Cash-hungry foreign casino companies could benefit from an upturn in Asian equity marketsMonday, 13 July 2009
The prospect of foreign casino companies with Asian operations raising equity in Hong Kong looks like a must-grab opportunity. It may be one of the few cost effective ways currently commercially available of relieving the pressure on their balance sheets. That pressure has been caused by an unprecedented amount of spending on infrastructure in Macau, combined with economic downturn of varying degrees in all the operators' key markets.
Set against the still-neurotic mood of global debt markets and the persistently high price of debt, Hong Kong's stock market looks positively sunny. Going down the initial public offering route does however have financial risks both for issuers and investors. There remain significant signs of volatility even in Asian equity markets and no clear indication yet that the bottom of the bottom has been reached.
In the early weeks of the financial crisis many casino operators, in common with other companies in other sectors, were naturally focused on making sure they could keep the business together as a going concern. That meant in many cases financial fire fighting in order to meet existing debt repayment schedules and covenants. This avoided the dread prospect of company credit worthiness being re-rated downward. That could potentially have led to a vicious downward circle of rescheduled loans at higher or even commercially unsustainable prices.
The ominous phrase 'going concern' came up at least twice in the industry in relation to casino operators with a Macau presence. The first time was in November last year in a US Securities and Exchange Commission filing from Las Vegas Sands Corp. (LVS), quoting the company's auditors. The second time was this year in relation to MGM MIRAGE, the 50:50 joint venture partner with Pansy Ho in the US$1.25 billion MGM Grand Macau. The corporation had warned in March that its auditors might include the language in its annual report.
By the end of June the market gloom surrounding MGM MIRAGE appeared to have lifted. The company issued a statement in the form of a filing with the US Securities and Exchange Commission saying there was no longer a substantial doubt about its ability to continue as a going concern. Shares of MGM MIRAGE rose more than 8% after the news. It followed a frenetic period of deal making by the company that saw it succeed in raising US$2.6 billion from the sale of debt and equity to offset its accumulated global debt. In April, The Economist magazine reported that debt stood at US$13.5 billion. Speculation also appears to have died down regarding the long-term ownership of MGM MIRAGE's Macau casino interests. The Malaysian gaming group Genting claimed recently its decision to take a 3.2% stake in the company for US$100 million early in June was driven more by a short term valuation opportunity than a medium- to long-term strategic wish to an independent presence as an operator in the Macau market.
After weathering the first part of the economic storm in varying degrees of financial health, the Macau casino operators certainly seem to have bought enough time to think strategically rather than just tactically. The difference between the casino operators and all the millions of other businesses around the world hit by the credit crisis is the sheer scale of the former's indebtedness—both in hard cash terms and as expressed as a multiple of their annual earning power. The willingness of the financial community to stand the operators so many rounds of 'drinks' was precisely because of the perceived long-term earning potential particularly of the Asia-facing part of the gaming industry.
Those fundamentals haven't changed, but the financial ground rules have. Investors in the casino sector appear less willing to delegate entirely the work of managing their money to the industry's senior executives in the way they tended to do in a bull market. They have shown a new interest in exercising additional layers of oversight on projects in terms of covenants about how the money is used. It was widely circulated in Macau gaming circles that City of Dreams, Melco Crown Entertainment's resort on Cotai, was required to open at the beginning of June under the terms of a covenant requested by lenders.
Such enthusiasm for conditions is not unique to the gaming industry, especially in the current bear market. In general terms, however, the tightening of the rules under which investment capital is allocated could have a significant impact on the operators' bottom lines, given the multiples of cash involved. An example is that if an operator is required to open a resort in a particular time frame by a group of lenders, it could also be required to raise additional cash for working capital to operate that resort, rather than being able to rely on organic growth of other parts of the business to supply that working capital.
The biggest, wisest investors certainly understand that they are into the casino operators for so much money that it is not in their interests to kill off the geese that may be laying regular eggs today but are likely to be laying golden ones tomorrow.
Past experience in other industries has shown that danger can sometimes lurk in syndicated loans. With those instruments, small lenders in the syndicate—often in more urgent need of liquidity than their bigger brothers—have on occasion dug in their heels and refused to reschedule the terms of a loan, thus bringing efforts to restructure a company's debt crashing down. In the 1980s, Rupert Murdoch's News Corporation, now one of the world's largest media conglomerates, was leaking cash because of the massive start-up costs of its satellite TV services, involving payments to Hollywood studios for films and to sports bodies for live coverage rights. The business came within hours of going under because one small lender on a syndicated loan to the company initially declined to reschedule. That kind of risk must surely have been magnified in the global casino industry by the inter-bank lending crisis.
In the Asian segment of the industry, many of the overseas-based operators were already pushing the envelope of the Western-style leveraging model even before the crisis. The credit freeze and the accompanying squeeze on liquidity and credit for Mainland China's businessmen—many of them big gamblers in Macau's overwhelmingly VIP-centric baccarat market—made a risky situation positively perilous.
Part of the answer in improving casino operators' balance sheets may be to set up local units capitalised locally. This would take advantage of the structural benefits of the East Asian regional economy—namely lower levels of personal and corporate indebtedness as compared to the West.
Before the global credit crisis escalated last autumn, Wynn Macau was touted for a potential US$2 billion-plus initial public offering (IPO) in Hong Kong. Wynn's local unit arguably would present the lowest risk, if not the cheapest entry price. As the least financially stressed of the three US-based operators currently in Macau, Wynn would be best placed to charge a premium for its stock. On the upside, it is likely to reward investors with steady growth rather than roller coaster volatility.
LVS remains under pressure on its debt schedule. But the stock of the LVS parent is now showing very healthy quarter on quarter improvements in its price from a low point at the end of last year, although some day-to-day and week-to-week volatility persists. By mid-June, LVS's stock had spiked at a level more than sevenfold that achieved in March. Macau accounted for 65% of LVS's global earnings before interest, taxation, depreciation and amortisation (and rental) in the first quarter of 2009, according to Dow Jones.
Overall these factors should make LVS another good candidate for a local IPO. An LVS offering in Hong Kong could raise up to US$1.1 billion, according to Merrill Lynch. Reuters reported recently that Goldman Sachs has been hired by LVS to prepare plans for such a move. In the absence of a general and sustained rally in equity markets regionally and globally there would, however, arguably be some question marks in the short term regarding potential volatility of any local LVS stock.
As with good comedy, the secret of any successful flotation is timing—and luck in finding a receptive audience. The Hang Seng Index has risen 62% since March—a net gain of 41% on the low experienced in the first quarter of 2009. But most analysts appear to think that even in East Asia the equity markets are some way off a sustained rally. That then raises the question of how companies price any offerings. They will need to be at a rate sufficiently attractive to demonstrate inherent value for short-term capital growth—not an easy task when appealing to currently risk averse investors. At the same time the pricing must not be so attractive that it leads capital to migrate from the parent unit in Las Vegas.
Any local IPOs will also need to be priced high enough to avoid saddling the new units with under capitalised balance sheets. That would risk reprising the leveraging issues exposed by the current crisis. "What I think is driving the speculation at this moment is the financial distress that a lot of the parent organisations standing behind some of the assets in this market are facing," Adam Rosenberg, Managing Director, Global Head of Gaming Group for Goldman Sachs & Co., told a conference session at G2E Asia 2009.
"As they've said, they're considering all alternatives to deal with their operational and financial situations," added Mr Rosenberg.
"The capital markets are presenting an opportunity," added Andrew Zarnett, Managing Director at Deutsche Bank Securities, during the same session.
"It's temporarily open, which means there's something to be done," stated Mr Zarnett.