Scientific Game

Stanley Ho and the Art of War

SJM's market rivals could do worse than read Sun Tzu's treatise on how to win a battle

Monday, 14 June 2010 08:00
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"The art of war teaches us to rely not on the likelihood of the enemy's not coming, but on our own readiness to receive him; not on the chance of his not attacking, but rather on the fact that we have made our position unassailable."

Sun Tzu 'The Art of War'

Stanley Ho still controls the largest single share of the Macau gaming market (31.9% of the gross in the first quarter of 2010) even eight years after the formal end of his monopoly and six years after the opening of the first foreign owned casino, Sands Macao.

It's easy to read too much into SJM's and Dr Ho's continuing ascendancy in the Macau gaming market. It could be as much to do with his competitors' mistakes (such as their initial determination to try to cut out the junkets) as his own good judgement. And SJM has suffered self-inflicted wounds along the way, such as the intra family litigation linked to SJM's flotation on the Hong Kong Stock Exchange.

Dr Ho is a mortal just like the rest of us, as his recent unfortunately extended stay in hospital illustrated. Like a good general or a good chess player, however, Dr Ho and his management team do seem to have the ability to see several moves ahead in the game. This means that when SJM acts in the Macau market, it may not be doing so in a strictly linear 'stimulus and response,' 'cause and effect' way. It may be positioning itself for an opportunity as yet unseen by the market as a whole or in order to counter a threat several steps down the track. In order to get that overview, you either need a high vantage point, or good intelligence. SJM has both.

Commission war

An example of staying several steps ahead in the market is the way that SJM-linked interests were able to head off the Western operators' attempts to gang up against SJM on junket commission rates. That commission battle started in late 2006 with the opening of Wynn Macau and heated up after the opening of The Venetian Macao in August 2007 and MGM Grand Macau (now MGM Macau) in December of that year.

Dr Ho went on record in September 2006 complaining that 'cutthroat' competition on junket commissions risked tipping a third of his junket operator partners into bankruptcy. He had a point. In 2002, before outside competition arrived, the average commission rate on VIP chips in Macau was 0.7%. By 2008, it had crept up to an average of 1%. But was Dr Ho's hand wringing merely a feint to buy time while he developed a new method of attack?

"Hold out baits to entice the enemy. Feign disorder, and crush him," as Sun Tzu puts it.

If it was a feint on Dr Ho's part, then Sheldon Adelson, the Chairman and Chief Executive of Las Vegas Sands Corp (LVS), certainly took the bait. Soon he was telling Dr Ho via comments to CNN and other media outlets to stay out of the competition kitchen if he found it too hot. Meanwhile, SJM-linked interests were quietly working behind the scenes on a deal that was to have far reaching implications in the commission war.

The Amax deal

Here's what happened next. In December 2007, AMA International, a junket consolidator, signed a deal to supply VIPs to Melco Crown Entertainment's Crown Macau property on Taipa in return for an eye watering 1.35% commission on rolling chip volume—nearly one third more than anything seen in the market up until then. In effect, MPEL was trading margin for volume. This had a huge impact on the profit potential of the other operators in the VIP baccarat-focused Macau market. They had a choice—either try and compete on price, or watch junkets up sticks and abandon their tables to join the AMA bandwagon. If they chose to compete on price, they would find their margins—already tight and reliant on play volume for profitability—squeezed still further.

Here are some facts about that AMA-MPEL deal:

  • AMA International is a subsidiary of Amax Holdings (formerly Amax Entertainment Holdings), a 49.9% stakeholder in Macau's Greek Mythology Casino.
  • Greek Mythology is an SJM-licensed, VIP-focused casino operation inside the New Century Hotel on Taipa.
  • The New Century is across the road from Crown Macau (now Altira Macau), the VIP-focused property built by Melco Crown Entertainment (Nasdaq: MPEL).
  • MPEL is co-chaired by Dr Ho's son Lawrence.
  • After opening late and over budget in May 2007, Crown Macau was struggling to make an impact and to grab market share in its target VIP segment.
  • Within two months of the AMA deal, Crown Macau had gone from also-ran to grabbing 18% of the gross in the Macau VIP market.
  • The commission rate hike hit SJM's VIP room business and profits as some junkets that had previously done business with SJM casino VIP rooms moved to Crown. But that migration hit the Las Vegas operators just as hard, if not harder, given they were operating on a lower volume of roll than SJM to begin with.
  • In early 2009, the Las Vegas operators called for talks on competition issues, including junket commissions, with the talks to be chaired by Dr Stanley Ho. Exactly who talked to whom to make that Crown Macau-AMA International deal happen is speculation, but it shows what the Las Vegas operators are up against in terms of SJM's market coverage and connections in the local industry.

