Description

Note: Assume currency is USD unless otherwise indicated.

Investment thesis

NagaCorp is a Cambodia casino listed on the Hong Kong Exchange and has a monopoly in Cambodia's capital for the next 22 years.  It trades at 6.5x (current EV) / (2019 EBIT) and a 50% discount to peers.  NagaCorp depends heavily on tourism, which in 2022 was 35% of pre-COVID levels and is rapidly growing since China ended COVID travel restrictions.  Cambodia expects a 100% recovery in total incoming international travel in three years which should increase profits and improve valuation.

Introduction

The thesis is simple, so this writeup is straightforward.  I'll start by describing relevant company background, then move on to why NagaCorp should recover.  I'll finish with why the thesis could go wrong, looking at how the company responded to recessions, debt, new facilities, staff costs and Cambodia.

Company Background

NagaCorp's casino license expires in 2065 and the company has the exclusive right to operate casinos within a 200-km radius of Phnom Penh until 2045.  Phnom Penh is Cambodia's capital, where roughly 10% of the country's population resides and has one of two of the country's major airports.  In 2019, non-gambling revenue was 2% of total revenue, so I'll ignore it for the rest of the report.  NagaCorp breaks gambling revenue into mass market (public floor tables and electronic gaming machines, 23% of rev, 56% of gross profit in 2019) and non-mass market (premium market and referral VIP market, 71% of rev, 41% of gross profit).  In 2022, mass market revenue was down 31% compared to 2019, while non-mass market revenue was down 91%.

Why NagaCorp should recover

The main reason NagaCorp profitability dropped sharply since COVID started is because gambling is only legal in Cambodia for foreign passport holders and tourism dropped from travel restrictions.  Cambodia has since fully resumed activities that were shut down as a result of COVID.

Based on official Cambodia tourism statistics, the graph suggests that this year, total international tourism should regain ~50% of tourists lost between 2019 and 2022 and ~100% in three years.  In the following table, I estimate TEV/EBIT and P/E if NagaCorp can regain 0 - 125% of the difference in tourism between 2019 and 2022:

I assume 2019 margins, which are generally lower as margins fall on higher revenue and I stripped out non-recurring benefits.  Actual 2019 net income was higher than the 100% recovery scenario because of a new tax which I’ll discuss later.

Compared to peers with casinos in Southeast Asia:

Melco and Las Vegas Sands have the highest EV/EBIT values due to their presence in Macao which benefited the earliest from China’s reopening last fall.  Genting Malaysia is the only major casino operator in Malaysia, while Genting Singapore is part of a duopoly in Singapore with Las Vegas Sands.  Bloomberry is a good company, but operates in the Philippines with multiple competitors.

NagaCorp's EV/EBIT is cheaper than all peers by at least 33% and cheaper than the median by 54%.  You could argue that NagaCorp should trade at a discount to peers since Cambodia is a less popular gambling destination and its CEO holds 96% of shares outstanding.  In the company's favor, NagaCorp has a monopoly in its region's capital city and has much lower tax rates of 4-6% vs peers whose tax rates vary from the high teens to high thirties.  Given NagaCorp's cheaper valuation and recovery potential, I'll shift focus to reasons why the company could underperform.

How did NagaCorp do during recessions?

In 2009 revenue fell 18%, EBITDA fell 32% and net income fell 49% from its 2007 peak.  The company was still profitable throughout the GFC for multiple reasons.  NagaCorp cut costs and used its monopoly in Phnom Penh to shut down competing gaming machine stations.  Its costs were also lower because it had negligible debt.  While not enough to make up for lower revenue, gross profit margin increased because lower-margin junkets - salesmen who bring in wealthy customers by offering incentives - fell as a percent of total revenue.

Another factor that helped NagaCorp was that Cambodia saw zero net change in tourist arrivals from 2008-09 compared to a 4% drop in global tourism.  In 2009, China was in much better financial shape than now and stimulated its economy, improving the economies of surrounding regions, including Cambodia.  It's unclear if China or any other country could effectively stimulate if a major recession happens in the next few years.  Debt is also higher, but still much less than all peers.

Turning to the effects of COVID restrictions, NagaCorp was profitable in 2020 and 2022, but unprofitable in 2021.  Given how much people suffered worldwide, I don't expect any country with significant tourism to Cambodia to care about new COVID variants or other diseases.  If the bubonic plague returned, it would probably need to kill a few percent of a country's population before they imposed travel restrictions again.  While a major recession wouldn't reduce tourism as much as COVID in 2021 (97% tourism reduction), it would sharply cut tourism and NagaCorp profit may be low for years.

Debt

NagaCorp has $472M in 7.95% senior notes due 7/6/2024. Debt / EBITDA is 1.9x.  The company issued the notes in 2021 when it was unprofitable and casino sentiment was worse.  Since NagaCorp became profitable again in 2022 and China reduced its travel restrictions, the company's prospects have improved and it should be able to refinance its notes without issue at a lower rate.

