G2E: Macau Casino Stocks Look Cheap

MGM Resorts International (NYSE: MGM) CEO Jim Murren said it best in his keynote speech at the Global Gaming Expo (G2E) in Las Vegas on Wednesday: Single-digit EV/EBITDA multiples don't make a whole lot of sense for the Macau casino operators, whether the Macau gaming market continues to grow at 45% or grows at "only" 30%.

I agree.

Last Monday, shares of Macau casino operator SJM Holdings plummeted 25% on the Hong Kong Stock Exchange in what apparently is some kind of a record, on fears that slowing growth in China's economy and a credit crunch could hit the Macau VIP gaming market hard. MGM China shares similarly dropped 20%, while shares of competitor Galaxy Entertainment also fell 19% in trading on the HKEX.

In U.S. trading, Monday's drops capped a three-day freefall that had seen shares of U.S.-based Macau competitors Las Vegas Sands (NYSE: LVS) fall 16% to $36.71, MGM  20% to $8.23, and Wynn Resorts (Nasdaq: WYNN) 18% to $110.67 at Monday's close.

Despite a strong rebound through the close of trading Thursday, shares of LVS, Wynn, MGM, and Melco Crown Entertainment (Nasdaq: MPEL) are still trading in single-digit EV/EBITDA multiple range if we borrow the 2012 EBITDA estimates from Morgan Stanley, which factors relatively modest 25% EBITDA growth for LVS and MGM, and even more modest low-to-mid teens growth from Wynn and Melco Crown.

Source: EBITDA estimates derived from Morgan Stanley Real Estate, Gaming, Lodging and Leisure report, dated Sept. 23, 2011.

Note that 88% of LVS's EBITDA in Q2 2011 came from Asia -- roughly half of it from Macau, the other half from Singapore. Of Wynn's Q2 EBITDA in Q2 2011, 70% came from Macau, while 100% of Melco Crown's EBITDA comes from Macau.

MGM, LVS, Wynn, and SJM: no visible impact
None of the casino operators in Macau seem to share the same fears that the stock market has. At the Deutsche Bank and UBS Gaming Investment Forum at G2E last Monday, representatives from MGM, LVS, Wynn, and SJM all answered questions about the impending "doom" roughly the same way.

MGM Resorts CFO Dan D'Arrigo said that Macau business continues to move in an "incredible direction," while payments from junket operators are still being made in 30 days.

LVS President and COO Michael Leven said there is "no indication of a slowdown" in Macau and that although there are no expectations of 45% to 50% growth, business is still healthy, with a "massively growing mass market, and a reasonably growing VIP market." Leven also said that people haven't stopped going to Macau and that what's happening in the U.S. and Europe "has not impacted business in Asia."

Wynn CFO Matt Maddox said that "nothing’s changed." If something was wrong, he said, the junket operators would have been asking Wynn to fund Golden Week, which is a twice-a-year, seven-day national holiday in China that began Oct. 1.

However, that is not what's happened. Rather, payments are still coming in. In fact, according to Maddox, payments are collected 2.5 times as fast in Macau as in Las Vegas, largely because the customer in Macau is a high-frequency player -- and if that player wants to come back and play, he or she first has to pay off the debt.

SJM President Frank McFadden said the company is not feeling a credit crunch, noting that junkets have been with the company for 45 years without a need for the company to provide them credit. Meanwhile, the collection time for junkets is still less than a month and has been flat for the past year.

Anecdotes aside, the evidence is in the final number: The Macau government reported Wednesday that gaming revenue was up 39% in September.

The opportunity: LVS, WYNN, and MPEL
The opportunity for Macau is still tremendous. Even if growth doesn't continue at 40%-45% from what's expected to be a roughly $34 billion market this year (about 5 times the size of the Las Vegas Strip gaming market in terms of pure gaming revenue), all indications are that we have barely scratched the surface of Macau's potential. According to MGM's Dan D'Arrigo, less than 1% of China is visiting Macau. There is a lot of room to grow, while the infrastructure in China continues to improve.

Macau Marketwide Gaming Revenues

Sources: UNLV Center for Gaming Research, 2011 analyst estimate.

That said, it's hard to be wrong to buy these stocks at these multiples. This is particularly true where the only new supply coming online for the next several years is LVS's Sands Cotai Central, which opens in phases starting at the end of Q1 2012.

I'd take a long, hard look at LVS, WYNN, and MPEL. All three companies have healthy balance sheets, with LTM debt/EBITDA multiples in the 2.5 to 3.5 range. All three companies are well positioned to capitalize further on the Macau growth story with the properties in place, as well as with those set to open in the near term (LVS's Sands Cotai Central) and with longer-term projects currently planned for Cotai (Wynn, Melco, and MGM). And that's not even accounting for super prospects elsewhere in Asia, most notably Japan. To stay updated on all the relevant news in the gaming world, don't forget to add these companies to My Watchlist, a foolishly free service.