Scientific Game

Rolling Downhill

It will be hard to improve on the 2008 performance of Macau's high-roller segment during 2009

Wednesday, 14 January 2009 00:00
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China's manufacturing sector is on the brink of technical recession, according to an influential monthly report produced by CLSA, a provider of brokerage and investment services.

Deutsche Bank was already predicting a 14% contraction in Macau's gaming revenue for 2009, but that forecast was based on a more bullish assessment by its regional economist that the Chinese economy would keep growing, but at a slower rate. An actual technical recession is likely to have gaming analysts reaching for their calculators to make a fresh and possibly gloomier assessment of Macau's prospects for 2009.

The reason for special concern about the CLSA report is that Macau's gaming industry is heavily dependent on VIP players (they account for around 70% of all revenues). Many of these VIP players are owners or investors in the manufacturing sector now reportedly threatened not just with a much-heralded downturn but a full-blooded recession.

Down and down

CLSA's snapshot of local business conditions is based on a survey of the intentions of manufacturing purchasing managers, and known as the PMI.

"With five back-to-back PMIs signalling contraction, the manufacturing sector, which accounts for 43% of the Chinese economy, is close to technical recession," said Eric Fishwick, CLSA's chief economist, after the latest index was published on 2nd January.

Another PMI issued two days later on 4th January by a Beijing-sanctioned body, the China Federation of Logistics & Purchasing, rose slightly to 41.2 for December, compared with 38.8 in November. The trend, however, is still recession-bound.

A PMI reading above 50.0 indicates manufacturing growth, and a reading below 50 indicates decline. Both the CLSA index and the CFLP gauge stayed below 50 in the fourth quarter of last year.

China's share market indices reportedly ended the year down 65% on average, adding further gloom to the regional economic picture.

Karen Tang, an analyst at Deutsche Bank, issued an overview report just before Christmas on the Macau market and its prospects for 2009. The report, though written without the benefit of the latest PMI data, pointed out that during an earlier downturn in 1998, Macau's gaming revenue declined 18% and then a further 10% in 1999, dragged initially by a contraction in VIP rolling and by a fall in mass revenue.

Soft landing?

"This time around, the decline might be slightly less, as in recent years new resorts have put Macau on a spectacular growth path," says Ms Tang. However, she had a caveat.

"...with travel restrictions likely to remain for the next six months, we expect gaming revenue to fall 14% in 2009, in line with comments made by Macau's Chief Executive in early November. For 2010, we expect industry growth to fall a further 6%," she adds.

In December, Jun Ma, Chief Economist for Greater China at Deutsche Bank, lowered his China GDP forecasts for 2009 and 2010. He did it because of a sharper slowdown in China's exports than economic analysts had generally predicted. He suggested GDP increases of 7% and 6.6% respectively over the next two years, from the 7.6% and 7% tipped previously. The latest economic picture painted by CLSA and the CLFP is even bleaker than the bank's assessment.

Because of Macau's dependence on VIP gaming, the loss of a small number of players or a reduction in their rolling is likely to have a disproportionate impact on the local market compared to mass play.

"Our recent conversations with junket operators suggest that the market is still underestimating the downside for Macau," says Karen Tang of Deutsche Bank.

"First, junket operators are cutting their lending to VIPs as their customers' net worth is falling. Second, and more importantly, the amount of VIP rolling which can be generated for the same amount of lending is now 30% lower than a year ago, and can get much worse. We expect Macau's gaming revenue to fall at least 14% next year, dragged by a 25% fall in VIP revenue," she explains.

Rolling—but not everywhere

"A year ago, for every HK$100 million of working capital, junket operators could typically generate HK$400 million to HK$600 million in VIP rolling per month. Now, many can generate only HK$300-400 million," she adds.

"Hence, the multiplier on VIP rolling is down 30%. The reason is that VIPs are delaying repayments. Longer credit cycles tie up working capital, and slow the process through which junket operators can lend to the next customer," she asserts.

Celeste Mellet Brown and Thomas Allen, analysts at Morgan Stanley, make broadly similar points in their overview of the Macau and Las Vegas markets, published just before Christmas.

"Macau was able to thrive in 2008 because of junket consolidators and operators offering large amounts of credit to both players and junkets," they state.

