Description

Investment Thesis – Wynn Macau (SEHK: 1128)

Recommend Wynn Macau as a short, as we see risks of further 25-30% declines for several reasons outlined below. The key thesis is that the revenue model is challenged due to i) chinese anti-corruption crackdown continuing, ii) upcoming big supply/competition, iii) costs escalating impacting margins/ROIC and iv) leverage. While it is no secret that Macau has problems, upcoming supply and continued regulatory risks mean at current valuations, stock are expensive as top-line is challenged, operating expenses rise (supply) and estimates are continued to be lowered. If the anti-corruption campaign is reversed, this would be a stock to own, but persistent regulatory risks currently pose a concern to the revenue model.

• Anti-corruption campaign unleased by China a tsunami event for Macau “revenue model” 

• Macau casinos enjoyed a golden period historically, but a tsunami event of a relentless, far-reaching anti-corruption campaign in China post President Xi-Jinping was a game changer. VIC US readers not familiar with this campaign can get a quick summary here: https://en.wikipedia.org/wiki/Anti-corruption_campaign_in_China 
• Upon taking office, Xi vowed to crack down on "tigers and flies", that is, high-level officials and civil servants alike. Wang Qishan, a no-nonsense man was anointed czar of anti-corruption. Economist article: “The Devil or Mr. Wang” link here: http://www.economist.com/news/china/21647295-chinas-second-most-powerful-leader-admired-and-feared-devil-or-mr-wang 
• Corrupt government and SOE officials had used Macau casinos amongst other venues to siphon assets out of country through the junket (middle men financiers) system. Unfortunately for Macau casinos, China has “zero” incentive – it’s a lose-lose, and therefore the whip was cracked down – Macau was at the mercy of this wide-reaching campaign.
• Long-time VIC member, mitc567 wrote an excellent note in 2012 on this theme. 3 years out – this campaign proved to be not just vendetta – but a tsunami event for Macau casinos. 
• The VIP driven revenue broken model had broken down like a house of cards.VIP and mass gaming revenue is ~50% and 30% off from the peaks reached in June 2014 and Oct 2014 respectively. 
• A important distinction between Macau and Las Vegas is “money flow” and the use of junkets. Junkets facilitate Chinese VIP customers taking money out of China. 
• There have been several regulatory crackdowns on this money flow. For instance:
  • Junket operators (middle-men financiers): On 22 Oct, just this week, Gaming Inspection and Coordination Bureau (DICJ) held a call with industry participants to refine regulations on the accounting and controls of junket operations. Link: http://www.gcs.gov.mo/showNews.php?DataUcn=93591&PageLang=C.
    • Three new directives discussed: i) starting in 2016, junket operators are required to maintain monthly financial records, which are subject to DICJ review upon request at any time. ii) Junket operators are required to provide background information of their senior accounting and finance staff. iii) Junket operators are to maintain financial records physically in Macau, subject to DICJ review upon request at any time. 
    • For VIC readers, not familiar with the “tsunami” impacting the junkets (middle-men financiers), below a few interesting articles to start: 
      
