When “Sin” Pays: Going All-in With the Gaming Industry

When most Americans think of gambling, they think Las Vegas, but the Sin City's take is dwarfed by Macau, which pulled in $44 billion in gaming revenue in 2014. SJM Holdings is currently the dominant force there, but other players have been gaining ground, including U.S. casino operators such as Las Vegas Sands (LVS -0.37%), MGM Resorts (MGM -0.33%), and Wynn Resorts (WYNN -1.78%).

The face of Macau is changing rapidly however, as regulations regarding VIP players change and companies race to complete higher-margin mass market resorts. Join us to find out which major American corporation is best positioned to cash in on Macau and other international opportunities.

A full transcript follows the video.

Sean O'Reilly: We are going all-in. This is the consumer goods edition of Industry Focus.

[INTRO]

Greetings Fools, I am Sean O'Reilly here with the one and only Vincent Shen. How are you today?

Vincent Shen: I'm well, how are you?

O'Reilly: Not too shabby. Thank you for joining us, to our listeners. We are joining you live from Fool Headquarters in Alexandria, Virginia. I thought it would be in the 65s this week, but I'm getting disappointed. What are you going to do?

Vince and I are going to be continuing with our "sin stock" series, and today we're talking about casinos.

Shen: That's right, the gaming industry. Very interesting industry.

O'Reilly: When was the last time you were at a casino, Vince?

Shen: That's a good question. Probably when I was in New Orleans, a few years ago.

O'Reilly: Years? Oh, man. Are you sure you're not lying, because your girlfriend or your mother might be listening?

Shen: No, I'm not a huge gambler.

O'Reilly: Okay, that's fair. First and foremost, everybody obviously knows about Atlantic City here, and Las Vegas, and Macau overseas and everything, but just give me a breakdown of the gambling industry, how big it is, and what we're basically going to be talking about. Then we can get a little bit more specific.

Shen: Sure. It's a big industry, for sure. Originally, when I first started looking into this -- when I thought of gambling I always considered Las Vegas to be the hub. Over time, you quickly realize, especially with the explosion of Macau in the past 10 years ...

O'Reilly: It used to be.

Shen: Exactly, it used to be. But before the recent slowdown, the revenue growth per year in Macau was equal to pretty much the entire take of the Las Vegas Strip.

O'Reilly: Every year it was going up the amount of Las Vegas' gaming revenue.

Shen: For the Strip, exactly.

O'Reilly: That's actually crazy. I did not know that.

Shen: Just for some context here, the Strip pulls in about $6.5 billion per year for their gaming revenue. In comparison, Macau for 2014 had about $44 billion.

O'Reilly: Wow. Who's bringing in all of that money?

Shen: In terms of the different casino operators, in Macau when they ended the state monopoly on the gaming industry there, there were about six players that jumped in. They include Galaxy Entertainment, Melco Crown (MLCO 1.13%), Sands China, SJM Holdings. Those are the biggest players in the city now.

O'Reilly: Who's the biggest operator in Macau, do you know?

Shen: It's SJM.

O'Reilly: Got it.

Shen: But it's very close. The other operators, like Galaxy Entertainment and Sands China, have been pushing for their integrated resorts, and that's eaten away a lot at SJM Holdings' former monopoly.

O'Reilly: Poor them!

Shen: They've been losing market share over the years, and the other operators are all pretty close now.

O'Reilly: Here in the United States, stateside, we're all used to these names -- Las Vegas Sands, MGM, Wynn, all that stuff -- but it amazes me how big Macau is for these companies. It's bigger than their entire state operations.

Shen: Yes, exactly. In the States, too, there are also some of the regional markets. Las Vegas Strip is obviously the biggest, but then you also have Atlantic City, about $3 billion in revenue ...

O'Reilly: We're building one here in D.C., right across the river.

Shen: Yes. You have Philadelphia, you have New York, New Orleans, but the size and the scope for Macau is pretty extraordinary, especially the growth that they're going through in terms of the new resort openings going on later this year.

O'Reilly: What's been going on in Macau? As I'm sure we've all been hearing recently, it's kind of slowing down for a certain reason.

