IAG 2006-01 Jan - page 16-17

Melco shares are looking awfully attractive, but remember, share prices can godown aswell as up
hehouseadvantagedictatesthatoverthe longrun,foreverydollaryoubet
onbaccarat,youwill,onaverage, lose1.17 centsoneachbanker bet and1.36
centsoneachplayer bet.Play longenoughandbigenough,andyouwill lose
quiteabit.Everyone isawareof thecasinocaveat,“thehousealwayswins.”
Unlike casinos, stockmarkets offer what appear to be tantalisingly sure bets.
At thebeginningof 2006,financial giant Citigroup said it believedeach share
of Hong Kong-listed Macau gaming-play Melco is worth HK$15, when the
shareswere tradingataroundHK$9. It seemed like investorshada surewayof
Soon after Citigroup issued its call,Melco’s sharepricebegan a steady ascent,
andasofmid-January,was tradingataroundHK$12.Melcohasprovedagreat
buy, with the share having risen steadily from just over HK$2 in September
2004.Still, that’snoguarantee itwill continue to rise,and theonly surewinner
isyourbroker,whoearnsacommissiononeachof your trades.
Baccarat players in Macau’s casinos can often be spotted carrying strips of
paper charting “patterns” of past outcomes (e.g. two banker wins, followed
by aplayerwin, then twomorebankerwins… the“pattern”dictates thenext
outcome will be a player win). Statisticians scoff at such behaviour, because
futureoutcomesare independentofwhathappenedbefore.
In stockmarket investing, however, chartingpast patterns is a legitimateway
to predict future outcomes. US funds have been aggressively buyingMelco
sharessince thebeginningof theyear,usingpastpatternsas their justification.
They recall thatNasdaq-listedWynnResorts jumped80% in the runup to the
company’s casino resort opening in 2005, and point out Melcowill open its
CrownMacaucomplex inSeptember 2006.
Melco’s price to earnings ratioof about 120 at aHK$12 shareprice compares
toP/E ratiosof 69 forNewYork-listedLasVegas Sands and24 forHarrah’s.But
the P/E ratio is based on past earnings, and it isMelco’s future earnings that
investorsareeyeingas theypush its sharepriceeverhigher.
Melco’s revenue for the time being is largely attributable to Melco’s six
MochaSlot outlets, throughwhich the company controls 30%ofMacau’s slot
machines. The number of slot machines in Macau has jumped from 814 in
2003 to over 3,000 by the end of 2005. Still, there ismuch room for growth,
with the ratio of slotmachines to gaming tables inMacau still just over two
times,compared toover 20 timeson theLasVegasStrip.
Mocha’s newoutlets alonewill add2,500moremachines by theendof 2006,
andby2010,CLSApredictsMacauwill have14,000 slotmachines.Meanwhile,
PriceWaterhouseCoopers (Macau) gaming practice director David Green
predicts therecouldbeasmanyas13,000 slotmachinesby2008.
Though slot revenue couldmultiplyexponentiallyover the comingyears,but
recent growthhas been subdued,withMelco’s revenue rising19% in thefirst
half of 2005 to HK$250.7 million (US$32.1 million). Citigroup says investors
should focusmoreon thefirm’s net asset value and completion schedules of
its twomajorprojects in theworks, rather than its immediateearnings.
The first of thosemajor projects is the HK$2 billion (US$256million) Crown
Macau being developed in a joint venturewith James Packer’s Publishing &
Broadcasting Ltd (PBL).TheMelco-PBL joint venture is alsobuilding theUS$1
billion City of Dreams, an integrated entertainment complex featured with
underwatercasino.MelcoplanstorecouptheentireCityofDreams investment
within “18 months after commencing operation inmid 2008,” according to
LawrenceHo’s plan, like theHK$15price target, is far from assured. However,
asurewin.When the likesofCitgroupbuyaggressivelyandconvinceothers to
follow their lead, theoutcomeof theirbets canbecome self-fulfilling.
Citigroup says investors should focus
more on the firm’s net asset value and
completion schedules of its two major
projects in the works, rather than its
immediate earnings.
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