China's "Sin City" Is Bouncing Back With 8th Straight Month of Growth

Macau, the world's biggest gambling market, saw devastating declines at its casinos and resorts following a 2014 government crackdown that shook the city's foundations. However, March marked the eighth straight month of growth, spurring investors' hopes that a recovery may finally be taking hold.

In this episode of Industry Focus: Consumer Goods, Vincent Shen and Fool.com contributor Seth McNew explain what investors need to know about the Macau gaming scene today. Listen in to find out about the main players, how each of them is recovering from the years-long downtrend, and how further government regulations could still stifle the recovery.

Also, the two share an update on the success of the Nintendo (NTDOY -0.41%) Switch and developments in Japan that may soon create a booming new market for casino operators.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and it's Thursday, April 13. We are prerecording for next Tuesday. Helping me with that is Fool.com contributor Seth McNew, who is calling in via Skype from San Francisco. Hey Seth! Welcome back!

Seth McNew: Hey! Thanks a lot, Vince! It's great to be back.

Shen: Last time you were on the show, we looked at developments in the video game industry. In just the two weeks or so since we talked, there have been some updates that I wanted to discuss before we dive into the main part of this episode. First, there was the Switch. This is the newest video game console from Nintendo that was originally unveiled last October, and made its official debut on March 3. In its six weeks on the market, the Switch continues to fly off store shelves. If you go to the official Nintendo Switch product page online, they have links to retail partners where you should technically be able to buy one of these consoles. I actually checked all six of them -- Best Buy, GameStop, Target, Wal-Mart, and Toys "R" Us. Can you guess, Seth, whether or not I was able to find a Switch available at those retail partners?

McNew: I would say probably not. If you're looking places like eBay, you can definitely get one if you're willing to pay a little bit of a premium.

Shen: Yes, exactly. Amazon was also one of the partners. It's available only from third-party sellers, not from Amazon themselves. They're charging a premium, like you said, in the face of such high demand. So, buyers can expect to pay at least $360, when the Switch's official MSRP is $299. I got curious, I did go to eBay to see what people had been willing to pony up to get their hands on one of these consoles, and more recent listings are similarly going for around $400. In the initial weeks after the release, when the frenzy was really building up and people had to get their hands on one, there were some listings for the Switch console being sold for well over $1,000.

McNew: That's absurd.

Shen: Pretty incredible. All of this incredible hype bears out in sales for the console in numbers that we've seen. There's a report from DIGITIMES that said, based on estimates from Nintendo's supply chain partners, the company could end up shipping as many as 20 million units in its first year. Looking out further, the president of Nintendo sees a lifetime total for the console of potentially 110 million units, which would far eclipse the previous generation Wii U.

McNew: 110 million units, but we don't know how long it's going to take for them to actually produce that many. At this rate, it could be a few years before they're able to get that out.

Shen: Yeah. It'll take several years for them to even get that number. Recently, they doubled their shipping estimates from 8 [million] to 16 million. I think that's going up again to potentially this 20 million number that we're seeing. But our biggest concern last episode, in addition to their inability to meet some of this demand, every store being sold out, there was also a concern about a relative lack of top-tier game titles. But with these kinds of forecasts, I have to imagine at this point the developers are getting pretty excited about tapping into this corner of the console market. What do you think? Is that something, with these kinds of numbers, that people, especially third-party developers, are perking up their ears and thinking to themselves, "It's time to get in on this."

McNew: Yeah, I think so. You're right that when the Switch came out it had such a lean amount of titles that came with it. They have already announced some pretty interesting new titles. Mario Kart is coming out this month, which is going to be a hit, I'm sure. Then, other games like Minecraft, Ubisoft has talked about Monopoly is coming out soon. So, you're having these very classic games like Pac-Man that you would expect for this kind of console, but you have some new franchises as well that are coming out as well, some different sports games. And then, I think it lends itself well to some competition. They talk about a Mario Kart competition. But, as we talked about last time I was here, with e-sports, this mobile gaming, it seems like such an easy way to get into that online competitive space. So, I would imagine a lot of third-party developers are pretty interested in that aspect.

Shen: I think Nintendo has also done its part with this specific console, a better job than they did with the Wii U, and that is making the platform more attractive to third-party developers. They're supporting common game engines that make it easier to create the games and the titles for the console. Something that might be more important, you mentioned e-sports, but there's also this online gaming element. The company has announced that there will be an online gaming platform for the Switch that will launch later this year. Initial testing has already started. Like its biggest competitors, Nintendo will actually start charging players for access to this service. That adds another income stream on one hand. On the other hand, I think game developers will be attracted, because you want a robust online player base for additional opportunities to monetize their titles. You look at Activision Blizzard, Electronic Arts, they're making 60% to 75% of their sales digitally, and it becomes very clear how important getting this online platform right will be for Nintendo.

Moving on, also making waves in the space recently was Microsoft. The tech giant released some additional details for its Project Scorpio. The official reveal will happen at the Electronic Entertainment Expo in June. But, the gist of it is, you get more powerful hardware, better graphics, 4K compatibility, and support for virtual reality headsets. As we discussed a little bit on the last show, titles will be compatible across Xbox One, the Xbox One S, and Scorpio, so game developers will be in a very favorable position where they can work on one title and tap into bigger player bases than they have in the past.

