Inside Asian Gaming

December 2012 | INSIDE ASIAN GAMING 35 will remain the only two major gaming destinations in the region, serving billions of Asian gamers. Japan could be the next meaningful market but will most likely serve the local population (see our ‘Asia’s wonderland’ report). Meanwhile, it is unlikely that the Chinese government will legalize gaming anywhere within the country, including island destinations such as Hainan. While Hong Kong would be an enormous market, we believe the probability of casinos being licensed there is less than 1%. 3. Is management candid with shareholders? With a long-term investment horizon, Buffett favors companies that are candid with shareholders. In Macau’s gaming industry, analysts and investors generally enjoy excellent access to CEOs and other senior management over a period of time. Companies tend to host regular conference calls, attend investor conferences, host property tours and have strong investor- relations teams. Financial disclosure is world-class in Macau, especially compared to some other Asian gaming companies such as Genting Singapore, which is weak on disclosure. 4. Does the business have a long track record of earnings growth? Buffett prefers companies with a long track record of delivering earnings growth. The Macau casino operators do not score well in this area, as most only have five years of operating history. US operators, such as Wynn Resorts and Las Vegas Sands, have a longer operating track record, but their earnings, historically, have been volatile due to high gearing levels during the financial crisis. This is unlikely to be repeated in the Macau gaming sector, with many companies in a net-cash position. We expect Macau to deliver more consistent earnings growth as VIP gaming revenue moderates on a high base. With a slowing VIP segment, we are also seeing increased earnings exposure to the more robust mass-market segment, which will help lower gaming companies’ earnings volatility. 5. Does the business have a consistent operating history? Buffett dislikes companies that expand beyond their comfort zone and favors those with a consistent operating history. We note that the Macau gaming operators have, over past years, been very focused on their expertise, which is to develop gaming properties in Macau or in Asia. This is not true for others, such as the Genting Group in Malaysia, which have been very aggressive in other industries and other markets. 6. High ‘owner earnings’ and lack of need to reinvest Buffett places significant emphasis on cashflow-generating capability and regards it as the best metric to evaluate the quality of the company. He favors firms that generate high ‘owner earnings’, also known as free cashflow. We share the same view and have been bullish on Macau gaming because of its strong free cashflow-generating capability. We were the first broker to discuss this theme in our ‘Raining cash’ report in September 2011. We expect the sector to deliver US$3-4 billion of free cashflow in 2012-14, representing 4-5% FCF yield. Buffett places huge emphasis on cash earnings generated by companies and gives preference to those where minimal capex is required to maintain competency. Comparing the Macau gaming sector with other sectors in Asia, the capex-to-sales ratio is very low, allowing most of the earnings to flow back to company shareholders. For casino properties that have been completed, maintenance capex required is also minimal. Not until recently have we seen a slight uptick in maintenance capex with high capacity utilization and slightly intensifying competition. But relative to the Ebitda generated by the casino property, maintenance capex required is still minimal. Looking forward to the next round of Macau gaming revenue/Ebitda growth Macau gaming: Free cashflow Source: CLSA Asia-Pacific Markets Source: CLSA Asia-Pacific Markets IN FOCUS