Macau’s high roller market may have reached a crunch moment after more than two years of record growth
Macau’s VIP baccarat revenue grew by 46% year on year in October. It was the 28th straight month of year-on-year VIP GGR growth since the second half of 2009. During that time, high roller baccarat’s contribution has crept up from 64% of Macau gross revenues at the end of 2Q 2009 to 74% at the end of 3Q 2011. It looks like an unstoppable trajectory. And yet rumours of a tightening of the VIP credit market persist inside and outside Macau. Is this anything more than fallout linked to general investor nervousness about the global macroeconomic outlook?
There are certainly people with vested interests in taking a contrarian position on the Macau VIP market—either because they wish to interpose themselves between the investors and the market as experts or consultants with special insight or intelligence to sell; or because they wish to rationalise their own shorting strategy. There are also people with an interest in painting the rosiest possible picture of the Macau VIP market—principally the casinos, the junket investors, junket consolidators and junkets and sub-junkets themselves. The VIP segment did, after all, supply 75% of gross revenue from all games of fortune in October—and gaming provides an estimated 95% of Macau’s total tourism revenues. But neither the doomsayers nor the rose-tinted spectacle merchants necessarily reflect the fundamentals of the Macau VIP business. Given the current global uncertainties, however, perceptions can easily end up creating new market realities.
Market events during October suggest some positive correlation between negative macroeconomic news in China and downward movement in Macau gaming stocks.
Monday 3rd October: The HSBC China Report on Manufacturing—based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 400 of China’s manufacturing companies—issued its September bulletin. It showed China’s manufacturing sector continued to contract for the third straight month in September due to weaker global consumer demand. Macau casino stocks plunged in Hong Kong—outpacing a 4.4% decline in the Hang Seng—reportedly on increasing fears tighter credit will cut off the funds of wealthy gamblers.
Thursday 20th October: Some of the financial media reported that Wynn Resorts missed its third quarter earnings target—though a number of analysts argued that if the hold rate on baccarat in Macau was normalised, the earnings were actually in-line with projections. Macau gaming shares moved downward on the news.
There was also some evidence in October of a positive correlation between good microeconomic news out of Macau and an upward movement in Macau gaming stocks.
Thursday 6th October: The Macau government said gaming revenues grew 39% year-on-year in September. Macau-related gaming stocks all moved higher.
But as November began, there appeared to be a breakdown in the correlation between good microeconomic news from Macau and Macau gaming prices.
Tuesday 1st November: Macau’s Gaming Inspection and Coordination Bureau said GGR grew 42% year-on-year in October to MOP26.9 billion (US$3.4 billion). But Macau casino investors continued to sell off, in tandem with other high-beta, potentially recession-vulnerable names. On the day, LVS was down 3.3%, MGM was down 7.2%, Wynn fell 5.5% and MPEL dropped 9.1%.
It’s too early to say whether this lack of positive correlation between good Macau revenue numbers and Macau gaming share prices is a trend. But it will be of some concern to the industry. It also raises the question of whether there are issues—other than the fact that investors may perceive a strong positive beta value between China’s macroeconomic growth and Macau gaming—that make investors nervous about Macau gaming stocks. It’s certainly true that aside from the headline revenue numbers, it’s not easy to get detailed background information on the mechanics and performance of Macau’s VIP baccarat market. That information is in the hands and heads of a very small number of people. When you invest in a Macau gaming name you have very little background information on how roughly three quarters of the gross revenues of that stock are actually being generated. The junkets don’t tend to share much information with the market because their core business—cross-border currency transfer—is a grey area in China. Those junkets that have opened themselves up to media scrutiny have sometimes been rewarded by lurid headlines about triads. The relationship between the foreign-owned casino operators and the junkets is sensitive. The Western operators aren’t allowed by their home regulators to have a casino within their casino. But some of them do have the same junket partners that got Stanley Ho blacklisted when he went shopping for foreign casino licences. This sensitivity means operators rarely go into much detail about their junket partners in their management analysis.
The suggestion made to IAG is that currently most junkets are working on a profit share model with the Macau operators (also known as revenue share)—with up to 47% of house net win offered to the junket by the most aggressive operator, another 40% going to the government in the form of gaming tax, and the remainder retained by the operator. IAG understands from industry insiders that the big junket consolidators with access to many players and high volumes of roll are all operating profit/revenue share, while the smaller junkets and sub-junkets with smaller numbers of players and lower volumes of roll are all operating on the traditional rolling chip commission model, capped at 1.25%.