Shen: Yes, that's what they're grappling with right now. A bunch of different factors are weighing in, especially on what was previously their main focus, which is their VIP players.

O'Reilly: These are people that come in, couple million dollars, sit down ...

Shen: These are the people who get to Macau, flying on their private helicopters, yes.

The issue is that the Chinese government has really been cracking down on some of these more extravagant displays of wealth and some of the junket operators that bring these high net worth VIP players into the area. As a result, that's why for nine straight months now, Macau has seen falling gaming revenues.

O'Reilly: Yes, I came across this note in Wynn Resorts. They actually just came out a couple of days ago with their full year fiscal 2014 operations. They noted for their Macau operations, "In the fourth quarter 2014, net revenues were $761 million, down 32% from $1.1 billion in the fourth quarter of 2013."

This is a 32% drop in gaming revenues in their most important region. I'm not saying they're in trouble. They're obviously still profitable there, and it's still a very big part of that business, but that's a lot of money.

Shen: The thing about the first half of this year especially is, in terms of the year over year comparisons, most of these operators are still going to be struggling significantly because the second quarter of 2014 last year was pretty much their record quarter, with the Lunar New Year.

Now you're coming up on these quarterly comparisons, so it's going to be very difficult until the latter half of this year, when year over year comparisons even out a bit due to the slowdown that took place during the latter half of 2014.

O'Reilly: The other thing that I wanted to highlight for our listeners, because we are all Fools and we try to "help the world invest better," is the old days 20-30 years ago, of just having a casino hotel -- you had a big casino on the first floor, hotel upstairs, that was it, you made your money -- those days are kind of gone. There are really two ways to make money these days.

Shen: This is something that's really coming through in the way they're building the resorts in Macau, where they're integrating large dining and shopping experiences, but also in Vegas where they're having record numbers of visitors, but falling gaming revenues.

O'Reilly: Everybody's going to see Celine Dion and Penn and Teller!

Shen: You're kind of hitting the nail on the head there, because the non-gaming revenue is not driving the growth now. It's the convention space, and also other non-gaming activities. A lot of the resorts and the hotels especially are raising their rates for their rooms.

O'Reilly: In order to compensate.

Shen: That's the biggest driver of profits for them right now, for growth.

O'Reilly: We'll talk about the more specific financials of these companies in a minute, but Las Vegas Sands, run by CEO Sheldon Adelson, one of the big reasons they've been so successful over the last 10 years is because they have the biggest convention center space in Las Vegas. They have like 2 million square feet of just space, to use for these conventions and everything.

Then of course that filters through to their hotels and the casinos, and then it's kind of "game over." If you're looking for high-volume traffic, that's the way to do it.

Shen: Exactly, especially in Vegas.

O'Reilly: The other way, of course, to make money is to get the VIPs in, as you were talking about. Really, the king of doing that is Steve Wynn. He's very, very good at getting people to drop a couple million dollars at the baccarat table!

Shen: I want to go back to that in Macau. They're seeing the struggling VIP segment. There are about eight new resorts coming in the next two years in Macau, most of them on the Cotai Strip. In addition to that, most of the operators are building these new resorts to cater to the mass market segment.

O'Reilly: The word "oversaturation" pops into my head there, but can we just give, real quick for our listeners, an overview of the geography over there? You've got Macau, you've got the Cotai Strip, and it's very close to Hong Kong. How does that work, with the bridge and everything?

Shen: One of the interesting projects they're working on right now is the highway from the city to the Hong Kong International Airport, but really the Cotai Strip, they're building it to kind of resemble the Las Vegas Strip, essentially. That's where a lot of the new development is.

The reason why they're pushing for mass market, it's where they're seeing most of the growth in the past few years, especially since the VIPs are taking a hit -- but also, the margins are very beneficial. Mass market table games see about three times the margins as their VIP tables, so it's obviously a huge incentive for them.

Another thing that the operators are doing with the resorts is they need places for people to stay. On the supply side, in terms of rooms, they're pretty much filled. They're occupied.

O'Reilly: Macau is full up!

Shen: For these operators, whoever is able to get their new resorts open first, benefit, because they should be able to fill the rooms and then let the shopping and the dining and the gambling ensue after that, and be able to recover some of the financials that they've lost recently.

