Inside Asian Gaming

inside asian gaming May 2014 42 is likely to encounter in converting the country’s massive market of pachinko players into slot machine players. Both firms take a top-down approach that looks at GGR in relation to nominal GDP to arrive at estimates of annual revenue in the realm of $16.5 billion to $23.8 billion (Jones) and $21 billion-$22 billion (Choudhary, Poon, Allen). The former’s low-end estimate comes in well below consensus in projecting a combined $10 billion from two casinos in Tokyo, $3.8 billion from a casino in Osaka and as much as $1.8 billion each from casinos in Hokkaido and Kyushu. The Morgan Stanley team qualify their estimate as a best-case scenario, implying they might not disagree with Mr Jones at his most conservative. To quote the basics of their argument for using GDP as an indicator: “The average is about 0.43% in Asia and US gaming markets,” they write. “If we apply this percentage to Japan’s 2013 nominal GDP of US$4.9 trillion, Japan’s GGR would be roughly US$21 billion, only half of the market consensus of US$40 billion. Even more importantly, this could be divided among 10-12 casinos across Japan and thus the Tokyo market’s GGR could be as low as US$5-6 billion (though impressive in the context of Las Vegas/ Singapore, which are US$6-7 billon markets).” They also offer a bottom-up analysis, looking at GGR as a ratio of lottery turnover—a “good indicator of how big the gambling business could be,” they say. “Singapore has the highest GGR to lottery turnover ratio among Asian gaming markets at 3.0. If we apply Singapore’s payout ratio to Japan’s drop of US$11 billion, we come to Japan lottery revenue of US$7.26 billion, implying casino GGR of US$21.8 billion. Considering the lottery business is much closer to mass (but not VIP), a ratio of 1.6x would imply mass revenue of US$12 billion. With a lower VIP revenue mix in Japan due to fewer Chinese players and potentially no junkets, overall GGR could be even lower than US$21.8 billion.” They note that bulls frequently point to the enormity of Japan’s pachinko market (US$36 billion in 2012) as an indicator of revenue potential, but here, too, they take a contrarian view. “[The market] has been declining for the last several years,” they note, citing steadily falling handle dating back to 1996 and, since 2009, a decline in the average number of players per machine. As they see it, both are reflective of declines which they’ve observed in the earnings of Japan’s leisure sector overall over the last several years and the spending power of Japanese consumers. “Secondly, not all pachinko players will transplant to casinos when they open,” they contend. But assuming 20% do, they arrive at a Tokyo slot market worth $1.2 billion based on $5 billion in current pachinko revenue—a market, interestingly enough, that would be smaller than Macau’s ($1.78 billion in 2013). Their conclusion is that companies banking on 20% ROIC in Japan are likely to be disappointed. They base this on three factors: 1) their assumption of a 20% direct tax on gaming revenue, which is not counting corporate tax and additional taxes and fees at the local level that might also apply; 2) the lofty price of entry—operators are talking about investments of $5 billion-$10 billion; and 3) the country’s relatively high construction and labor costs. “Returns of newer casinos have been falling mainly due to rising capex,” they write. “ROIC (EBITDA/invested capital) in the first year have been falling from as high as >100% (Sands Macao in 2004) to the recent 10-15% for Sands Cotai Central in Macau and Solaire in the Philippines (15%). With lower expected unit productivity in Japan, limited VIP/Chinese penetration and high capex, the casinos could generate lower returns.” “Returns of newer casinos have been falling mainly due to rising capex. With lower expected unit productivity in Japan, limited VIP/Chinese penetration and high capex, the casinos could generate lower returns.” Feature Macau’s Sands Cotai Central