"While the impact of less credit from junket consolidators is at least partially understood by the market, we believe reduced credit from some operators is not. We believe the reduced credit will have a more significant negative impact on VIP gaming revenue and now model Macau VIP gaming revenue down 17% in 2009. While we expect mass-market revenue to increase in 2009, we have lowered our estimate to 10% year-on-year growth (from 20%)."

Morgan Stanley says its conservative estimate reflects the impact of an economic slowdown in China and the rest of the world; lower spending per Mainland visitor as more come on whistle-stop package tours rather than using Individual Visit Scheme visas, and lower growth in the second half of 2009 as City of Dreams will now be the only new venue to open, following the suspension of Las Vegas Sands Corp's Cotai plots five and six, and the postponement of the opening of Galaxy's Cotai IR until 2010.

The points made by Ms Tang of Deutsche Bank about the mathematics of the VIP market apply to all operators and their agents. They are likely to be of particular significance to any VIP venues that were already underperforming relative to the Macau market's general growth in the first eight months of 2008. In this context, Galaxy's CityClubs immediately come to mind.

Survival of the Fittest

Macau's legacy casinos are likely to face particular pressure in a tougher VIP market

Legacy casinos are so-called because they were built before Dr Stanley Ho's Macau casino monopoly ended in 2002. All of them operated on SJM gaming licences, though other companies managed a good number of them. Another thing they all had in common was a relatively uniform approach to provision of facilities. To have seen one legacy casino prior to 2004 was pretty much to have seen them all. They had the same smoky gaming rooms, the same style of rather tired furnishings and the same unrelenting focus on VIP play. The few mass-market players there were at the time mainly came from Hong Kong and Taiwan—the players' tired and pinched faces often hinting more at financial desperation than leisure and relaxation.

The liberalisation of the gaming market, the relaxation of travel rules for Mainland Chinese citizens and the introduction of Las Vegas-style casinos dramatically changed the picture. First on the scene in May 2004 was Sands Macao, a mass-market focused casino operated by Las Vegas Sands Corp. The culture shock caused by Sands Macao's arrival and the fact it generated enough cash to recoup its US$265 million initial investment within a year did more to raise product quality standards across the Macau market than anything that had happened in the previous four decades of monopoly.

Eye opening

One of the things that made a particular impression on the incumbent SJM and on Hong Kong-listed Galaxy Entertainment Group, another early entrant to the new-look Macau market, was the ability of a new venue's 'buzz factor' to build margin through volume of play.

Although SJM and Galaxy already had plans of their own for new resorts, they realised that in the short term, they needed to organise refurbishment of legacy properties in order to hold or build market share.

There was, though, an important problem. The sheer scale of a purpose-built new venue such as Sands Macao gives an operator the chance to offer a wider range of facilities than legacy casinos, thereby boosting the mousetrap effect.

Old versus new

Here's what Karen Tang of Deutsche Bank said about legacy versus non-legacy venues in a report released before Christmas on Stanley Ho's casino operating company SJM Holdings.

"Grand Lisboa [a new property] has proven that, under new management, EBITDA margin at new properties can be substantially higher than at legacy casinos (1H08: 18% vs. 2%)."

The same logic appears to apply to Galaxy Entertainment Group, when the performance of its purpose-built StarWorld resort on the Macau peninsula is compared to its loss-making CityClubs, three of which are refurbished buildings aimed at the VIP market. Since StarWorld opened in October 2006, as a mixed VIP and mass-market casino resort, its performance has been solid, enabling that one venue alone to maintain a 6% share of the entire Macau market.

StarWorld's Q3 '08 revenue was up 2% quarter-on-quarter to HK$1.71 billion. VIP rolling was up 12% quarter-on-quarter to HK$19 billion per month (a 2.2% table hold), while mass table win was up 5% quarter-on-quarter to US$4,400 per table per day. In Q3 '08, StarWorld's EBITDA was up 21% quarter-on-quarter to HK$136 million due to slight margin expansion from 7% in Q2 '08 to 8% in Q3.


By contrast, Galaxy's CityClubs, consisting of three refurbished buildings and one purpose-built resort, all aimed at the VIP market, have been going into reverse. City Clubs recorded a HK$4 million loss on fee income stream in Q3 '08. In Q2 '08, they made a HK$1 million loss.

