Investors in Las Vegas Sands (NYSE:LVS) seem to be abiding by the motto "your location is not your destination." Macau, one of the few places in China where gambling is legal, may be stumbling through 26 consecutive months of declining gaming revenues, but shareholders are willing to believe the first monthly tick higher in mass-market revenue in two years is a signal of where the casino industry is going.
Las Vegas Sands derives 55% of its net revenue from its casino operations in Macau, so the downturn in the market has hit the company particularly hard. Second-quarter revenue from the region fell 17% to $1.44 billion, while operating income dropped 18% year-over-year, dragging down the casino operator's net profits 32% to $0.41 per share.
But as Las Vegas Sands' billionaire chairman Sheldon Adelson noted in the earnings announcement, there's a clear bottom visible in Macau, particularly in the mass-market arena, which has many investors believing the turnaround is close at hand. Their optimism has pushed Sands stock 4% higher since the earnings report, and its shares are up almost 15% in 2016.
Macau has been undergoing a transformation from serving primarily as a playground for high-roller, VIP gamblers to a more Vegas-like destination with touristy, family-friendly entertainment and recreational gambling opportunities for the average vacationer.
Yet it has not been an easy transition. The casinos are hurting from a crackdown on corruption that snared several junket operators -- the middlemen who fly in the VIP gamblers and loan them money to play at the high-stakes tables. At the same time, China's economy has slowed considerably, creating a more difficult environment for mainland residents to travel to the island oasis.
Melco Crown Entertainment (NASDAQ:MLCO) opened its Studio City resort last October with the idea it would be fully dedicated to the mass market. Of the 250 tables it was awarded by the gaming commission, it chose not to allocate any to VIP gamblers. But the experiment has been something of a disaster -- Studio City generated total net revenue of just $179 million in the first quarter.
Reeling from the poor showing, Melco has agreed to install three VIP tables, and other casino operators are committing to have more installed as well. Las Vegas Sands recently confirmed its new Parisian casino, scheduled to open in mid-September, will indeed have VIP junket rooms, and Wynn Resorts (NASDAQ:WYNN) will likely have them as well at its new mass market Palace, which is scheduled to open in a few weeks.
When MGM Resorts International (NYSE:MGM) opens its MGM Cotai early next year, don't be surprised to see them there as well.
Yet that's the problem Las Vegas Sands and the others face as Macau goes family friendly: The pie may not be growing but instead remains static, meaning ever-thinner slices for each resort as new venues open.
Although the 4.5% decline in Macau gaming revenue in July was the smallest drop in recent memory, it was going up against particularly easy comps that were down more than 30% a year ago, and it still couldn't surpass that month's results. This might not only be the floor, as Adelson sees it, but the ceiling too.
Over the past five quarters, gaming revenue has consistently averaged about 54.8 billion patacas ($6.85 billion) with no indication they will grow anytime soon. And with three new casinos opening in the months ahead, resort owners will be under intense pressure to attract customers, which may cause them to turn to discounting, a move that would further undermine profits.
Moreover, Macau is taking a hard line on gaming table growth. It imposed a 3% annual limit on the number of new tables it will approve, and Wynn was just granted only 100 tables for the Palace, half the amount analysts were expecting and well below the 500 it can support. It will likely get more tables assigned to it after the resort opens, but in the meantime, Wynn will be moving existing tables from Wynn Macau to the Palace, a move that may very well cannibalize revenue from the older venue.
It does look like Macau's market has stabilized, as Sheldon Adelson says, but rather than the salvation of Las Vegas Sands and the other casino operators, that stability also may be their undoing.