Scientific Game

Manila Envelope

The Philippines is busy building the first of two casino resorts—but will tourists come?

Wednesday, 15 April 2009 00:00
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'Build it and they will come' was more or less the mantra of Las Vegas Sands Corp. in Macau. They did, but 'they' didn't—or at least not in enough numbers and not quite quickly enough to keep nervous bankers happy. To be fair to LVS, the company had a once in a lifetime run of bad luck with world economics, compounded by some microeconomic and political issues unique to China.

So if Macau is struggling to find success with the brave new world of Asian integrated resort gaming in the present global downturn, what are the chances of a secondary market such as the Philippines making a success of it?

Broadly speaking, the plan of the Philippine Amusement and Gaming Corporation (Pagcor), the government-owned gaming operator-cum-regulator, is to marry the market experience, relative liquidity and local fundraising skills of domestic real estate developers with the operational and equipment manufacturing expertise of foreign gaming companies by building two integrated gaming resorts in Manila.

Making plans

Part of the difficulty for outside investors and analysts in assessing the medium to long-term prospects of these schemes is that the details appear to change on an almost daily basis. Even the names of the projects vary depending on to whom you talk.

The scheme that's already well under way—Newport City, near Manila's international airport—has been touted by the country's president and central government as an economic regeneration project. Nowhere on Newport City's website however will visitors find the word 'casino'. There's lots of talk about hotels, an 'entertainment complex', a 'sports complex' and a golf course, but the 'c' word is notable by its absence. In the Philippines it appears that gaming is often a product that dare not speak its name for fear of offending opponents. This is in stark contrast to Macau where gaming is at the heart of the economy.

Newport City (also sometimes referred to as Newport Entertainment City) covers a 25-hectare site in the Pasay City district of Metro Manila within sight of the international airport. Building work on the gaming resort portion (about eight hectares) is already well under way and that part of the scheme is touted for completion this year. Inside Asian Gaming understands it will have a casino (though the precise branding of the casino is yet to be confirmed officially) as well as a Marriott Hotel (understood to be the first Marriott-branded property in Metro Manila) and a suites-only Maxims Hotel—a Genting branded product.

The second gaming resort project is a more ambitious 40-hectare site on reclaimed land at Manila Bay near to the SMX Convention Center. This site has been referred to at various times in various ways as: Bagong Nayong Pilipino—Manila Bay Integrated City; Bagong Nayong Pilipino—Entertainment City Manila; Pagcor City and just plain 'Manila Bay'. What does seem clear is that it will have a casino resort under the branding 'Okada Resort Manila' or possibly 'Okada Resort Manila Bay', in recognition of Kazuo Okada, founder and chairman of ARUZE Corp., which has confirmed it will be the gaming partner for the second scheme.

Funding is still being finalised for the second scheme, says one of the partners, SM Investments Corporation, the holding company of the Philippines-based SM Group, although no clear guidance has so far been given to the media on the budget. In September last year, a figure of US$1.1 billion was mentioned in the local media in relation to development of an area referred to as 'Manila Bayshore', a zone that forms part of the Manila Bay regeneration area. It seems reasonable to assume that this budget may well have been revised downward in the wake of the global credit crisis that gripped financial markets soon afterwards.

SM Group's parent company was publicly listed in 2005 and is now one of the Philippines' biggest conglomerates, occupying a leading position in shopping malls, retailing, banking, finance and property.

The success of both Manila schemes may depend on how much the two business models rely on foreign visitors and how much on home-grown customers. Those numbers will in turn be influenced by what happens in the regional economy.