O'Reilly: What do we think about these major players, the Melco Crowns, the Wynn Resorts, the Las Vegas Sands? What do we think about them financially, and how their operations are running? Who's your favorite? Who do you think is struggling?

Shen: I think Las Vegas Sands is an interesting place because they their big resort ...

O'Reilly: The best balance sheet? No, I'm just kidding!

Shen: They have the Parisian Macau opening. It was supposed to open in the second half of this year. There have been some delays due to permits.

Another interesting thing around the development is that, eight new resorts opening, they estimate that's going to require, in terms of employees, construction, 50,000 workers, and they've also run into supply side constraints with workers as well.

O'Reilly: Wow.

Shen: They've also had some permit delays. That's what Las Vegas Sands has experienced. Now the resort is forecast to open early next year -- adds 3,000 rooms.

But another thing that they have that benefits them is they have the dominant mass market position which seems to be, going forward, probably one of the better avenues for growth for them. They also have a really good valuation. They're cheap, compared to their peers -- the cheapest, really.

O'Reilly: And they're the most financially healthy. They've got $22 billion in assets, $14.8 billion in liabilities, they make well over $2 billion a year. It's not contest between them and a Wynn or an MGM Resorts.

MGM has $26 billion in assets, $19 billion in liabilities and they were break-even on a GAAP basis last year. They lost $149 million.

Wynn, it's very deceptive because you look at their return on equity and it looks awesome, but they've got $9 billion in assets, $8.8 in liabilities. They make $700 million a year, but they're supporting this huge balance sheet. It's kind of no contest.

Shen: Yes. The Sands also, they have their Singapore operation too, to diversify away from the region a little bit. I think it's about a quarter of their top line now. I'd say that's the clear winner for me.

O'Reilly: Which of these companies has the best foothold in Singapore? I know we haven't been talking about that a lot, and I do want to talk about the future of gaming before we go.

Shen: When I was there, when you look at the skyline you cannot help ...

O'Reilly: ... but see a ton of casinos!

Shen: ... but notice the Marina Bay Sands. It's a much smaller market. For 2014 I think it was about $2 billion -- like an Atlantic City, in terms of size, but ...

O'Reilly: It's definitely there, it's profitable, it's growing.

Shen: Yes. The Marina Bay Sands really stands out.

O'Reilly: Awesome. Before we go, I did want to talk about the future of casinos. Neither of us really knows what's going to happen with this, but I did want to talk about Japan.

Shen: Yes. There's a very interesting situation now with the legislation being proposed, but also a bit of an uncertain political environment. Currently, casinos cannot be operated in Japan.

O'Reilly: This is a fairly large country, a little over 100 million people.

Shen: Exactly. A lot of analysts are estimating that if it goes through and they're able to start opening casinos there, it will be the third biggest market, after Macau and then Las Vegas.

O'Reilly: That's actually crazy, to think about that. I love the quote Sheldon Adelson, the CEO of Las Vegas Sands, came out and said if it got legalized, he would be willing to spend $10 billion to get in there. He would spend that much money to get into Japan.

Shen: To give you some context there for that, that is a fantastic number because the biggest and most expensive resort that's opening up in Macau next year, I believe, is from Wynn and that's a $4 billion project, and it's massive.

O'Reilly: He's willing to go all-in on Japan.

Shen: $10 billion is definitely impressive.

O'Reilly: Boy, so someday we might be seeing a Sands Tokyo.

Shen: That's right, potentially. But keep in mind it's something that's going through the political process, so it's uncertain. It's probably something that wouldn't be ...

O'Reilly: Happening next year.

Shen: Exactly. Maybe 2020, if anything.

O'Reilly: For sure. Very good. Thank you for your time, Vince. We'll hopefully get you into a casino here soon -- I'm kidding!

Shen: Thanks, Sean!

O'Reilly: That is it for us, listeners, but before we go I wanted to make our listeners aware of a special offer for Industry Focus listeners, for a subscription to Motley Fool Stock Advisor newsletter. Just go ahead over to focus.fool.com to find out more.

As always, people on this program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Thanks for listening, and Fool on!