Description

We’ve seen some pullback in the consumer “crowds and travel” names, prompted by rising COVID-19 cases and hospitalizations in a number of states, most prominently Texas, Arizona, and Florida. Since June 8, when recent highs for the broader market and most of these names were made, casinos are down 10-40%, with Las Vegas Sands (LVS) down somewhere a bit better than average at -20%.

Casinos are joined in their retracement and broader market underperformance by other travel sector and leisure names dependent on crowds to make their money. As examples, see performance from June 8 through June 29 at movie theater Cinemark (CNK -41%), concert sponsor and Ticketmaster owner Live Nation (LYV -22%), cruise line Carnival (CCL -33%), and hotel giant Marriott (MAR -23%).  

These stocks are all “coronavirus risk on/risk off” names, some of which probably got ahead of themselves with the level of speculation in the market, given their popularity with the Robinhood crowd.

But 2021 earnings risk is not equal among this group of risky names, nor are the balance sheets.

At this point, it is pretty clear that the U.S. has botched its pandemic response relative to Europe, and especially relative to Asia. LVS represents a compelling value relative to the rest of this domestic gaming, lodging, and leisure group, and with 90%+ of its value derived from outside the U.S. and instead from Asia, I think its ability to make 2021 estimates is much less of a bimodal bet on the path of the virus trajectory in the U.S. than the rest of the travel and leisure names. If you are looking for a stock that remains substantially depressed off its pre-COVID February highs, LVS is one of the least risky of your options.

LVS at the current quote is about 60% off recent highs, which means that in the case of a quick resolution to the current crisis (vaccine, effective therapy, virus somehow mutates into a less dangerous entity - take your pick of optimistic scenarios), LVS could double. But in the case that none of those things magically happen and we remain:

1.    mired in this current scenario of balancing the needs of public health and the economy for a year or more,

2.    in a situation in which re-openings are sometimes met with walk backs,

I think LVS can still meet current 2021 estimates, which is something that may not be true for its more domestically focused peers. 2021 estimates for most travel and leisure names currently discount a big improvement in the COVID trajectory for 2021. I obviously hope all these companies make their numbers and this thing goes away, but if that is not the case, I think there will be a lot of relative value in LVS.

Pandemic optimists have a chance to double their money here, and pandemic pessimists who are out shorting the AMCs and CCLs of the world might consider LVS as a portfolio hedge.

LVS admittedly doesn’t have the juice of the most financially leveraged names that are wholly dependent on either the U.S. crushing COVID (or the company getting a bailout). Some of those names could in the best-case scenario could be triples, but also could be zeroes in the worst case. I admittedly lean a little to the virus pessimist side, but with a long enough time frame, I think you can double your money here, because LVS has the balance sheet to get through even some pretty bad scenarios.

Company Description

I am not going to get into tremendous detail because this is a huge company with tons of easily accessed public information. This is the world’s largest publicly traded casino operator, and its founder, Sheldon Adelson, is one of the richest men in the world.

Last year, LVS had $13.7 billion in revenues and $4.9 billion in EBITDA, for a 36% EBITDA margin. In the last 10 years, as the company expanded its Asian operations, its EBITDA increased nearly 10x, from $557 million in 2009. Going back to 2007, to remove the impact of the financial crisis, EBITDA was $533 million, so it’s also up almost 10x since then, over 12 years, or a 20% EBITDA CAGR.

From 2007 to 2019, EBITDA margins also doubled from 18% to 36%. The casino business is high capex and high risk, but when companies get it right, build well, don’t suffer regulatory blows or unanticipated increases in competition, it is a super profitable business. And nowhere has the business been more profitable than in Asia, which is why LVS has grown so much and expanded its margins so dramatically. Last year, operations in Macau and Singapore represented 87% of LVS revenue and 91% of EBITDA.

Without getting into a property-by-property history of Macau, suffice to say that LVS opened its first property there in 2007 and has been expanding ever since. That first property, which cost $265 million to build, paid back in just one year. Along the way, they took a chance on opening on the Cotai strip, when it was a fledgling gaming area and as the original Macau gaming district was running out of room for development. LVS helped firmly establish the Cotai strip as a desirable destination and development location within Macau.

Macau does nearly 6x the gaming revenue of Las Vegas, and properties in Macau get almost 90% of their revenue from gaming. In Vegas, properties only do about 35% in gaming, the rest comes from food and beverage, hotel ops, retail, and entertainment. This is one of the reasons margins on casinos in Macau are so much higher than in Vegas.

The average visitor to a Las Vegas casino loses about $150. The average visitor to Macau loses around 9x as much, or approximately $1350. Macau is also a more table-oriented market – slots make up only about 5% of gaming revenue in Macau, whereas slots are 2/3 of Vegas gaming revenue. This reliance on tables is a big part of what brings up gaming revenue/visitor in Macau. The other thing pulling up gaming revenue/visitor is the reliance on high rollers in the market, who account for 55% of Macau gaming revenues. Margins at LVS’s Macau properties are all higher than at its Las Vegas ones, most by several hundred basis points.