If it was a victory for SJM, it was a pyrrhic one. But it also arguably saved the prospects of Lawrence Ho and his business partner James Packer in the Macau market, by generating cash to help pay for Crown Macau, and creating some leverage for the funding of MPEL's Cotai property, City of Dreams.

As Sun Tzu says: "...when using our forces, we must seem inactive".

Gaining Intelligence

As vital for business as it is for war

Another Asian warrior-philosopher still read today by business executives is Oda Nobunaga. He was a 16th century Japanese warlord and a student of Sun Tzu's teachings. He used to reward his spies as handsomely as warriors who fought bravely for him in battle. His logic was simple. Knowing what the enemy is doing before, during and after battle is as vital to military success as prowess on the field itself.

SJM doesn't have spies, it has 'guanxi' or 'connections'—a far more valuable commodity. Both Dr Ho and Dr Lui Che-woo, the mainland-born founder and chairman of the other Chinese-run Macau gaming operator, Galaxy Entertainment Group, are committee members of the Chinese People's Political Consultative Conference, the advisory body to the leadership of the People's Republic of China.

SJM and Galaxy have at least three major advantages over their foreign operator rivals in the Macau market when it comes to gathering political intelligence that can affect the market, such as China's thinking on how to implement the Individual Visit Scheme of independent travel visas for mainland residents wishing to visit Macau:

  • access to the ongoing conversation within China's political leadership regarding policy on Macau (if not direct access to some of the politicians themselves);
  • the advantage of insight, via shared language and culture, into understanding what shapes the thinking of the leadership in making those decisions;
  • knowing the political and business culture and knowing how and when to conduct negotiations in private and how and when to make pronouncements in public.

Forewarned is forearmed

An example of the political problems that can arise suddenly and seemingly without warning for foreign operators in the Macau market is the Macau government's announcement in late April that it would only authorise work permits for migrant workers on Macau construction sites on a 'one for one' basis, i.e., one migrant for every one local employed. Sands China says it needs 10,500 workers for its US$4.2 billion Cotai extension, but only 2,500 local construction workers were registered as unemployed and seeking construction jobs in 2009. Leaving aside the conspiracy theory that the government was somehow 'punishing' Sands China for the past 'sins' of LVS, such as pressing ahead with its Singapore resort while suspending work on Cotai, it's not hard to see how having advance warning of such a policy change could carry commercial advantages for a casino operator or at least protect it from commercial risk.

The benefits of such political channels and political intelligence to the incumbent SJM and to Galaxy should not be underestimated. Rumours had been circulating since last December that the government was going to cap the number of gaming tables in the Macau market. The cap was eventually announced in April at 5,500 tables between then and the end of 2012. And yet Louis Ng, an executive director of SJM, confirmed on the day that SJM's latest property Casino Oceanus opened in December 2009 that SJM had an allocation of 1,700 tables in the market. Mr Ng may have been revealing more than he realised. At the end of the fourth quarter of 2009, the Macau market had 4,470 tables, according to the Gaming Inspection and Coordination Bureau (DICJ). That means if Mr Ng is right, SJM was guaranteed 35.6% of the tables in Macau at that time, despite in 2009 as a whole having only 26.5% of the market by share of gross gaming revenue.

That might explain why SJM's market share rose to 31.9% in the first quarter of 2010—a reversal of a three-year trend that had seen SJM's market share fall from 70% in 2006, to 27% in 2008. SJM may have in effect been re-programmed for success in the last few months by being given an overweight allocation of tables compared to its rivals. How could that have happened? Most likely by harvesting goodwill SJM had previously sown among government leaders.

As Sun Tzu also says: "The victorious strategist only seeks battle after the victory has been won, whereas he who is destined to defeat first fights and afterwards looks for victory."

The Art of Jaw Jaw

Can Western operators do more to help themselves in Macau?

Galaxy has perhaps slightly less of a hotline to government than SJM, though it does appear to have got most of what it wanted in table terms for Galaxy Macau, its new project on Cotai due to open in the first half of 2011. Galaxy hasn't, however, been entirely immune to the migrant worker controversy. Its Galaxy Macau construction site on Cotai was raided in April by inspectors from the Labour Affairs Office. But they were there to clamp down on sub-standard migrant worker accommodation, not the 800 migrants legally employed there on a live-in basis. The raids also had something of a stage-managed feel to them. Copies of notices giving Galaxy advanced warning of the inspections were found on site by local reporters covering the story. Talk privately to executives of the Las Vegas operators, and they will tell you they feel they are rarely given any leeway or benefit of the doubt by the Macau authorities when it comes to following rules and regulations, whereas they feel the Chinese operators are.

