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Placing All Bets: And the Winner Is Melco Crown
Posted by: Patricio Kehoe (IP Logged)
Date: February 20, 2014 11:03AM
Operating a casino in China’s Macao market can be highly beneficial, given the limited six licenses available for casinos and resorts. With industry giants like Las Vegas Sands Corp. (LVS) or Wynn Resorts Ltd. (WYNN) running the gambling circuit, it can be tough for a smaller competitor to enter the market and be successful. However, the Hong Kong-based casino operator, Melco Crown Entertainment Ltd. (MPEL), is one of Macao’s six crown jewels and should be one of the most exciting companies for investors looking to gain long term profits. Thus, investment gurus George Soros (Trades, Portfolio) and Andreas Halvorsen (Trades, Portfolio) bought over 300,000 company shares each last quarter.
Melco’s combination of the VIP customer-focused megaresort Altira, the mass market and VIP resort City of Dreams (located on the Cotai Strip), as well as eight other gaming venues have helped this firm grow at high rates over the past few years. Founded by one of the richest men in Asia, Stanley Ho, his son Lawrence Ho now holds the position of CEO of the company. And this family is no stranger to the casino industry, as it has majority or partial ownership of half the operating casinos in Macao (in 2002 it was a monopoly). Furthermore, Ho and co-chairman James Packer each own over 30% of the company, making them the majority shareholders.
However, the Ho family has done an excellent job at expanding its market share, and with the Macau Studio City casino expected to open its doors in 2015 on the Cotai Strip, Melco Crown will benefit from gambling preferences, which have been slowly migrating from the Macao peninsula to the Cotai Strip’s fully integrated resorts. The expected 12% to 15% annual growth for China’s casino industry over the next five years, as well as single-digit supply rate, should additionally benefit this company, allowing for significant boosts in EBITDA, ROIC and free cash flow. Also, with only 2.5% of the Chinese population visiting Macao, the market is vastly underpenetrated, leaving plenty of room for the firm’s future growth.
Valuation and Risks
Melco Crown’s market presence in Macao and the Cotai Strip has earned it an economic moat, mainly due to the high barriers to entry in the limited Chinese gambling market. And financial results over the past year, as well as quarter results, accompany the moat rating. Despite competition from the new Sands Cotai Central opening, the firm’s revenue increased 27% in fourth quarter of fiscal 2013, and 100% in the year-over-year period, amounting to more than $5 billion. Adjusted EBITDA increased a quarterly 49%, driven by the combination of premium mass-marketed gaming revenue and a leveraging in fixed costs. Although revenue growth is expected to slow down in the 10-year forecast period, marking 8.6% average annual increases, the Manila casino opening in the Philippines in 2014 will continue to boost growth.
However, the 65% revenue retrieved from VIP rolling chip customers is susceptible to changes in the Chinese economic market, credit market and interest rates. Also, Melco Crown has not yet reached the scale and strength of its competitors Wynn Resorts and Las Vegas Sands, but I feel bullish that this will change over the next decade. Furthermore, with earnings per share growing at a 75% rate (10 cent boost in one quarter) and 42% returns on invested capital, shareholders would be wise to invest in this casino operator. And although the company is currently trading at a 95% price premium relative to the industry average of 23.0x, I believe Melco Crown will reap nothing but profits in the long-term future.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.
Guru Discussed: Andreas Halvorsen: Current Portfolio, Stock Picks
Stocks Discussed: LVS, WYNN, MPEL,