Crown Resorts Limited, the Australian hotel and gaming company controlled by billionaire James Packer, is reducing its stake in Melco Crown Entertainment Ltd (NASDAQ:MLCO), one of only six gaming companies allowed in Macau. The company's sale comes as Melco Crown's Studio City resort struggles and a Philippines property fails to generate much cash, but Crown's employees being detained in China could have been the final straw. Here's a look at what investors should know.
Crown Resorts' big sale
There were two transactions announced in the last 24 hours that affect Melco Crown. The first is Crown Resorts agreeing to sell 198 million ordinary shares (which convert 3:1 to U.S. traded ADSs), or 13.42% of the company, to Melco International Development, a company controlled by CEO Lawrence Ho. This will increase Melco International's stake in Melco Crown from 37.89% to 51.31% of the company.
Crown Resorts is also selling 40.9 million ordinary shares, or 13.6 million ADSs, in a secondary public offering, which is expected to close around December 20, 2016.
A vote of no confidence from Crown Resorts
This is a huge shift for both Crown Resorts and Melco Crown. Crown Resorts was instrumental in funding Melco Crown's growth in Macau, and it is now abandoning ship on that investment. And there are a couple of reasons that make sense for the sale right now.
Melco Crown has tried to expand its operations with partial acquisitions of Studio City in Macau and City of Dreams Manila in The Philippines. But neither resort is having a big affect on financial results, and they may be more of a headache than anything else. Studio City recently had to refinance its debt on risk that it would default on covenants with the previous debt agreement.
Crown may also see little opportunity for growth in Macau. The Chinese government has spent over two years cracking down on money leaving China through Macau, and the latest move to limit ATM withdrawals was a sign that the pressure isn't slowing.
The timing of the sale is also curious given the Crown employees who were detained in China this fall. Crown could see greater risk in dealing with China, and this is a way to sell exposure to China's gaming enclave of Macau.
How Melco Crown shareholders should view this sale
When a co-founder and major shareholder decides to sell their stake in a company, it's never comforting. And in the case of Melco Crown, I think this is a sign that Crown and James Packer have lost faith in the gaming company's operational future. They could be worried that an enterprise value/EBITDA ratio of 10.5 is too high given growth opportunities in Asia. And they could see canibalization from new resort openings as a reason revenue and EBITDA will decline in 2017.
Crown Resorts may also have an eye on the Japanese gaming market. Japan may open up to casino bids later this year and reducing the tie to Melco Crown may allow the company to bid on its own.
While Crown Resorts' sale alone isn't a reason to panic-sell because there are many reasons that could be driving Crown's sale. But it is a good time to reexamine your investment thesis and consider whether Melco Crown's future is as bright as it once appeared.
Travis Hoium has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.