It's been a rough week, to say the least, for gambling stocks with exposure to Macao's once-thriving market, with most of the industry down double digits over the last five trading days. Melco Resorts (MLCO 5.09%), Las Vegas Sands (LVS -1.89%), and Wynn Resorts (WYNN -0.56%) have been the hardest hit because they generated a majority of their revenue in Macao before the pandemic began. MGM Resorts (MGM -1.36%) has two resorts in the region as well, but most of its properties are in the U.S., so it's been spared the worst of the market crash, while Caesars Entertainment (CZR -2.33%) is trading higher because it doesn't have a presence in Macao at all.
Sometimes a sell-off like this is an overreaction by the market, but in this case the underlying business operations in Macao could be under threat. Here's what we know today, and what we'll need to know by June 2022 when Macao's current gambling concessions are expected to be renewed.
Macao's wild week
The biggest news of the week was the government potentially looking to add restrictions to gambling companies. We don't know what final rules will be yet, but the government opened a 45-day public consultation period on September 15 looking for comments on topics including:
- The number of concessions, which currently stands at three, with another three sub-concessions.
- Term of concessions, which was 20 years for initial concessions with an expectation for five-year renewals.
- Levels of local ownership.
- Level of supervision by the government.
- The ability of companies to pay dividends (which would be paid to U.S. owners of Macao subsidiaries).
We don't know exactly what the government is thinking, which isn't new for investors in Macao, but if the rules are changing to restrict the revenue opportunity or squeeze margins it could be very bad for a region that was once a cash machine.
There are two areas where I think we're clearly seeing the government focus over the next year. One is that it would like to see more mass-market tables, rather than high-limit junket rooms, which once accounted for 70% of Macao's gambling revenue. The second is that Macao would like to see more non-gambling revenue.
Gambling companies have been talking about adding more non-gambling products for many years, so that wouldn't be a surprise for most companies. A focus on mass-market gamblers has also been a trend for every operator, although it's hard to turn down a player who might lose millions of dollars in a weekend.
It's possible that new rules would have very little impact on Macao operations and that these will become great growth stocks coming out of the pandemic, but the opposite could also be true. I think the best-case scenario for gambling stocks is that the status quo holds.
The Chinese cloud over Macao
Complicating matters for Macao casino companies is China's crackdown on businesses and consumers over the past year. The government has put rules on activities it doesn't approve of or sees as vices, like kids playing video games, for-profit education companies, and ultra-wealthy entrepreneurs.
As China looks to crack down on "undesirable" activities by its citizens, investors have to wonder if there will be restrictions on visiting Macao.
Worse yet, Macao's relationship with China is complicated. The region is what's known as a Special Administrative Region of the People's Republic of China, with economic autonomy and separate borders but some control from China. It's one of the "One Country, Two Systems" regions, just like its neighbor Hong Kong.
As China exerts more control over Hong Kong and puts limitations on businesses and consumers within China, there's a risk it will do the same in Macao. Until now, that risk has seemed small -- but it's absolutely worth taking it seriously now, even if we don't know what the outcome of any reforms or Chinese intervention will look like.
Why I'm not selling... yet
I own shares of Wynn Resorts, which has two casinos in the U.S. and two in Macao, and MGM Resorts, but I'm not selling yet. I think there's a significant risk to the casino business in Macao, but if the regulations the government puts in place are light, we could see a rapid recovery in Macao's casino stocks, which are still down big from where they traded pre-pandemic.
Like a bet in a casino, there's a big risk to holding Macao's casino operators today, and it's possible the bet will go against me. Until we learn more about what the rules will be like after June 2022, when concessions are due to expire, investors should be ready for anything -- because investing in Macao got a lot more complicated this week.