As great as the Macau business is, the crown jewel of LVS is really the Marina Bay Sands, one of only two casino resorts in Singapore. In 2006, LVS was granted one of only two available gaming licenses in Singapore. After three and a half years and $5.6 billion in investments, LVS opened the Marina Bay Sands, which immediately because one of the most recognized pieces of architecture on the planet, with its three towers and the highest infinity pool in the world sitting on the top. The property generated $1.5 billion in EBITDA last year and had a 49% EBITDA margin, which is probably the highest margin of any major casino property in the world. LVS is undergoing a $3.3 billion expansion of this property.

Back in Las Vegas, the Venetian and Palazzo remain among the top properties on the Las Vegas Strip in terms of room rates, amenities, and popularity, and are anchored by their sizable on-site convention facilities and north end of strip proximity to the massive Las Vegas Convention center.

Coronavirus Risk

Gaming in Macau was down 60% in the first quarter, with casinos closed from February 5 to 19. Business has been slow to come back, with travel restrictions between mainland China and Macau a constraint. On Friday, June 26, the Macau Chief Executive offered some reason for optimism that the barriers between Macau and Hong Kong and the Guangdong province of China could reduce soon. He said, “Gaming operators have supported us for half a year and have made great contributions to Macau,” he said. “If they can persist, I think good news will come very soon.”

In Singapore, tenant-operated retail and food and beverage facilities began reopening with limits on capacity in mid-June, but the casino and other LVS-owned operations remain closed for now. Singapore has been in Phase 2 of reopening for a couple of weeks now, and if cases stay down, should move to the next Phase soon. LVS management indicated on the first quarter call that there is pent up demand for gaming in Singapore and local clients are calling and asking when they will open. Restrictions on travel from China into Singapore could postpone a recovery in Singapore even after it is open.

Despite cases being much worse in the U.S. than in Singapore, Las Vegas of course opened back up in late May. LVS has cautioned that they expect business to be very bad in the U.S. for some time. While they conveyed confidence that Macau and Singapore could come back strong by later in 2020, they did not think that Las Vegas would be very profitable this year, as communicated on the first quarter call in April.

LVS management has some history to draw on when making these predictions. They have been through other viral epidemics in Asia, and so have their customers. Simply put, this is not the first rodeo for Chinese and other Asians with regards to a novel disease outbreak. Mask culture is well-established not only in China, Hong Kong, and Macau, but other countries in the region that Macau and Singapore draw substantial traffic from, including Japan and South Korea. LVS expressed a lot of confidence that masks and social distancing wouldn’t be incompatible with table play in Asia. They didn’t have the same confidence about Vegas, but at 9% of EBITDA, a bounce back in Vegas profitability isn’t required for the stock to rebound. What is needed is a free flow of people across borders within Asia, and Macau and Singapore fully open with no viral flare ups.

The caution on Las Vegas properties was expressed back in April, before they had reopened and when the Northeast was the center of COVID-19 activity in the U.S. Now that the virus has shifted to the Southwest, Southeast, and Southern California (a huge drive-in source of customers for Vegas), prospects in Vegas may have worsened. Last week’s order requiring masks for casino guests/visitors by Nevada Governor Steve Sisolak (before only employees had to wear masks) is probably a marginal positive for LVS, since it should reduce the chance of casinos becoming a source of outbreaks and also enhance their relative positioning, as the higher end properties owned by LVS and WYNN seemed to be pushing more restrictive mask policies for customers, which possibly put them at a relative disadvantage temporarily to properties that weren’t being as strict.

LVS has an extremely strong balance sheet, especially relative to its peers. LVS ended 2019 with just under $10 billion of debt, right around 2x EBITDA. Leverage will of course increase as EBITDA falls temporarily in 2020 and could be as high as 6x this year’s EBITDA, but should be back under 3x by next year, assuming no future closures in Macau and that Singapore opens and stays open. Competitor WYNN is not expected to be EBITDA positive this year and on next year’s estimates, they would be around 6x leverage. MGM will be around 75x leveraged on this year’s very depressed EBITDA, and on street estimates will still be 10x leveraged at year-end 2021. The domestic-only players that trade in the US are also more leveraged than LVS.

LVS has stated that in a “zero revenue” scenario, which is a risk it has moved past at this point, it could fund up to 18 months of operating expenses plus its maintenance and growth capex.

LVS almost hit the wall in late 2008 and was forced to raise $1 billion at $5.50, when it had traded over $130 the previous fall. The problem then was unfunded near-term growth/construction capex obligations in Macau at the time the debt markets temporarily shut because of the mortgage crisis and its contagion. This time around, even though the crisis was perhaps less predictable, LVS was prepared for a rainy day (or quarters of rainy days).

Given its strong balance sheet, if the return of normal business levels in Asia proves to be more prolonged than expected, they have the liquidity to wait it out. Additionally, they have the financial flexibility and have expressed the willingness to step in and consolidate the industry should competitors with attractive properties in desirable markets experience a liquidity crunch.

This is definitely a management that learned from its prior mistakes.