The profit/revenue share model is more attractive to the casinos because it frees them of a fixed cost (i.e. rolling chip commission) that doesn’t vary even when the house win rate varies. Although on the face of it profit share looks like a worse deal for the junkets than the rolling chip commission model, it arguably strengthens the market partnership between junket and casino, and reduces the impact of potential competition from existing and planned casino jurisdictions that have lower tax rates.
Credit pullback
One persistent rumour—that might speak to the issue of why investors continued to sell off even with the good October gaming revenue numbers out of Macau—is that a major Macau junket has halved its credit issuance in recent weeks. Even if this were true, no-one seems to be able to offer clarity on whether it’s a function of responsible forward management of risk by a junket operator in uncertain macroeconomic times, or whether it’s a reactive response to non-performance on existing player loans. The two are very different things.
Even assuming for a moment that a junket operator had reduced its debt exposure in response to some non-performing loans, any attempt to extrapolate a trend from a single data point or tiny number of data points (e.g. using individual cases of VIP bad debt among the billions of Hong Kong dollars rolled in the VIP rooms every quarter to create a theory or model for the whole market) looks at best like poor statistical analysis and at worst like an attempt to ‘massage’ opinion regarding market outlook.
Lest we forget, it’s the junkets that are shouldering the VIP credit risk on behalf of the Macau casinos and investors in the first place. Whether the junket is using a revenue share or commission model, it is operating on small margins, needs to maintain cage liquidity and constantly has to guard against the risk of non-performance on its issued credit. With the commission model, the junkets may get to keep as little as 0.35% net commission out of 1.25% rolling chip commission they earn from casinos—with much of the rest being rebated to the junkets’ players to incentivise them to keep playing. Given the slim margins on VIP (albeit high volumes), if a debt or series of debts goes bad it’s not the casino that will go bust—it’s the junket or sub-junket. The junkets aren’t supported and subsidised by the mass-market and other revenue streams such as retail and entertainment in the way that the casinos are.
Might some people have an active interest in talking the Macau VIP market and the general Macau market down—despite its stratospheric growth in recent years? Well, yes they might. The diversified ownership of the casino operating companies in Macau via public offerings means there are investors with competing and sometimes contradictory business strategies.
As one observer of Macau stocks put it to IAG: “You have so many different styles of money invested in these names. Understanding the market would certainly be easier if investors only focused on ‘What is Macau going to look like in five or ten years from now?
“You have so many fast money types—the hedge fund types—that are literally whipping these stocks around day-today; trading on rumours that an obscure Chinese-language tabloid in HK publishes a story that over a recent weekend Macau junket rooms were empty—even though they weren’t—people are going to see that and the rumour mill is going to start whirling. The next thing you know these stocks are down 5% or 10% on the day. These people feast on that. But the same people that might have been selling these names hardcore are then buying them right back—looking to play them up and down every day. That’s just a style of investing.”
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Macau junkets are legally licensed by the Macau government, but they are engaged in at best a grey area of business in China. This is the granting of credit for gambling and the subsequent exporting of Chinese currency—well in excess of the Rmb20,000 per person per trip minimum officially allowed by the Chinese government—in order to cover any losses incurred by players. The fact that nowadays this trade is most likely to be done via methods familiar to financial services companies—such as getting a lien [legally enforceable claim] on a player’s personal assets back in China—rather than the more primitive blue collar methods associated with the Macau junket trade during the STDM monopoly years (such as a home visit by heavies) doesn’t make the process any less opaque.
Let’s assume for a moment that the bears/short-term money people are right to be concerned about the state of VIP credit in Macau. Would we get any advanced warning if there were a disorderly unwinding of VIP credit? A potential canary in the coalmine could be if one of the operators widely rumoured in Macau to be ‘buying’ its VIP business—by offering aggressively high levels of revenue share relative to competitors—has a bad quarter in VIP unrelated to the usual baccarat hold volatility. The assumption behind that thought is that any bad debt registered that quarter would show up in the property’s rolling numbers. That may be a false assumption. There have been rumours in the industry circulating for many months that one of the Macau operators has a packet of bad VIP debt dating back several years that has so far been kept off the operator’s books. Ultimately, it may never rear its ugly head on the operator’s balance sheet. There’s a suggestion in the past few weeks that some form of mutual write downs between the operator and the junkets concerned may serve in effect to cancel out the debt. Presumably the tax on the gross has already been paid to the Macau government even if the junket and casino never collected on the principal loaned.
Essentially, Macau investors and casino operators have a hard choice. They can either have an opaquely-managed junket system with huge volumes of player roll; or they can have a transparently-managed junket system with only direct players, the risk managed by the casinos and much smaller levels of roll. But unless things change rapidly in China regarding cross-border currency management, they can’t have Singapore’s system of high rolling volumes on casino-issued credit.