Gone with the Wind

Manila Bay will be radically different from the scheme first announced last year

Bagong Nayong Pilipino (aka Manila Bay) will be a pale shadow of the grandiose US$15 billion scheme proposed back in April last year, when credit was cheap and plentiful and consumer confidence in the region was soaring. Gone is the Universal Studios theme park proposed by Genting International, the development wing of Malaysia's gaming operator Genting Group Berhad. Gone indeed from the Philippines' gaming expansion plan is the Genting parent, leaving its subsidiary Star Cruises, the casino ship operator, as the only participant from the group. Star Cruises has set up its regional back office at the Newport site and has also taken an equity stake in Alliance Global Group, the local conglomerate developing the Newport resort.

ARUZE Corp., the gaming equipment maker and casino hotel operator with roots in Japan is though a good catch for Pagcor as a gaming partner, given its powerful position in the international industry. According to a 10-K filing with the US Securities and Exchange Commission on 2nd March this year, ARUZE, through its subsidiary ARUZE USA Inc., is a 21% shareholder in Wynn Resorts' common stock (equal to Steve Wynn's personal holding). As the Wynn filing puts it: "As a result Mr Wynn and Aruze USA Inc., to the extent they vote their shares in a similar manner, may be able to control all matters requiring our stockholders' approval, including the approval of significant corporate transactions." Kazuo Okada, chairman and founder of Universal Co. Ltd, which became ARUZE Corp in 1998, has served as vice chairman of Wynn Resorts since 2002. ARUZE has underlined its commitment to the Philippines by recently moving its gaming machine manufacturing facility there from Japan. The company adds it also plans to relocate its game software development team to the Philippines.

Kingson Sian, President of Travellers International Hotel Group Inc, a 50:50 joint venture between the local conglomerate Alliance Global Group and Malaysia's Star Cruises, gave an update on the Newport project during Asia's GEM, the annual congress and expo of the Philippines gaming industry organised by Pagcor and held at the beginning of April.

"Last year we [as Global Alliance] applied for a gaming licence [for Newport] and that was granted on 2nd June last year," said Mr Sian.

"On 31st July we sold 50% of the company to Star Cruises and thus we brought in a gaming partner—Star Cruises being ultimately owned by Genting Group of Malaysia. Together we are embarking upon creating a dream and making the dream a reality. We are embarking on two projects. The first is called Newport Entertainment City, a 7.8-hectare property across from the [Manila] airport Terminals 2 and 3. The construction there is ongoing and we are looking to spend around US$450 million. The project will be completed in phases but we should be open this year," added Mr Sian.

Hotel offer

He added the company was working to complete a five-star, 365-room Marriott Hotel on the Newport site and a 70-room all-suite hotel under a Genting brand called Maxim's Hotel, plus a 1,000-room budget hotel.

"Another part of the integrated entertainment concept will be a 1,000-seat theatre and there'll be a mall. Most of that should be completed this year," he stated.

It's reasonably safe to assume that when the planners came up with the name Newport City, they did not have in mind Christopher Newport. He was one of the most successful English pirates and explorers of the 16th century, plundering huge amounts of gold from the Spanish (the colonial power in the Philippines from 1565 to 1898) and from the Portuguese (the European settlers and later administrators of Macau from 1557 to 1999). Newport may need to plunder a few visitors from other regional casino jurisdictions if it is to be a success.

"Because of this financial crisis the entire system changed, so certainly some [casino] operators around the world are struggling right now," says Mikio Tanji, Executive Adviser in charge of preparing ARUZE's entry into the Philippines market.

Prospects

"But in the medium to long term certainly, growth can still be expected in this particular industry. That's because fortunately the number of rich people is getting bigger and bigger in places like China, in India, in Brazil—in fact all over the world. It seems to be a kind of human instinct that people want to play machines or table games. They are tired to sit at a desk [at work] and face their computer and their paperwork. So maybe once or twice a year they like to get away from that and go on holiday to try their instinct and their luck on machines or table games," he explains.

"One important aspect for us on this project is certainly to invite Filipino people to our [Manila Bay] resort but at the same time to invite foreign people to the Philippines so that they can play at our casino and spend money here," adds Mr Tanji.