      • https://www.ggrasia.com/macau-junkets-face-tougher-accounting-rules-from-2016/
      • http://edition.cnn.com/2015/09/30/asia/macau-junket-missing-millions/
      • http://www.ggrasia.com/investor-claims-in-dore-junket-case-up-to-us57-mln/ 
      • http://www.cardplayer.com/poker-news/19409-junket-operator-says-conditions-in-macau-could-worsen 
      • http://www.wsj.com/articles/junkets-that-fuel-macau-casinos-are-on-a-losing-streak-1411698784 
    • Several experienced sources in the junket industry do not see any signs of Beijing easing its “strangulation” of Macau anytime soon. “They just don’t care about us,” he said. “We can disappear and no one will shed a tear in Beijing”. 
    • Recent casualties, on September 10, Dore, the biggest VIP room operator at Wynn, and the well-known flagship room of Charles Heung Wah-keung, found a hole in accounts that could be anywhere from a few hundred million HK dollars to a few billion. 
  • UnionPay annual cap - Chinese debit card users can only withdraw cash up to Rmb100,000 per card annually overseas (no restriction previously) from Jan 1, 2016. This is negative for premium mass players who withdraw cash from ATM machines to buy chips from cage or tables and were frequent visitors (>10 overnight days in Macau per year). Chinese government stance towards the sector has not changed with the recent raid on 5 pawnshops in Macau. 
  • Transit visas - Increased scrutiny on transit visas at Chinese immigration checkpoints of persons seeking to travel to Macau Implementation of full smoking ban on mass and premium mass gaming floors
  • US-China Economic and Security Review Commission - This is a congressional commission of the US government which is responsible for investigating national security and trade issues between the US and China.  Below some links that highlight how the US regulators think about Macau money flows and triads. This is important for US companies with operations in Macau.
    
    • AG Burnett, Chairman Nevada State Gaming Control Board: http://www.uscc.gov/sites/default/files/A.G.%20Burnett%20Testimony.pdf 
    • Money Laundering in Macau and Implications for the US: http://www.uscc.gov/sites/default/files/JAMES%20H.%20FREIS%20Testimony_0.pdf 
    • Macau and China’s Gambling Problem: http://www.uscc.gov/sites/default/files/I%20Nelson%20Rose%20Testimony.pdf 
    • Money Laundering in Macau: http://origin.www.uscc.gov/sites/default/files/Annual_Report/Chapters/Chapter%203%3B%20Section%203%20Macau%20and%20Hong%20Kong.pdf (this is a good summary on the AML techniques using junket/casino system by the USCC) 
  • SVA, a recognized expert on Macau (former Hong Kong police – Criminal Intelligence Bureau) has written a few interesting articles on this theme and the sector. For interested VIC readers, below some interesting links: 
    
    • http://stevevickersassociates.com/media/category/articles/chinas-gamblers-flee-overseas/
    • http://stevevickersassociates.com/media/category/articles/national-interest-could-add-competition-in-macau-sva/ 
    • http://stevevickersassociates.com/media/category/articles/door-is-about-to-slam-shut-on-high-rolling-holidays-to-macau/
    • http://stevevickersassociates.com/media/category/articles/the-games-up-for-macau-money-funnel
    • http://stevevickersassociates.com/news/macau-politics-junkets-triads/
  • Therefore, the problem is that while the bad news is in the press and not a secret – VIP customers, premium mass customers and junket financiers (middle-men financiers) and shadow banking channels have broken down

• VIP-focused casino in Macau – Wynn Macau is vulnerable 
  
  • The issue for Wynn is that it nearly 60% of revenue and an estimated 45-50% of EBITDA generated from VIP customers. 
  • Furthermore, Wynn Macau has significant exposure to “premium mass” customers which account for 60% of mass gaming volume since 2012. The line between VIP and premium mass is increasingly blurry in the current environment.
  • Although we recognize Wynn's brand targeting the high-end gaming segment, its dependence on VIP play at the current time is a problem in the current weak gaming environment. 
• Imminent over supply but where will “new demand” come from? 
  