New infrastructure

In 2019, the company announced that it would construct Naga 3 - a set of buildings which would expand NagaCorp's gambling facilities, hotel rooms, conference rooms, dining and non-gambling entertainment.  Naga 3 will connect with existing NagaCorp buildings, Naga 1 and 2, and will increase gambling facilities by roughly 100%.  NagaCorp estimates it will finish construction in 2025 September.

Naga 2 took one year to fit-out and reached 75% and 84% average occupancy one and two years after opening, respectively.  If Naga 3 follows the same course, it will start generating revenue in late 2026.  NagaCorp estimates that total build cost will be $3.5B.  The contractor agreed that construction cost would not exceed $3.5B, although I can't see NagaCorp abandoning construction even with severe delays and overruns.  On the positive side, NagaCorp is using the same contractor that completed Naga 1 and 2 and the contractor finished Naga 2 within deadline.

It's unclear if Naga 2 had cost overruns since NagaCorp's CEO paid for all construction expenses and sold Naga 2 to NagaCorp for a predetermined amount of equity.  For Naga 3, NagaCorp and its CEO agreed to evenly split construction costs: $1.75B each.  The CEO agreed to sell his half of Naga 3 when completed for 1.15B shares (26% of 2022 year-end shares outstanding) at 12 HKD / share, a 29% premium over the last traded price when he signed the contract.  In case of overruns, the CEO agreed to pay for all overruns and will not receive additional shares.  Note however that the CEO owns 96% of shares outstanding - if he wants to renegotiate the payment terms, he'll renegotiate them.  NagaCorp also increased shares outstanding by 10% in 2013 and 8% in 2016 without good reason.  It's questionable whether NagaCorp would have diluted shares if it weren't building Naga 2.

NagaCorp will directly spend at least $1.75B in construction costs.  In 2021, it issued $550M in senior notes at 7.95% due 2024-07-26.  $472M remain after partial repayment.  Given the current $3.4B market capitalization and $3.7B TEV, TEV will increase 57% to $5.8B after share count increases 26% and the company raises an additional $1.2B debt ($1.75B - $550M).  Putting aside how the company raises $1.2B, interest payments, and a minimum three year wait before Naga 3 generates revenue, if NagaCorp can increase TEV by 57% to increase profit by 100%, then finishing Naga 3 works out from an investment perspective.  It's uncertain whether profit can really increase 100%, how much NagaCorp will further dilute stock or raise debt to indirectly fund costs and how quickly Naga 3 can generate meaningful revenue.  There are too many uncertainties, so I assume that Naga 3 has net zero effect and left Naga 3 out of the valuation.

Staff Costs

While 403K international tourists reached Cambodia in January 2023 and Cambodia is on track for 4M annual visitors, 2023Q1 gross gaming revenue only increased 6% year-over-year while EBITDA fell 3%.  NagaCorp cites "luck factor" where revenue varies due to the probabilistic nature of gambling and higher staff costs, but does not break out staff costs.  As no item in the income statement perfectly matches staff costs, I increased "Cost of sales" by 10%, which changed TEV/EBIT on 75% travel recovery from 8.1x to 9.6x and 100% travel recovery from 6.5x to 7.7x.  The lower EBIT isn't ideal, but it's not low enough to break the thesis, especially when peers should also have higher costs.  What real impact staff costs have on margins and whether staff costs will remain high and go higher are serious issues that investors need to watch closely.

Cambodia

The IMF estimates that Cambodia will grow 6.2% this year from growing tourism and supportive policies.  Cambodia is also more stable than many would assume.  According to the World Bank, political stability in 2021 was -0.13 on a scale of -2.5 (weak) to +2.5 (strong).  To put Cambodia's score in perspective, The United States scored 0.00.  An improving economy should improve stability, so I expect Cambodia to stay the same or improve in the next few years.

There are some Cambodians who hate casinos.  I don't know if they're typical of the average Cambodian.  In any case, NagaCorp has good relations with the local government and plays an important role in tourism, so the company should be fine in the near term.

In 2021, Cambodia began taxing VIP gaming revenue at 4% and mass-market at 7%.  Cambodia's tax rates are much lower than other Southeast Asian countries. On the low end, Singapore has a minimum 14% tax on premium and 24% on non-premium player revenue where tax rates increase with increasing company revenue.  On the high end, Macau has a 39% tax on gaming revenue and a 5% tax on the commissions that casino operators pay to junkets.  While Cambodia could raise taxes in future, tax rates should be steady for a few years given that Cambodia just raised taxes two years ago and new laws take years to pass and implement.

Catalyst

Tourism and profitability keep improving