Wanted: Customers

Not enough foreigners are currently saying 'Wow' to the Philippines holiday offer

If the Newport City project is relying on foreign tourists alone it could struggle, despite its proximity to Ninoy Aquino International Airport.

A modest 3.14 million foreigners visited the Philippines in 2008 according to the country's Department of Tourism. That's a little more than one-tenth the number of visitors that Macau recorded in the same period. The good news is that of the top four national markets delivering tourists to the Philippines (judged by volume) three are countries with a lot of dedicated gamblers, namely: South Korea (611,629 visitors and a market share of 19.48%); Japan (359,306 and a share of 11.44%); and China (163,689 and a 5.21% share). Of more concern to investors will be the sluggish growth rate of Philippines tourism. Despite the regional boom time that lasted up to the third quarter of 2008, the country managed only 1.53% year-on-year growth in tourist numbers, as compared to 2007, according to DoT data. By contrast, Macau's visitor numbers soared by 13.4% year-on-year in the first 11 months of 2008.

The success or otherwise of both schemes is also likely to depend on controlling capital costs; on how highly leveraged the partners are on the projects and what the covenants are from the lenders regarding repayment of the interest and the principal. Last, but by no means least, it depends on the risk appetite and patience of the investors.

"From our perspective, we accept there will be challenges in terms of funding and credit tightening," says Mr Sian of Alliance Global.

"But fortunately for us, we were able to bring in a very strong partner [at Newport Entertainment City] and we were able to close a deal prior to the global meltdown.

Funding has been secured for that first project," he adds.

Local funding

"Although credit has tightened globally, I think in the Philippines liquidity is still there for good projects," says Mr Sian.

"We're looking to go out into the market and raise something like US$150 million to US$200 million dollars. We believe we will be able to secure that entirely in the Philippines. And so, for well developed projects with good proponents, people should be able to get credit still in the Philippines market."

"Pagcor has done a wonderful job in laying out the foundations for attracting investors," he adds.

"The proof is that ARUZE is here. Our partner Star Cruises has also invested here. In fact, Star Cruises have not only invested in us, in terms of Travellers' International [a joint venture company between the two to run the hotels on the Newport City site] but they have also decided to move their entire back office to the Philippines. We're talking about regional surveillance, their legal centre, their training centre—so that is the kind of commitment they are putting into this country after they have seen the quality labour we have in the Philippines. I think the incentives and the policies have already been well laid out by Pagcor. I think it's time for us as investors to actually execute it, so we're doing just that," asserts Mr Sian.

Manila Bay

"The other project we will start this year is what is called the Bagong Nayong Pilipino project and we have a 40-hectare development there. This will be part of a larger vision of the [Pagcor] chairman [Efraim Genuino] in that area. We will start this year on that project. Since that is a larger project, it will obviously be completed over a number of years," explains Mr Sian.

Merril F. Yu, President of the Philippines company SM Hotels, part of the SM Group, is another participant in Bagong Nayong Pilipino. SM's parent company SM Investments Corporation is through its other subsidiaries the developer and operator of the SMX Convention Center and the Mall of Asia near to the proposed Manila Bay gaming resort site.

"We have a very aggressive schedule in terms of supporting tourism around the country," says Mr Yu.

"We want to develop the Mall of Asia as a tourist and entertainment hub in Manila. That supports Pagcor's drive to make Manila a competitive centre that draws its fair share [of visitors] against the other short haul Asian markets, including Macau and Singapore when eventually it [the casino resort sector] opens.

"There are fairly extensive designs for the casino as well as the existing SMX [Convention Center] which we plan to expand. It is aggressive, but we are taking the extra time to make sure that what we build is competitive and augments the existing Mall of Asia complex," adds Mr Yu.

"We are one of the three licence holders [in the Metro Manila gaming market expansion]. And SM even before this has always been a firm believer in the natural talent of the Filipino people. We hold the greatest strategic location in the short haul market in Asia. For that reason we've supported the initiatives," he explains.