So can those foreign operators do something to improve goodwill with the authorities and therefore improve their market intelligence and market position, or are they 'out of the loop' simply by dint of the fact they're not Chinese?
While not being Chinese does appear to be a handicap, they can still improve relations with the government. LVS started strongly on the goodwill front, and has been donating to local charities and community groups since it started operations in Macau in 2004. It also set up a local branch of the Sands Foundation, donating money to help the Sichuan earthquake victims in mainland China in 2008, and providing scholarships for local students to study at the University of Macau and other tertiary educational institutions.

Slow beginnings

Steve Wynn had a shaky start with the locals following a dispute with the government over legislation to allow casinos to write off uncollected gambling debts for tax purposes (it's allowed in Vegas and Mr Wynn noisily demanded it be allowed in Macau as well—which could be part of the reason it still is not). He learned quickly, however. A few months before the opening of Wynn Macau in 2006, he famously purchased a Ming Dynasty vase for HK$78 million (US$10 million at current exchange rates and a world record for a vase) at a Hong Kong auction. He then immediately made a present of it to then Macau Chief Executive Edmund Ho. It's now exhibited in the permanent collection of the Museum of Macau.

But while Wynn Resorts' romance with Macau seems to be blossoming, these days LVS seems a little cranky with Macau—like a misunderstood lover that has showered his partner with gifts only to be given the cold shoulder.
From LVS's point of view, the company may well feel a little aggrieved that having invested around US$2.7 billion in The Venetian Macao and Sands Macao combined, having created thousands of direct and indirect jobs to service the properties and being on the verge of spending US$4.2 billion more on its Cotai extension, it seems to be getting not praise and love from the Macau authorities, but negativity and heartbreak. There is potentially another way of looking at things. You need to grin and bear it. Imagine buying a Ming Dynasty vase and then not insuring it. And you need to keep paying the insurance premiums even if you feel they're going up too quickly and you can't see any immediate benefit. That's arguably where LVS is at the moment in its Macau business and in its relations with the Macau government.

The second issue facing the Las Vegas operators—that of not being Chinese—is a more difficult problem to fix, even if you hire more locals at senior level. Even being ethnic Chinese, speaking the language and understanding the system isn't enough to get you out of a tight corner with the Chinese authorities if you lose political support. Huang Guangyu, former head of the Gome electrical appliance retail chain and once China's richest person, found that out recently. In mid-May, he was sentenced to 14 years in prison at the Beijing Second Intermediate People's Court on the charges of bribery, illegal insider trading and illegal operation.

Nonetheless, in an operational sense, SJM and Galaxy do arguably have the commercial advantage of understanding Chinese consumers because the majority of their staff (if not their leaderships) are Chinese consumers themselves. And Chinese consumers are profoundly different—despite the rapid modernisation of China—in their tastes and ways of thinking than Western consumers, with whom the Las Vegas operators are most familiar.

In addition, SJM also has 40 years worth of infrastructure in venues, transport, marketing and casino management to help feed VIP and mass-market players to its casinos.

SJM also probably has the most capital efficient operation of all the concessionaires. Even its flagship property, the Grand Lisboa, was built at only a fraction (a first phase spend of US$640 million) of the cost of the properties put up by the Las Vegas operators. Such caution on capital spending helped protect SJM from the worst of the chill caught by the Macau market in 2008 by the twin effects of restrictions imposed on inward travel from China by the mainland authorities and the global credit crisis.

Dr Ho and his management have never suffered from a vice sometimes found in Western companies—that of pursuing a spending project even after the financial case for it has weakened.

"The general who advances without coveting fame and retreats without fearing disgrace, whose only thought is to protect his country and do good service for his sovereign, is the jewel of the kingdom," as Sun Tzu puts it.

There may not be much romance in the soul of SJM, but there is a very healthy dose of pragmatism. When the effects of Chinese visa restrictions and the global credit crisis hit the Macau gaming market in late 2008 and early 2009, SJM sharply scaled back its plans for its new property, Casino Oceanus, next door to Macau Maritime Ferry Terminal. It had originally been conceived as a US$800 million, French designed, iconic structure shaped like a sailing ship. It ended up as a much more modest HK$1.5 billion (US$190 million) box—its humble beginnings as a former shopping centre barely disguised by a shrink wrap style blue plastic façade. It doesn't matter. Oceanus helped to contribute towards the HK$12.7 billion revenue produced by SJM in the first quarter of this year.