Now, for our main discussion topic for this episode. It's gaming-related, but we're talking about roulette and blackjack and baccarat kind of gaming. Macau, which is the special administrative region in China, which also happens to be the most densely populated region in the world, has been the gambling capital for over a decade. But, following a government crackdown on corruption and money laundering in the region, plus an economic slowdown, Macau suffered huge declines to its gaming industry starting in 2014. For 26 months straight, their market reported declines year over year in gaming revenue. Macau peaked in 2013 at over $45 billion, and by 2016, it had shrunk 40% to about $28 billion. Is there a light coming over the horizon? What are investors seeing now, Seth, broadly, for this market?

McNew: To put some of those numbers in perspective, you have to imagine that 2013 number, you're talking seven times as much gaming revenue as Las Vegas. Even though this last year, when they had faced so many months of decline, we're still talking three times as much revenue as Las Vegas. So, this is certainly a massive part of the gaming industry still, and now it looks like it's regrowing again. In March, we had total gaming revenue grow 18% over March of last year. It looks like this trend that we've seen since last August, that every month, it's getting a little bit better, is now really starting to show some pretty substantial growth.

Shen: There have officially been eight straight months of growth now. I think in the beginning of the year, people were still kind of skittish, not really sure if this was building out into something you could call a trend. But February and March saw revenue up about 18% year over year. So, it seems like that momentum is really picking up in their favor. But let's turn our attention now to the major casino operators, who are based in Macau, or have significant business there. Who do you want to start with, Seth?

McNew: There's really four operators that make sense for investors to be watching. The one that's been the best performing so far this year is definitely Wynn Resorts (WYNN 1.38%). Wynn had their new massive Wynn Palace resort open last August, which worked out well with the first month that Macau showed some positive signs of turning around, probably helped out by the new resort by Wynn. And in 2016, Wynn really posted some pretty substantial growth in earnings. If this resort works out pretty well for them in 2017, we should see that growth continue.

Shen: Yeah. For this company, Wynn, 64% or so of their revenue is based in this region. So, obviously, an important market for them. Really exciting with the newest resort that they opened last year. But they're not the only ones. Las Vegas Sands (LVS -1.18%), over half of their revenue also is based in this region, they opened the Parisian. What's going on with them?

McNew: That's true, Las Vegas Sands open their new resort as well, a couple months after Wynn. You're right, Las Vegas Sands is by far the dominating force in Macau right now. Wynn has doubled its own presence there, but with its two casinos, it still pretty much pales in comparison to Las Vegas Sands and its five casinos. The other thing is it has more hotel rooms than any other company by far. It has more gaming tables. So, especially as we're seeing this shift toward mass-market, you're wondering who's going to get that spillover and that increase in visitation. It's probably going to be these casinos that Las Vegas Sands holds.

Shen: Sure. For another company that is a really significant business here, based mostly here and in the Philippines, is Melco (MLCO 0.49%). They have gone through a bit of a shake-up recently. What's the story there?

McNew: Yeah, to say the least. They have their own little bit of drama lately. One of the partners, Crown, has divested itself from the company. They'll be rebranding to just Melco Resorts and Entertainment. Along with that, they'll have a little bit more control. It sounds like they're going to overhaul some of the properties, some of the uneven parts of the property, changing up some of the feel of the hotel towers and whatnot. That could be really good for the company as they're shaking things up. That might be a good way for them to also bring in some new visitation that would otherwise go to some of these new resorts.

Shen: Sure. The last company we'll talk about here, they have a resort that's been delayed several times. I think it's slated at this point to maybe open later this year or even next year. Correct me if I'm wrong, Seth. That's MGM (MGM 0.99%). Their presence is not as significant as some of these other companies in terms of their business overall. About 20% of MGM's revenue is based in Macau. What's the story there with their Cotai Resort?

McNew: That resort has been pushed back a few times. The latest on their website right now says second half of 2017. So, we'll hope to see that open. I was just there a couple months ago, and the resort looks great. From the outside, it looks completely finished. I'm not sure what's taking so long. But, it looks like a beautiful resort. And yes, Macau right now makes up a relatively small portion of their overall revenue. But, you can understand that if things are pretty much stable in Las Vegas -- and that's their bread and butter -- by doubling their operations in Macau, it could be a pretty huge growth driver for them in 2017 and 2018.

Shen: Yeah, especially if the market there broadly is expanding and improving and this trend really does continue. A lot of these companies will be releasing their next bout of quarterly earnings in the next month or so. What do you think you'll be watching in the results, as these companies give updates on the situation in Macau, the status of their new resort openings, or the ones that are in process -- what do you think?