  • 5 more mega casinos slated to be opened over next 2-3 years. The problem for Wynn Macau is that the $4bn investment for Wynn Palace (slated to open 1H 2016) new supply was planned when “times were good”
  • Unfortunately, supply does not lead to new “demand” i.e. incremental GGR. In the past, there was an imbalance between supply and demand – as the anti-corruption campaign didn’t exist. 
  • So far, Galaxy’s new property opening has not had a impact in generating incremental demand and all eyes are on Studio City. 
  • Although there is no doubt that Wynn Palace will be a new landmark property in Macau, being one of several to add capacity in a market that has changed means significantly lower returns on unlevered equity in the new environment
  • Moreover, the added uncertainties on table allocations for Wynn Palace mean revenue will be challenged, while operating expenses remain high therefore the risk of margin dilution and cost pressure in a declining revenue environment. 
  • Until now, Mr. Wynn does not know how many tables they are going to get for Wynn Palace. As such, it is hard for them to pre-plan their hiring process, especially for croupiers. What is more definitive from the call is that Wynn Macau will move over 2,000 staff at Penninsula to Cotai March 2016
  • Interesting Bloomberg article: http://www.bloomberg.com/news/articles/2015-10-21/steve-wynn-is-overplaying-his-hand-in-macau-david-fickling
  • Why is more table allocation important to Wynn ? One of the major impediment to Wynn Macau growth in the good old days is the lack of hotel rooms and table. Of course, everyone hopes to get more than their competitors but that is not going to happen.
  • Many countries including the Philippines, Australia and Cambodia are ramping up their facilities and products to bring more Chinese VIP visitors through Macau junkets. Our conversations with industry experts suggest junket operators that survive will continue to diversify towards other countries

• Gearing and dividends is an issue for Wynn
• Gearing is an issue for Wynn Macau with over HK$15bn in net debt. There has been talk that it could breach debt covenants by end of the year as it piles up more debt for Cotai property. 
• Wynn can avoid breaching debt covenants in two ways: “Hope” that GGR will recover and boost its EBITDA in the coming quarters. Raise more equity to boost its cash holdings and reducing net debt. 
• Unlikely, no dividend payment for a long time upon the completion of Wynn Palace March next year as Wynn Macau piles up debt on its balance sheet. 

• Valuation: Expensive stock with revenue model challenged and costs rising
  
  • Even though, the stock has fallen since peak in 2015, it still trades at between 25-28x PE based on our 2015E and 2016E earnings estimates. We expect a further 25-30% downside as there are few issues. First, the Revenue model – VIP will decline further in 2H15 due to junkets closing down and customers in hibernation. Second, earnings risk - Apart from negative operating leverage, fixed and rising staff cost, and rising promotional allowance, additional cost of Phase 2 will push the overall returns on equity and margins down. Third, Wynn Macau faces multiple contraction risk – although Macau stocks have fallen hard, they are still expensive  given near-term growth prospects, leverage, competition, no support from dividend, and negative earnings revisions. 

Risks to thesis

• Chinese anti-corruption bet off and faster than expected recovery on VIP segment
• Wynn palace successful with larger than expected table slots
• Sell side who was bullish early this year has begun downgrading the stock. 

Other Macau related links: 

www.macaugamingwatch.com

www.cotailanddeal.com

Disclaimer: The write up is not investment advice or a recommendation or solicitation for any fund or to buy or sell any securities now or at any time. The author and related persons may hold a position and make no representation that it will continue to hold long or short positions in the securities and disclaims any obligation to notify the market of any changes. The author and related persons may change its views about or its investment positions at any time, for any reason or no reason. This includes buying, selling, covering or otherwise changing the form or substance of its investment. The author disclaims any obligation to notify the market of any change. The information and analysis presented is based on publicly available information through filings, sell-side research, industry analysts and/or company or otherwise sourced. The author recognizes that there may be non-public information in the possession of the company or others that could lead the company or others to disagree with the author's analyses, conclusions and opinions. Any forecasts or estimates should not be relied upon (not the least due to the disclosure) and could turn out to be incorrect. While the author has tried to present the facts it believes are accurate, the author makes no representation or warranty, express or implied, as to the accuracy or completeness of the write up, and expressly disclaims any liability relating to the write up or such communications (or any inaccuracies or omissions therein). Thus one should conduct their own independent analysis before independently considering a position in securities. Except where otherwise indicated, the write up speaks as of the date, and the author undertakes no obligation to correct, update or revise the write up or to otherwise provide any additional materials.

Catalyst

Regulatory risks, Chinese anti-corruption not slowing down, leverage, supply/competition.