Scientific Game

High Mass

Will 2011 mark a shift in the balance of power between high roller action and main floor gaming in Macau? Morgan Stanley Research considers the possibilities

Saturday, 01 January 2011 16:29
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Morgan Stanley Research Asia/Pacific’s latest report, ‘Macau Gaming & Property 2011: Another Year of Outperformance’, presents a number of potential scenarios for the coming year. It refers to them as ‘themes’ and provides data in support of each hypothesis, while being careful not to state any of them overtly as ‘predictions’. One of these potential scenarios is titled “VIP in the Near Term; Mass in the Medium Term”. Morgan Stanley offers an argument that the trend in the growth of mass market gaming revenue is likely to continue.

Under a sub-heading titled “Mass is for the long run: Revenue growth less volatile than VIP”, the report, by Praveen Choudhary, Executive Director, and Calvin Ho, Research Associate, Morgan Stanley Asia Ltd, offers the following analysis:

“Mass gaming revenue tends to be less volatile than VIP, which tends to follow cyclical indicators such as new loan creation and Chinese property prices. Hence the former should be more defensive than the latter in an industry downturn.”

Under another sub-heading, “Infrastructure is shaping the landscape”, the report adds: “We believe the various infrastructure improvements could offer major upside potential for the mass market. They should alleviate the infrastructure bottleneck within the territory and make the mass-focused Cotai strip an easier destination for visitors. Most visitors to Macau arrive at the northern Gongbei border with Zhuhai.”

Morgan Stanley adds the caveat, however, that in the short term, the VIP market will remain the key driver of balance sheet and stock performance for the Macau operators.

The report states: “The VIP business has been growing at a faster rate than mass since August 2009 and stocks more leveraged to that have performed better. This is driven by easy money and credit access, plus strong GDP growth in China and Hong Kong. We do not expect these to change in the near term. Mass revenue per visitor is increasing but the growth would not be as fast as VIP in the near term. Average stay for hotel remained stagnant at 1.5 nights as well.”

The suggestion from Morgan Stanley is that the potential growth spurt in the mass will be linked to a positive upside on the mass sector, including specific economic and social catalysts.

“This is driven by an additional attraction (Galaxy Macau), infrastructure improvements (Guangzhou-Zhuhai Intercity Mass Rapid Transit), and wealth effect. However, in 1H 2011, VIP could continue to grow faster due to easier credit conditions,” state the authors.

Morgan Stanley also adds some insights on the potential upside risk in the VIP sector.

“We expect Macau Gross Gaming Revenue (GGR) to grow at 15% YoY in our base case for 2011 and we think risk is on the upside. We expect Mass Revenue is going to increase by 21% YoY while VIP Revenue is going to increase by 12% YoY. We see upside risk from VIP revenue growth while we see limited downside risk for the mass revenue growth. We make our projection through bottom-up approach from respective projections of the operators.”

The report’s authors emphasise they see the risk in the VIP segment as principally related to structural issues in the wider Chinese economy and unlikely to feed through to the market for some time.

“Market is worried about the recent credit tightening started in November by the PRC will have impact on the Macau gaming sector; we think it is too early to worry about that. Gross gaming revenues continued to grow during the last tightening cycle starting 2004. Both Macau GGR YoY growth rate and Gaming Index increased with the China PBoC [People’s Bank of China] Lending rate and the Required Reserve Ratio (RRR) until 2007-08.”

But Morgan Stanley cites potential changes in Shanghai money markets—the de facto financial capital of China—as having a knock on effect for the Macau VIP business; albeit with a nine-month time lag. Much of China’s high-end wealth has been generated out of equities listed in Shanghai, or via loans for property development done via the Shanghai banking system.

“Rising SHIBOR (Shanghai Interbank Offered Rate) could impact VIP Roll YoY growth % in 9 months: Our correlation tests show that SHIBOR has strong inverse relationship with VIP Roll YoY% (SHIBOR leads VIP Roll YoY% by 9 months). SHIBOR has been increasing and thus could impact VIP volume growth, but as long as the growth rate remains higher than 15% (for which PBoC rate needs to go up another 100 bps), the surprise to investor expectations would be positive,” says the report.

Set against potential upside risk on the VIP trade is the possibility that growth of the mass market—with its higher margins—could make a proportionately greater contribution to the bottom line.

