from Vietnam are growing almost 37% a year. Many of them come by bus from Ho Chi Minh City, less than 6 hours away, to try their luck on NagaWorld’s main gaming floors. About 40% of the casino’s mass market visitors are Vietnamese.

“The Vietnam market is really starting to underscore their [NagaWorld’s] mass market momentum,” says Michael Beer, an analyst at Citi.

For much of the rest of the region, including Indonesia, Singapore, Malaysia, Korea and China, NagaWorld has to a great extent succeeded by targeting mid-range VIP players. Rather than going for the obvious whales, it works to attract a somewhat more modest level of player. To get them, it offers a relatively high commission of 1.7% (for overseas visitors)—compared with Macau’s 1.25%—and also extras not normally available to the sub-high-end player visiting Macau or Singapore.

“Out of China, if you’re a HK$1 million check-in player in Macau, you are not a big VIP player, so you don’t get all the frills,” says NagaCorp’s Philip Lee. “You get the basic VIP treatment. We feel that that’s a niche market we can serve because of our cost structure. We are offering a commission of 1.7% and full-blown VIP treatment.”

“From Malaysia and Singapore, we get the low-end VIPs, those who check in with about HK$150,000.” he continues. “In Macau, they would probably be public-floor players. Our strength is that we can attract players from Singapore and Malaysia because our commission is 1.7%, and secondly because Phnom Penh is a much cheaper entertainment destination compared with Macau and Singapore.

“Gambling is a business of escapism,” he continues. “They not only want to gamble, but they also want a variety of entertainment. With the low-end VIP players, every dollar counts. The cost of entertainment here—karaoke, dinner, drinks and even cigarettes—is a fraction of what it would be in Singapore or Macau. We have a strong following from this category of player. We give them the full-blown VIP treatment, even with only HK$150,000.”

Citi’s Michael Beer adds: “Those small to mid-sized players who may not qualify for VIP treatment in Macau or Singapore can receive exemplary service at a place like NagaWorld.”

It is essentially pragmatism that has seen NagaCorp through. It started out mostly doing junkets. It then began to serve the mass market, slowly achieving a more balanced mix, with main floor gaming (referred to by NagaWorld as “public floor gaming”) including slots now approaching two-thirds of total revenue. With the junkets, it aimed for the sub-high-end market because that’s where it could best compete.

“We have never really tried to target the high-end VIP business that you’ll find in Singapore and Macau,” says Timothy McNally, chairman of NagaCorp. “Consequently, we have never seen ourselves in direct head-to-head competition with these jurisdictions.”

Integrity also plays a role. The idea of a casino that started out on a barge in a country that barely had a functioning government at the time raises all kinds of questions. But all along, NagaCorp has worked to make sure it’s a first-rate best-practices organization. The company has no debt (though that is partly a function of the fact that Cambodia’s sovereign credit rating—’B’, from S&P—makes debt too expensive). It doesn’t offer credit to players. It has been listed since 2006 in a first-tier market, Hong Kong. And it brought on Mr McNally, a 24-year veteran of the FBI and the former executive director of security and corporate legal services at the Hong Kong Jockey Club, in part to make sure the company was up to standard in terms of internal controls and anti-money laundering procedures.

NagaCorp remains pragmatic and opportunistic. It will continue to enter markets and pick up customers when and where it makes sense. Vietnam remains key. The company will further develop that market with various packages, promotions and transportation options and with Vietnam-themed attractions and services, such as Saigon Palace (15 tables, 80 slots and Vietnamese-speaking staff). The company now has 10 buses plying the Ho Chi Minh- Phnom Penh route.

“They are spending money to cultivate their core audience,” says Mr Beer.

The company also has its sights set on Thailand, a market that it has yet to tap (Thai visitors account for less than 1% of NagaWorld’s mass market business), but one that it is keen to exploit. Thailand has almost 70 million people, the highest GDP per capita in the region north of Malaysia, and a good number of rich and very rich. It also borders Cambodia. But because of history and geography, it is not so easy to travel overland between Bangkok and Phnom Penh. The roads are bad, the crossing is hectic and the distance is significant.

Naga is about to initiate a Sachi and Sachi-developed marketing campaign in Thailand. It will take advantage of the frequent and relatively cheap flights between the countries. The trip takes 50 minutes and a round trip ticket costs about US$200. And it plans to open an office in Bangkok. Elsewhere in the region, the company will continue to source VIP customers. To that end, it recently acquired a Gulfstream private jet, primarily for flying high-end guests down from China.

Some analysts have criticized the company because it hasn’t achieved critical mass and has been slow to develop new facilities. In June last year, NagaCorp responded by announcing a scheme to expand its facilities, as part of a deal with its Founder and CEO, Dr Chen Lip Keong. Within a three- to five-year period, two projects will be developed next to NagaWorld by Dr Chen, NagaCorp’s majority shareholder, and then acquired by Naga upon completion. The projects are NagaCity Walk, a two-level pedestrian mall linked to the existing NagaWorld site, and an integrated resort complex, which will include hotel rooms, shops and convention facilities. Investors might be interested to note that the latter facility will be known as the ‘TSCLK complex’— which is short for ‘Tan Sri Chen Lip Keong’; Tan Sri being an honorary title granted to Dr Chen by his native Malaysia.

The reasons these two projects are being developed independently by Dr Chen rather than directly by Naga are—according to company sources—that land grants for casino projects are politically sensitive in Cambodia. It made more sense for the government to do the land deal personally with Dr Chen as thanks for his charitable and other public works in Cambodia, said sources. After all, NagaCorp may have been the first Cambodia-based business in modern times to list on an international bourse, but it still needs to be mindful of the realities of operating in a third-world country if it intends to maximize shareholder value.

The combined development costs for TSCLK and NagaCity Walk—known jointly as Naga 2—are expected to be US$369 million. That comprises US$275 million for TSCLK and US$94mm for NagaCity Walk. On completion, scheduled for 2015, NagaCorp will acquire the projects from Dr Chen, in exchange for shares or convertible bonds to the capital value of the project. After conversion of the instrument issued to Dr Chen, minority shareholders in NagaCorp will be diluted by approximately 42%, though analysts point out that shareholder dilution should be quickly offset by increased earnings generated from the new project.

There are several potential challenges on the horizon for NagaWorld. While Naga 2 is set to transform the property, it could also put margins under pressure and expose the company to the risks that come with rapid expansion. Another possible risk is competition from new casino projects outside Naga’s monopoly zone. A few prospective developers have announced plans to develop a casino in Siem Reap, home of the magnificent Temples of Angkor, but thus far, none has committed shovels to the ground.

The biggest threat to NagaWorld is that it could lose its key competitive edge relative to Macau and Singapore after its concessionary tax rate expires in 2018. There is no clarity as to what taxation regime Naga will face after that.

Mr McNally remains sanguine about NagaWorld’s prospects, however, believing the government will avoid any policy that will disadvantage the company, which not only provides Cambodia a valuable tourism draw, but has also long been in good standing with the authorities.

“The government is trying to do everything it can to develop the country. It’s very pragmatic,” says Mr McNally. That pragmatism could very well translate to Naga continuing to enjoy its favorable position in the country for the foreseeable future.

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