Strategic Allies

SJM has its forces spread across Macau

SJM produced HK$760 million (US$97.6 million) profit attributable to shareholders, according to its unaudited results for the first quarter of this year. That's a 451% increase on the HK$138 million profit achieved in the year earlier quarter.

The improvement was due to a number of factors. One is SJM's low level of debt relative to its Las Vegas rivals. It had HK$4.9 billion (US$630 million) of debt excluding convertible bonds as of 31st March this year. On the same date, LVS' global debt stood at US$10.46 billion. Another factor likely to be favourably affecting SJM's profitability is that the company's share of the bigger margin mass-market segment has been rising, according to a conversation IAG had recently with Dr Ambrose So, Chief Executive of SJM. But more than half of SJM's gross revenues in Q1 2010 came from satellite casinos, where  SJM doesn't own the full economic benefit of that revenue. As a result, SJM's adjusted EBITDA for the quarter was HK$1.1 billion, providing an EBITDA margin of 8.6%.

The satellite properties aren't owned by SJM, but give a share of their revenue to SJM in return for access to the SJM gaming licence. Four new satellite properties have been added to the SJM family since 2005. There is no official limit to the number of satellites that SJM can cover with its licence; however, in practice the Macau government regulates the number of satellites allowed into the market.

In the first quarter of 2010, the satellite properties contributed more revenue to the SJM balance sheet than the company's flagship Grand Lisboa and the company's other directly managed properties (known as self promoted casinos within the SJM group, including Casino Lisboa, Casino Oceanus and Jai Alai) combined.

The arms-length operations produced revenues of HK$6.6 billion (US$850 million) in the first quarter, compared to Casino Lisboa's HK$3.2 billion and the self-promoted casinos' contribution of HK$3 billion.

The satellites include some of Macau's most famous 'legacy' casinos, such as the Golden Dragon, as well as newer properties, such as The Grand Emperor Hotel & Casino that opened in January 2006. What they all have in common is that they are predominantly VIP-focused operations that appear to have been able to ride the tidal wave of VIP revenue growth seen in Macau in the first five months of the year.


The percentage of the gross contributed by the satellites to the SJM operation amounts in some cases to almost 100% profit for SJM, depending on whether SJM is contractually required to offer marketing support and table dealers as part of the satellite agreement.

Some of the casinos in this satellite grouping pay five percent of their gross to SJM. Those using a more traditional arrangement common prior to market liberalisation in 2002, when Dr Ho had a monopoly, operate on a 40:40:20 model (i.e., 40% to the government in tax, 40% to the property owner and 20% to SJM.

SJM has been steadily switching its profit sharing agreements from the 40:40:20 model to a 40:55:5 arrangement (40% for the government in tax, 55% for the owner and five percent for SJM). The benefit of this latter system for SJM is that the property owners must assume all of the labour costs, which have been steadily rising in Macau, with the median wage for a casino dealer in the first quarter of 2010 now standing at 13,000 patacas (US$1,600) a month, according to data from Macau's Statistics and Census Service.

So why with so many apparent structural advantages accruing to SJM in the Macau market isn't more foreign investor money piling into SJM? The answer is probably transparency—or rather, concern there isn't enough of it. Foreign investors fret that despite SJM's listing on the Hong Kong Stock Exchange, they don't know exactly what they're getting exposure to—particularly in relation to VIP room operators in SJM casinos. That point has been reinforced by the recent report from the New Jersey Division of Gaming Enforcement finding Pansy Ho an 'unsuitable' partner for MGM MIRAGE in Macau because of her father Dr Ho's long-standing relationship with junket operators, some of whom the US federal authorities suspect have connections with criminals.

As Sun Tzu points out: "We cannot enter into alliances until we are acquainted with the designs of our neighbours."

Given the low gearing of his company and the healthy returns currently being generated for shareholders, Dr Ho is in less need of fresh equity investors than his Las Vegas rivals. But SJM is an investment play that cannot simply be ignored ad infinitum. Eight years after market liberalisation, SJM shows no signs of going away, and indeed actually seems to be getting stronger in market share terms. When a succession plan for the company's management becomes clearer, it could potentially lift the regulatory cloud lingering over SJM from the days of its parent company STDM's casino monopoly. Once that happens, the world may come knocking on SJM's door for some lessons and, more importantly, for some of the profits that can be made from fighting casino wars.

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