Concession Risk

All operators in Macau operate under government concessions. The first of these concessions will expire in 2022 for LVS. There was a prior LVS short write up on VIC posted in July 2018 written by jso1123 which discusses this issue and includes the risk disclaimers found in LVS filings. When the author pitched the short, LVS was trading around $73. The author closed their position and recommended the cover at $55.

Unless you think the current pandemic will drag on for years and force multiple short-or longer-term closures lasting meaningful amounts of time, the case for the “lost concession” short should be no more convincing now that it was then, nor should the cover price on this thesis be moved materially down.

This “concessions could be lost” bear thesis has been back in the news recently because Jim Chanos has been talking about it (although has not yet disclosed if he is short LVS or WYNN or both).

I think this a risk that can’t be outright dismissed, but I think it is a remote one, and priced in at these levels (see Valuation section).

One reason people are afraid that LVS will be punished by China in Macau is because of the current trade tensions between the U.S. and China, which have only been exacerbated by the attempts to blame the virus in the U.S. on the Chinese, call it the “Chinese flu” (and much worse) by members of the Federal Government.

I look at the concession risk pretty simply. I think if Biden wins, the trade war goes away, and so does this overhang. I think if Trump wins re-election, Sheldon Adelson is his #1 donor, and Trump will ultimately back off the trade war if it threatens to strip his biggest donor of tens of billions in wealth.  

If Macau is going to be a bargaining chip, the horse-trading surrounding Macau may very well occur and be resolved behind the scenes (and behind closed doors), as threatening to kick out American businesses is really only a card the Chinese can play once.

I view the threat of kicking out LVS, WYNN, and MGM as more of a negotiating tactic than a likely event. While the contracts for the concessions as written would allow it, it would set up a terrible precedent for foreign direct investment in China. Given the billions of dollars invested in completely not portable real property, such a seizure of the business could throttle Western interest in making capital investments in China and its territories for years.

For more discussion of this risk, check out the very thoughtful and comprehensive message board under the short LVS call from July 9, 2018.

I concede that LVS getting kicked of Macau isn’t a 0% risk, but it probably isn’t more than a 10% one either. And in that instance, LVS would still retain about half of its EBITDA before unallocated corporate expenses, thus there is no risk of a $0 here even in the worst-case scenario.

The bigger risk is China turning on and off the spigot of free movement of people and money into the Macau region, for reasons unrelated to public health. Every few years the Chinese government decides to crack down on corruption, and Macau gets caught in the crossfire. Macau definitely is the site of money laundering and currency leakage out of the Mainland. These anti-corruption initiatives come in waves and are usually hard to predict the timing of. Thankfully, they have historically been relatively short-lived, causing Macau casinos to see lower volumes and miss numbers for a series of quarters, but usually not longer than a year or so. Since this is a recovery-driven call as opposed to an environment in which hitting/exceeding short-term numbers is as important of a driver, I think any anti-corruption efforts are unlikely to drive the stock in the intermediate term. I also think the government is unlikely to kick a dog when it’s down and start rattling cages on the regulatory front, given business has been down so much because of the pandemic, and related closures and restrictions on travel.

Valuation

I’m looking forward to 2021 numbers in doing a valuation, since most investors are looking at 2020 as an aberration and a write off. 2020 will likely see EBITDA down around 65-80% (range of outcomes), net income slightly negative, and a few hundred million of cash burn after capex (includes expansion capex). I see EBITDA rebounding to at least $4 billion in 2021. I think by 2022 EBITDA, earnings, and free cash flow should be roughly level with 2019 levels.

LVS has traded at an average of 12x EBITDA. At that valuation, you could see a rebound to $66 off 2022 numbers (includes $3 billion of cash generation between now and 2022). Free cash flow per share would be approximately $2.35, implying a yield of 4%.

Looking forward to 2023 as some new capacity comes on line and capex rolls off, I forecast $5.6 billion in EBITDA and $4.50 in normalized free cash flow (forward free cash flow eliminating expansion capex, which could support a valuation of $90 (5% free cash flow yield/13.5x EBITDA), or $74 today discounted back two years at a 10% discount rate (only discounting back to 2021 since everyone is pricing everything off 2021 now).

In the 10% scenario in which LVS lost all its Macau rights, normalized EBITDA would likely settle out at $2.2 billion, and at a reduced multiple of 10x, the stock would be worth $19, assuming ALL Macau went to $0 in 2023 (they actually wouldn’t lose it all at once).

90% of $70 (average of $66 and $74) + 10% of worst-case target $19 yields a price of $65, almost 50% upside from here.

I have incorporated the worst case here of losing Macau, but not incorporated a number of positive scenarios, such as an accretive acquisition or a quicker resolution of the virus.

Risks:

1.    Second wave of COVID-19 in Macau or Singapore leads to extended closure of properties, delaying recovery in EBITDA and stock.

2.    EBITDA recovery in Macau further delayed by a renewed interest by China in anti-corruption efforts.

3.    Concessions for Macau properties not renewed, commencing 2022 (remote risk).

Catalyst

1. Recovery of operations in Macau and Singapore.

2. Return to pre-pandemic EBITDA (over next 2 years). 

3. Possible accretive M&A.