McNew: We probably can expect that Las Vegas Sands will be the first one to report. Not all of these companies have said when they're reporting Q1. But, when they do report, that will be interesting to see, what is happening with the mass market and VIP switch. Is it true that the mass market is rising enough to overtake what is being lost in that VIP segment? Also, we want to see things like hotel occupancy and average daily rate. Are those really growing consistently as much as is needed? Do we see increased visitation that's spurring on a really robust recovery in the overall gaming? Or is it maybe just increased gaming by per spend from player? Those are things that, that's interesting with the regulation there as well. Is the government going to increase regulation again because they're worried that gaming is getting out of control? Or is there a shift to mass-market entertainment that the government is really fond of?

Shen: On that note, on the regulation side, it's really important for anybody who's thinking about investing in these companies, or who is looking for exposure to the gaming site in Macau, as prospects brighten here, are you concerned that Beijing officials ultimately come in and clamp down yet again to take the momentum out of this rally? Because, it was only in December that they instituted this new capital control regarding ATM withdrawals. Basically, they cut in half the amount of money that Chinese tourists could take out with their popular Union Pay cards. Just like that, a huge impact on the shares of the major casino operators we're talking about here -- Las Vegas Sands, after that was announced, was down 13% on the day. Wynn Resorts was down 11%. Melco was down 14%. That's always looming, is it not, this potential change where the officials in Beijing decide there's too much money going out of China and into areas like Macau and some of the resorts in Singapore as well, and they decide to crack down again?

McNew: Yeah, that's always a thing. Even if it's just one sentence from an official in Beijing talking about, they want to crack down on companies that are advertising gambling in mainland China, which is still illegal. That's what I'm saying, if the recovery is really about entertainment and hotels, and they're building some other stuff right outside of Macau, if that's truly the recovery, I think that will be really positive for the government. If it's really about gambling, maybe not so much.

Shen: Sure. On the flip side of that, and to wrap up our discussion here, I'm sure the gaming industry is revving its engine right now, anticipating the opportunities in Japan. We talked about this earlier this year, the fact that the government in Japan essentially approved the beginning of the process to open some integrated resorts in that country. Some of the really bullish initial forecasts put the size of the Japanese gaming market as high as $25 [billion] to $40 billion. That's based on the popularity of gambling-like games that currently exist in the country. Some of the more conservative estimates come in at around $5 [billion] to $10 billion. I think the entity that ultimately holds the key to exactly how lucrative and large the market becomes is, of course, the Japanese government. They're in the process now of deciding the rules and regulations for the industry -- where the resorts can open, how they'll operate. Do you think companies are overly optimistic, hoping for a way out of the volatility that can happen in Macau? Ultimately, how do you think things will shake out for Japan?

McNew: I don't know if I would say overly optimistic. Even on the low side of those estimates, that's a really big bump in the gaming industry, and also for something that's diversified.

Shen: Yeah, it's like a second Vegas, admittedly.

McNew: A second Vegas that's in a new country, a country where you can expect some new attention being paid to it because of the 2020 Olympics coming up. So, even if it's on the low end of that, I think every one of these companies should be excited about trying to get a resort there.

Shen: Some of the comments that management and the leaders at these companies have made, to give you a sense of exactly how powerful and how excited they are for this opportunity -- for example, I have Sheldon Adelson, the Las Vegas Sands founder and CEO. He's called Japan "the ultimate opportunity for his business going forward", and he has aims to spend something like $10 billion in that market once things kick off. Then, there's also Lawrence Ho, CEO at Melco, he's basically echoed that sentiment. He said, "This opportunity is priceless, and we will spend whatever it takes to win." So, obviously, these leaders of these companies, the leaders of that industry, the bullishness that they are showing should give investors an idea, once we have a better idea of what the regulations will shake out to, whether there are limitations, just as an example, in Singapore, as a permanent resident or citizen, they charge an entry fee, because they want to limit any negative effects that the gaming industry can have, or that these casinos can have. In that region, there has been some talk, some rumors that there might be something similar. So, whether this goes from $5 [billion] to $10 billion, or as big as $25 billion, as the more optimistic people hope it will be, it's going to really depend on how some of that regulation ultimately shakes out. Any other final thoughts, Seth, to wrap up?

McNew: Talking about Singapore, I don't know if you knew this but I actually lived and worked in Singapore for some time. It was really interesting to be around the casinos there, and see how they're really marketed toward visitors, they're marketed toward these international people that are coming to stay in Singapore, and yet they are a crown jewel of the island. The Marina Bay Sands there, it's on so many of the postcards and the pictures of Singapore, because it's such an iconic piece of the total country. So, when you're looking at what company might want to license in Japan, the Prime Minister Shinzo Abe has already talked about, maybe the model in Singapore is what they need in Japan. So, you look at Las Vegas Sands as, obviously, a leader in the market.

Shen: Yep, there you go. With that, I think it'll be a very interesting time to follow this industry, follow these companies over the next year or two, as the details behind the development in Japan gets ironed out, and we get more information. But thanks again, Seth, for joining us today!

McNew: Absolutely, thank you!

Shen: Fools, remember that you can reach out to the Industry Focus team via Twitter @MFIndustryFocus, or send any questions to [email protected]. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell stocks based solely on what you hear during the program. Thanks for listening and Fool on!