“We expect Macau Gross Gaming Revenue (GGR) to grow at 15% YoY in our base case for 2011 and we think risk is on the upside. We expect Mass Revenue is going to increase by 21% YoY while VIP Revenue is going to increase by 12% YoY. We see upside risk from VIP revenue growth while we see limited downside risk for the mass revenue growth. We make our projection through bottom-up approach from respective projections of the operators.”

Table games in general and baccarat in particular will undoubtedly remain the dominant gaming action in Macau during 2011, as Morgan Stanley suggests. Until now, the main battleground for the six concessionaires and sub-concessionaires in Macau has been market share of the VIP baccarat trade. Baccarat hold volatility (aka house ‘luck’) affects both the high roller and mass-market businesses and thus the profitability of both segments. But the mass segment clearly offers greater underlying profitability to operators (typically 35% gross margin on the mass versus typically 7% or even as little as 3% on the VIP because of fierce competition on rolling chip commissions and win-rate sharing). Important factors in the greater profitability of the mass segment are its lower marketing and player incentive costs because the casinos don’t need to use junkets to bring players to the table. The performance of Sands China in the third quarter of 2010—when its EBITDA margin was boosted by a combination of the company continuing aggressively to control costs and it capturing a large percentage of the mass market (23% in November 2010) despite a more modest showing in VIP market share (12% in November 2010)—shows the inherent value of the mass if significant volume can be built.

“[Sands China] EBITDA margin improved gradually from 17.6% in 1Q09 to 23.6% in 3Q10. This is helped by rising mass win rate and operating leverage. For example, its staff costs as a percentage of total revenue has decreased by 650 basis points since 2007,” says Morgan Stanley.

The report writers suggest combined 25% year on year growth in gross gaming revenues across the mass and VIP markets may be possible. When sector growth rates are analysed individually, the mass could expand by as much as 23% year on year, suggests Morgan Stanley.

Some projections

“Under the following aggressive but reasonable assumptions, we think Macau could achieve 25% YoY GGR growth,” say the authors.

“Mass Revenue to grow at 23% YoY: Visitor Arrival at Macau and Mass Revenue per Visitor could grow at 12% & 10%, respectively in 2011 considering they had grown at 12% & 14% CAGR from 2004 to 2010,” suggests the report.

“VIP Revenue to grow at 25% YoY: Market will see increase in number of VIP tables by 8% and VIP Win/Table/Day could potentially reach to US$30k (level reached in 2005) from current level of US$25k in 3Q10.”

The authors also point out that market consensus typically starts conservative on Macau yearly revenue growth projections and then adjusts as the thing plays out.

“Macau Gross Gaming Revenue (GGR) has shown growth of 57% YoY for 2010 up to November. Consensus is factoring in 16% in revenue growth for 2011. Over the past few years, consensus estimates have typically started off at 10-15% at the beginning of the year, then adjusting upward/downward accordingly through the year.”

Morgan Stanley adds that supply-side limitations on the market (with only one new property, Galaxy Macau, offering approximately 400 new live tables coming on-stream in the second quarter of 2011) could help boost table occupancy and thus profitability—provided operators can up their operational efficiency and control costs at the same time.

Other analysts have also suggested possible government caps to control aggressive competition on win-rate shares in the VIP sector could also support operators’ profitability in 2011 and beyond.

“Drivers of 25% growth in VIP revenue: We estimate that the average number of VIP tables could grow roughly 8% YoY in 2011 given the opening of Galaxy Macau. If the credit environment remains easy, we think VIP Win/Table/Day will have to reach US$30K (similar to the peak reached in 2005), up from the current level of US$25K.”

A key take away from the Morgan Stanley report is that the market has to love the VIP segment because of its sheer size. But the lower volatility in mass market volumes of play (because of the segment’s lack of correlation with key economic indicators such as SHIBOR) and its better margins makes for a more sustainable business.

“In the near term, we continue to like the VIP segment due to its size (72% of total revenue) and tremendous growth (69% YoY YTD). Although VIP remains more volatile, risky and prone to any downturn, we expect momentum to be sustained in the near term. The mass business, however, is more resilient, less volatile and generates a higher margin for operators. Thus we think it is likely to be the better business in the longer term,” states the report.

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