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The tiny Chinese enclave of Macau is the largest gambling region in the world, accounting for more than six times the gaming revenue of the Las Vegas Strip. Over the past decade it's gone from a seedy mob-infested region to a glitzy entertainment capital. But beneath the shining lights, there's a secret world of money laundering.
The downside of wealth in China
China is notoriously controlling over its currency; for example, citizens are allowed to take only $50,000 outside the country every year. For people looking to buy real estate overseas or even emigrate from China, that's not a lot of money, so they need to find other ways to get money out. The result is money laundering, and it's big business in Macau. The 2013 International Narcotics Control Report highlights that the gaming industry is highly dependent on loosely regulated gaming promoters and collaborators, known as junket operators, which allow for anonymity and create vulnerabilities for money laundering. The Macau government has indicated that the gaming industry is one of the primary sources of laundered funds in the region.
In Macau, the very setup of gambling has made money laundering extremely easy. Gamblers borrow renminbi, China's currency, from a junket in Mainland China, and the junket gets chips from Macau casinos for the player to gamble with. Once the chips are played, the winnings are paid out in Macanese patacas, not the renminbi the player borrowed. A quick trip to a jewelry store, a pawn shop, or Hong Kong, and the money can be transferred into Hong Kong dollars and leave Macau.
No one knows how often this happens or how big the market is, but it's estimated to be in the billions of dollars. Why would casinos need junkets at all if it weren't for money laundering? In the rest of the world, casinos will lend money directly to a player, giving discounts or other benefits, instead of paying a junket a percentage of gaming revenue to bring in players.
Picking off easy targets
Chinese and Hong Kong law-enforcement officials have had a hard time bringing cases against major players, but there have been some recent convictions. Reuters recently reported the story of the conviction of Luo Juncheng, a 19-year-old high school dropout who opened a bank account in Hong Kong and began laundering money. Eight months later, he had moved $1.7 billion through, with 5,000 deposits and 3,500 withdrawals.
Reuters also tells the story of Lam Mei-Ling, an illiterate 61-year-old who suddenly began moving money through Hong Kong banks in 2002. By 2005, she had moved $876 million through the region, and she also ended up in jail.
These are two low-level players in a vast money-laundering scheme. Advocacy organization Global Financial Integrity estimates that $2.83 trillion flowed out of China illegally from 2005 to 2011, and most of it went through Hong Kong, in Macau's backyard.
Even the U.S. Department of State has taken notice, calling for "robust oversight of junket operators, mandating due diligence over non-regulated gaming collaborators, and implementing cross-border currency reporting."
Casinos play dumb
Don't tell casino owners or Macau officials there's money laundering, because they don't want to hear it. Well-known CEOs, including Steve Wynn of Wynn Resortsand Sheldon Adelson of Las Vegas Sands (NYSE: LVS ) , have denied for years that money laundering is a problem.
But there's still evidence that it exists, even if authorities don't push hard for information. MGM Resorts (NYSE: MGM ) was forced to divest its New Jersey properties because of the company's relationship with Pansy Ho, whose father had ties to triads in Macau. Las Vegas Sands is under investigation by the U.S. attorney's office for possibly violating money laundering laws in Macau last year.
As gaming expands in Asia, the illegal flow of money is a huge concern for officials elsewhere as well. Melco Crown (NASDAQ: MPEL ) will soon open a resort in the Philippines, and the country recently increased anti-money-laundering laws just as gaming expands. Interestingly, it left casinos out of tougher regulations, hoping to capture gaming dollars going to Macau and Singapore right now.
Big money in turning a blind eye
The tie between Macau and Hong Kong makes it a prime location for laundering money out of China, whether it was earned legally or illegally. With China's economy growing like crazy and some wealthy citizens looking to get money out of the country, it's a perfect point of exit. The big question for investors is whether to turn a blind eye to money laundering and its importance to casino's profits in the region. With such a large amount of these casinos' valuation dependent on increasing revenues in Macau, is that a risk worth holding on to in your portfolio?
How big can Macau get?
The crackdown on junkets was one of the top three risk factors I pointed out in our premium report on Las Vegas Sands, in which you'll learn about all the opportunities and risks facing the company. We're providing a full year of analyst updates to go with it, so make sure to claim your copy today by clicking here.