Part of the problem with CityClubs may be that they have outlived their purpose. It's possible to argue that at least part of the reason for that is faulty strategy and execution on the part of Galaxy. Three of the four CityClubs were supposed to be an instant foothold in Macau's lucrative VIP market, refurbished quickly and opened in advance of Galaxy's purpose-built venues StarWorld and its integrated resort on Cotai. In the event, CityClubs were delayed and opened only months before StarWorld, which made its debut in October 2006.

The revamped President Casino and the Rio Casino didn't open under the CityClubs banner until the first quarter of 2006. The purpose-built Grand Waldo Casino, with accompanying hotel and spa, joined the party in May that year. The Waldo Casino & Hotel was the only one to open well in advance in July 2004.

Jumbo junket

Galaxy's long-term commitment to the CityClubs concept must now be open to question, given the company's decision in the second half of last year to open a jumbo-sized 100-table VIP facility at StarWorld with junket aggregator Neptune. If the VIP market stands still or even contracts in 2009, then there is a distinct chance that the StarWorld VIP facility could cannibalise some of the CityClubs' business.

"While management guides that three of the company's [CityClubs] properties have now been moved to top-line revenue agreements, the effectiveness of this strategy in generating positive earnings over the near term remains uncertain, in our view," says Deutsche Bank's Karen Tang.

Although Grand Waldo has facilities that compare favourably with the foreign operators, it has suffered to some extent from its location, being on the border between Taipa and Cotai but physically isolated from the growing buzz factor of the Cotai Strip™ by a piece of no man's land. While visitors to Las Vegas Sands Corp's Venetian Macao and Four Seasons Macao properties will soon have the option of making a short walk to Melco Crown Entertainment's City of Dreams site if they want fresh entertainment options, anyone wanting to go to the Grand Waldo must take a taxi or make a ponderous and circular 10-15-minute journey by foot using the local vehicle service roads.

Job cuts

Even before the global financial disaster, Galaxy was laying off workers at its CityClubs. In the first round of redundancies the company cut 140 mid-level foreign workers at the Grand Waldo and President casinos. Then, in July, Galaxy let go of 270 local casino staff, mostly dealers. While there may have been solid commercial reasons for the decision, it attracted a lot of negative publicity and censure among legislators. The fallout was so great, in fact, that it appears other operators seeking to cut costs in the downturn are effectively protecting local employees from redundancy, regardless of their qualifications or competency.

On the plus side for CityClubs, the A-Max inspired junket commission price war seen across the market in the first half of 2008 now seems to have abated. Anecdotally, it appears that the net effect of that price war was to push up junket commission rate averages across Macau, which must inevitably have put further pressure on any VIP venues that were already underperforming.

Light in the tunnel?

During 2009, Galaxy will need to show investors that it has turned the corner with CityClubs and re-established the business model for the unit on strong foundations even if it cannot immediately return them to profit. One method will be to expand the volume of VIP turnover, although as Karen Tang points out, this is a big ask during a regional economic slowdown and credit crunch.

Another method is to dramatically cut costs. Galaxy may try to follow the formula adopted by SJM to improve the efficiency of its legacy properties.

"For self promoted casinos, it [SJM] will reduce the dealer-to-table ratio to lower labour costs; 2) For third party-promoted casinos, it will increase its revenue share, or reimburse more expenses; 3) For VIP operations, it will consolidate underperforming VIP rooms," says Ms Tang of Deutsche Bank in her report on SJM issued before Christmas.

"We estimate that cost savings [to SJM] could amount to HK$280 million," she adds.


If such measures are impractical for Galaxy's legacy properties, then the company could as a last resort seek government approval to sell one or more of the CityClubs to an outside promoter to run as a cheap and cheerful junket venue. But the property would need to operate under a licence from Galaxy or one of the other existing operators or sub-operators. Galaxy cannot sell on a sub-licence, as that went to LVS as a compromise deal organised by regulators when the original plan to pair Galaxy with LVS in a joint venture in Macau fell through. One thing seems sure. With the opening of Galaxy's new Cotai integrated resort now put back to 2010, Galaxy must be wary of reducing its already slender footprint in a highly competitive VIP market.

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