Inside Asian Gaming

December 2012 | INSIDE ASIAN GAMING 37 peak and there were worries about the company going bankrupt. 10. Current valuation offers margin of safety Buffett also stresses the importance of a margin of safety, which is the discount to fair value that the stock is currently offering. We understand the importance of having a margin of safety and we do not rate a stock a ‘BUY’unless we see more than 20% upside to our fair-value estimate of the stock. Warren Buffett defines fair value as the discounted value of the cash that can be taken out of a business during its remaining life. That is different from our sum-of-the- parts’ valuation methodology, in which we value the existing operations on EV/ Ebitda and add an additional option value for the upcoming Cotai project. Historically, EV/Ebitda is used because the gaming companies incur a large amount of pre- opening cost, non-cash cost (depreciation and amortization) and interest cost which resulted in a low net profit figure. That is no longer true, with most of the casino properties fully ramped up and companies generating strong net profits. We value the Macau gaming companies based on 10-15x EV/Ebitda. We give preference to stocks that have: short-term earnings growth; higher exposure to more defensive mass-market and non-gaming segments; a Cotai or other growth story; and pay dividends. We score the six Macau operators on these metrics, with Sands China earning 14 ticks, Wynn Macau 11 and SJM 11. Even if wewere to abide to free cashflows and dividends that Warren Buffett pays most focus to, Macau is still undervalued with their expected free cashflow yield at 4-5% in sector to have a net debt/(cash) as a share of equity ratio of 1%, with three out of the six Macau gaming operators in a net-cash position. However, the situation only changed recently, with some concerns of bankruptcy particularly at the US parent company level only a few years ago. Las Vegas Sands was badly hit during the financial crisis. In 2008-09, the company had just opened The Venetian Macao and Four Seasons Macao, while Sands Cotai Central and Marina Bay Sands still remained under construction. The earnings base of the company was much smaller then, while net gearing was sky high at 300% in 2007 as project loans were yet to be repaid. With the low income base and the high interest cost, LVS recorded two consecutive years of net losses in 2008-09. The share price of Las Vegas Sands was down 97% from the Asia: Return on equity, 2012 Asia: Net debt/(cash) as a share of equity, 12CL Source: CLSA Asia-Pacific Markets Source: CLSA Asia-Pacific Markets You leave yourself an enormous margin of safety. You build a bridge that 30,000-pound trucks can go across and then you drive 10,000-pound trucks across it. That is the way I like to go across bridges. Warren Buffett IN FOCUS