Macau has a strange relationship with Mainland China, falling under Chinese rule in some ways but playing by its own rules in others. The special rules are the reason it's the only place in China where gambling is legal, and it's why there's periodically tension between the two regions trying to regulate gaming revenue.
For investors, this is probably the biggest risk facing their investment in Macau gaming. China can limit travel to Macau and gambling at Las Vegas Sands (NYSE: LVS ) , Wynn Resorts (NASDAQ: WYNN ) , Melco Crown (NASDAQ: MPEL ) , and MGM Resorts (NYSE: MGM ) casinos. All of those companies, except MGM, generate most of their revenue in Macau, counting on the region for growth, so this is a big deal for investors.
China limits low-end travel
China recently put a ban on "zero-fare" package trips, which reportedly resulted in a 20% to 30% decline in such trips over the high-traffic Golden Week. But Macau appears to be faring well despite the ban, with overall visits up 4.7% from a year ago. Early estimates have also put gaming growth at 14% to 17%, which would be in line with Macau's growth of 16.7% for the first nine months of the year.
This isn't the first time the government of China has attempted to slow growth in Macau. From 2008 to 2010, the government limited visas to Macau in an effort to curb gambling growth there. The affect was a sharp decline in revenue in 2010, which rebounded once the limits were lifted.
So far, it appears that travel package bans have had little effect, but if this is a sign that China wants to slow Macau's growth, it would likely be a huge hit to gaming stocks, which are trading at a premium right now.
We usually look at enterprise value/EBITDA as a good metric of value, and I consider a reasonable long-term EV/EBITDA range of eight to 10 times a normal range. Melco Crown has growth options, but at an EV/EBITDA value of 17.4 right now it's priced for perfection. Las Vegas Sands has a huge exposure to Macau and a 15.7 multiple, while Wynn Resorts trades at 12.2 times EBITDA, lower than competitors, but it also has slower growth. Even MGM Resorts' 10.8 EV/EBITDA multiple is steep considering the slow growth in Las Vegas, where the company gets most of its revenue.
The biggest risk facing gaming in Macau
When you're looking at investing in Macau, the biggest risk isn't competition or poor execution, it's regulatory risk. Gaming in Macau has generated $42.8 billion in revenue over the past year, which is about 0.5% of the entire economy of China ,and gaming is growing at more than twice the rate of the Chinese economy. How long will China allow that kind of growth?
It's also a well-known secret that Macau is a big money laundering hub for wealthy Chinese looking to get currency out of the country. The new Chinese leadership has talked about cutting down on money exiting China in the past, which would also pose a risk to Macau's gaming. So far, none of these risks have hit gaming stocks, but they're something to be aware of.
Foolish bottom line
We tend to focus on the positive news coming out of Macau, and for good reason. But investors also need to understand the risks. As Macau grows, it will get more scrutiny from the Chinese Mainland, which may want to slow growth in the region. This is the biggest risk for gaming companies, and we need to watch out for new regulations now and in the future.
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