"We're in the process of executing a development plan that will fulfil our requirements to really achieve this dream in the near horizon. Specifically we have already announced a rather large project which is a Radisson Hotel which will augment our SMX [Convention Center] operations. We also have planned a secondary hotel to support the casino operation as well as some other things in the pipeline. We are really quite excited about getting started on this. When you look at the horizons past the present financial crisis—within say a 24-month horizon—we'd expect our operation to be open."


Net Benefits

On tax at least, the Manila schemes should be competitive with Macau

As well as the potential goodwill created by local resort developers being able to raise money locally, the tax burden on the new Philippines resort schemes will also be lower than that found in Macau (which comes in at just under 40% of the gross when payments for social schemes are included). It will however be less competitive than Singapore's regime, where the IRs will pay 15% of gross revenue on the main floor as direct tax, but only 5% on 'premium' play (i.e., that of high-rollers and players brought in by junkets).

Singapore will however charge its citizens and permanent residents a fee—S$100 (US$65) per day or S$2,000 per year—to enter the IRs, while admission for tourists will be free.

Under the terms of reference supplied by the government-owned operator-cum-regulator Pagcor (the Philippine Amusement and Gaming Corporation), the new Manila resorts will pay the following taxes:

- 15% of gross gaming revenues generated from high roller tables;

- 25% of gross gaming revenues generated from non-high roller tables;

- 25% of gross gaming revenues generated from slot machines;

- 2% of total gross gaming revenues generated from both high roller and non-high roller tables, for the restoration of cultural heritage.

In addition, Pagcor will charge junket operations 15% of gross gaming revenues generated from both high roller and non-high roller tables.

"We are trying to come up with the best environment for our investors and at the same time to do the best for our country," says Rafael Francisco, President of Pagcor.

"The Tourism Act of 2009 means the government will definitely support the Entertainment City and other projects in the pipeline."


Risky Business?

Investment in the Philippines gaming industry may require some appetite for adventure

In the Philippines the risk factors for investors in the local gaming industry include not just the standard market question of 'Will they (the customers) come?' but also political and regulatory issues.

The Philippines is by no means universally regarded around the world as either a stable or as an exemplary jurisdiction when it comes to financial matters. This may account for why the investors in the two Manila projects are all East Asian or Southeast Asian institutions, namely: Malaysia's Star Cruises; ARUZE Corp., a gaming equipment maker and operator with roots in Japan; Alliance Global Group and SM Investments Corporation, both based in the Philippines. They all presumably have a greater insight into local market and regulatory conditions than would Western companies.

At Asia's GEM, the gaming industry congress and expo held annually in early April by Pagcor, guest speakers were generally full of praise for Newport City and for Bagong Nayong Pilipino.

But even before Asia's GEM had closed its doors on 3rd April, the Organisation for Economic Co-operation and Development (OECD) in Paris named the Philippines as one of 84 'non-cooperating jurisdictions' in relation to the transparency standards of its taxation laws. Within days, though, the Philippines had been taken off the list after the organisation said the country had committed to meeting the OECD's policy guidelines.

Risk factors

Political and regulatory risks remain for investors in the Philippines market. On 1st April the country's lower national legislature, the house of Representatives, passed to the nation's Senate a bill requiring, quote: "that all the funds and transactions of Pagcor including revenues, income and expenditures, be examined by the country's Commission on Audit (CoA)."

The CoA has been involved in some auditing of Pagcor for years. What was significant about this bill is that it seeks to amend Presidential Decree No. 1869 issued by former president Ferdinand Marcos. That decree currently limits CoA audits to ensuring that the government's cut—i.e., 5% in franchise tax and 50% of gross earnings—is fully accounted for. If the new bill becomes law then in future (possibly as a result of pressure from international bodies such as the OECD), the auditors will be able to shine a light over every corner of the Pagcor books. Given what the CoA has found in the Pagcor figures previously even under its existing limited mandate, fresh scrutiny could raise fresh concerns for the investment community.

Audit evidence

CoA documents seen by Inside Asian Gaming and issued after the Commission's audit of Pagcor's accounts for 2007 claimed at that time examples of lax regulation, non-payment of tax, overspending and unauthorised enhancement of employment benefit packages by Pagcor. These issues and the legislators' external pressure to implement a full audit on Pagcor must call into question just how committed Pagcor really is to reform from within.

Take this example from a CoA document titled: "Status of Implementation by Auditee of Prior Year's Audit Recommendations". The document, relating to the 2007 audit of Pagcor by the Commission (the most recent currently publicly available), is divided vertically into three columns reading from left to right: "Audit Observations"; "Recommendations" and "Actions Taken/Comments"

One audit topic reads: "Cash dividends from Pagcor's net earnings for calendar years 2005 and 2006 not remitted to national government." Next to this is the auditor's advice: "We have recommended that Pagcor comply with RA 7656 (the relevant Republic Act) and its implementing rules and regulations to remit annually the 50 percent cash dividends of Pagcor net earnings to the national government to avoid penalty charges and criminal liabilities." Under the "Actions Taken/Comments" column is the bald statement in bold type: "Not Implemented", followed by an explanation: "Pagcor reiterated its position that it is not covered by the memorandum on the maximization of dividend payments to the national government by GOCCs [Government Owned and Controlled Corporations] and GFIs [Government Financial Institutions] citing the same grounds invoked in Pagcor's exemption from RA 7656. Pagcor sent a letter to the Office of the President concerning the proper interpretation of RA 7656. The Office of the President referred the letter to the Department of Finance."

The fact that Pagcor appears in these documents to be conducting negotiations over its tax liabilities direct with the President of the Republic must raise questions about its potential exposure to hostile regulatory action by politicians in the country's Senate.

Give and take

Experts on tax law and tax compliance would no doubt point out there's generally more room for negotiation between governments and big corporations over tax payment than there is between governments and average individuals. In other words, governments always push corporations to pay more, and companies return the favour by seeking loopholes and favoured status. In that respect, Pagcor may only be doing what businesses across the world try every day. The difficulty for investors in Philippines gaming projects is the current relative lack of transparency in relation to Pagcor's tax liabilities. It makes it difficult to anticipate what Pagcor's tax liability will be in a year or 18 months' time and whether any new liabilities as established by the courts or the legislature will be passed on to the investors.

Perhaps the most damning revelation of all made by the Commission on Audit team when looking at Pagcor's books for 2007 was an admission by Pagcor that if accounting standards recommended by the Commission were adopted, it would mean a halving of Pagcor's previously stated net income for the year.

"Recasting Pagcor's 2007 Statement of Income and Expenses based on CoA's position on what constitutes gross earnings will result in a 52.39% decline in Pagcor's net income and a cash loss of PHP776,703,081.91 [US$16.3 million]. In any case, pending final resolution of the cases before the Supreme Court there can be no definitive finding on the matter, with Pagcor, CoA and the Department of Finance/Bureau of Internal Revenue (BIR) having different positions on the issue."

Worries

This kind of regulatory uncertainty would probably get the due diligence teams of most foreign investors reaching for a bottle of strong liquor. Time will tell whether sufficient safeguards and rigour can be injected into the system to turn investment in the Philippines' new generation of casino resorts from a wild card play to a blue chip investment.

Mikio Tanji of ARUZE is upbeat though about the prospects of the Manila projects.

"Our aim in Manila is to try to reach the best and the most sophisticated customer all over the world here in Manila Bay," he says.

"Although we are a shareholder in Wynn Resorts we would like to surpass Wynn Resorts. We would like to combine the hospitality people here in the Philippines with Japanese sense of service and design. I think we can achieve this."

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