As of March 2016, Macau has experienced 22 straight months of year-over-year declines in gaming revenue -- the fallout of a government crackdown on corruption in China. Despite the major headwinds and ongoing uncertainty in this region, casino operators have invested billions of dollars in luxurious new resorts to attract gamblers, and now more than ever, vacationing families.
In this week's episode of Industry Focus: Consumer Goods, Sean O'Reilly and Vincent Shen cover the latest developments in the world's gambling mecca. From Studio City to the Parisian Macau, they cover the newest resorts hitting the Cotai Strip and how shifting market dynamics could present challenges for the casino companies.
A full transcript follows the video.
This podcast was recorded on April 12, 2016.
Sean O'Reilly: We're hitting the tables in Macau, on this consumer goods edition of Industry Focus.
Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Tuesday, April 12th, 2016, and joining me in studio is Vince "I'm-at-the-tail-end-of-a-cold" Shen. How's it going, man? Feeling any better? Drinking lots of clear liquids?
Vincent Shen: Yeah, I'm feeling a little better. Thanks for asking.
O'Reilly: You sound good.
Shen: I sound OK, hopefully I don't get into a coughing fit in the middle of the show.
O'Reilly: Of course not. But you've got your water next to you if you do. So, it's been a while, when did we do that Sin Stocks Week? We were just talking to the founder of the Fool, David Gardner, about it, and I was trying to remember when... was that our first series, a year ago?
Shen: I will say that, I do recall that probably being the first series of shows we did where it wasn't a week-to-week news topic.
O'Reilly: Maybe it was last summer.
Shen: Earlier than that, I think it's been about a year ago at this point. It wasn't that long after I'd just started joining you in IF.
O'Reilly: Wow. Happy anniversary, Vince.
Shen: There you go.
O'Reilly: So, we're not talking broadly about gaming or anything, we're actually just talking about Macau.
O'Reilly: Now, that being said, you're talking about the largest gambling mecca on the planet Earth. What were you saying, even after the drop they've experienced in the last year ...
Shen: Even now, it's multiple times the size of Las Vegas, this strip. And, as much as, within the U.S., I think a lot of people think of ...
O'Reilly: Well, it's very easy to go to Vegas and get a sensory overload. Now, multiply that by five, and that's Macau. (laughs)
Shen: Or seven, exactly. Definitely a gambling paradise. These days, they've begun this shift, where the Chinese government basically said, "You need to diversify your economy a little bit and bring in more family entertainment, and things along those lines." Previously, though, it was very much so a gambling-focused economy and market.
O'Reilly: So, how much money trades hands in Macau? Have you come across that at all?
Shen: Sure. Just to give listeners a little bit of context, we know that since about June 2014, Macau has struggled. And that was after 10-plus years of incredible growth. I think Macau surpassed Vegas as the largest gambling enclave or market, in about 2007. And since then, the growth just kept ramping up, until 2014. Then there was the government crackdown on corruption and luxury spending, which have sent the market, I think it's 22 straight months now of year-over-year declines in gaming revenue in Macau.
Shen: So, to give you an idea, 2010, the overall total gaming revenue was about 188.3 billion Macanese pataca, the exchange rate is about 8 pataca to about $1 USD. So, that's about $23.5 billion. 2013, it peaked at about $45 billion, and in 2015, it's fallen back down to about $29 billion. So, you can see how significant that is. The amount that they've lost in terms of gaming revenue in the last two years is far more than Vegas sees in an entire year. Just how much they've lost.
O'Reilly: Right. You've never been, have you? I went to Hong Kong when I was in China in 2009. Have you ever been to Macau?
Shen: You're not too far across the water, but no, I was in Singapore, where I was able to see the Marina Bay Sands and what Las Vegas Sands (LVS 5.03%) has there. But, unfortunately, I did not make it to Macau. That would have been an incredible experience, even now, especially because -- and this is another reason I want to talk about Macau today -- there are some huge new luxury resorts coming out from several of the major players there, including MGM, Las Vegas Sands, who we'll be talking about, Wynn Resorts (WYNN 2.11%), and others.
O'Reilly: Yeah. Before we move on, I want to talk about, it was always interesting to me how Las Vegas was this, like, desert stopover thing that just popped up after World War II, and of course, the mafia got involved and all that good stuff. But Macau was designed by the People's Republic of China to be a big gaming mecca, and it's just this island just south of the island of Hong Kong. It's actually trickier to get to. I had flirted with the idea of getting over there, but I think I would have had to show my passport again on the ferry and all this stuff. In any case, it's always been interesting to me how planned it was, and how the purpose was clearly to be this enormous mecca.
Shen: Well, yeah, the moment they lifted that monopoly on who could operate the casinos, the amount of foreign investment that went into the area ...
O'Reilly: It was nuts.
Shen: ... just like that, you have now what is still a massive market.
O'Reilly: Did you come across -- I wish I knew this off the top of my head -- what are the biggest games there?
Shen: I actually have a little bit of a breakdown I can share with you. I gave you the total gaming numbers, but just to give you an idea, VIP baccarat -- we're talking about VIP clientele, so, high net worth individuals -- is still by far the biggest, even though it's lost its share. So, in 2010, VIP baccarat made up about 72% of total gaming revenue. But that share has fallen down to like 55% as of 2015. And again, that is going to have to do, obviously, with the bit of the crackdown that I mentioned earlier. But, if you go down market slightly to normal, more mass-market, or premium mass-market baccarat, that was at about 18.5% in 2010, and its share has grown to about a third in 2015. So, the game is still by far the most popular.
O'Reilly: For sure.
Shen: No. 3 is actually slots, and as of 2015, it only has about a 5% share of gaming revenue there. So, those two table games are by far the most popular.
O'Reilly: The penny slots are just not doing it.
O'Reilly: OK. Well, before we move on, I wanted to point our listeners to the newly redesigned Focus.Fool.com. As I've mentioned in the past, all loyal IF listeners have access to a special discount on The Motley Fool's Stock Advisor newsletter that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again, that is focus.fool.com.
So, Vince, the coup de gras, the new casinos that are opening up in this area. This has actually been a long time coming. Is anybody nervous? Because, from what I could tell, they're all gung-ho, opening all these casinos and all this. Does anybody think the timing is a little bad?
Shen: Well, yeah. The timing of when a lot of these projects broke down ...
O'Reilly: It was the heyday.
O'Reilly: It was awesome. (laughs)
Shen: So, are a lot of these developers and operators facing uncertainty right now in terms of the fact that they have a lot of new supply coming in, not only in table games but in slots and also hotel rooms? Absolutely. Lots of uncertainty. But a lot of people right now who are more bullish in terms of the near-term prospects, for example, February -- I was talking about the 22 months of declines -- most of them have been double digit for the past year, year and a half. But February was a bright spot. Year-over-year decline was only about 10 basis points.
O'Reilly: Oh, so that's a fraction... yeah.
Shen: They happened to get a lot more traffic because of Chinese New Year. So, people saw that as a really positive sign, a lot of the stocks have done well since the beginning of February as a result, because, you know, these gaming companies had seen their shares down 75%.
O'Reilly: Yeah, whenever you mention basically gaming in Southeast Asia, you pretty much always come across Melco Crown (MLCO 4.70%) Resorts. Correct me if I'm wrong, but they're in Singapore, too, right?
Shen: No, they're in Macau and in Philippines.
O'Reilly: Oh, in the Philippines, I'm sorry, that's actually what I was thinking. Anyways, they own 6% of that new one that's opening up in Macau, the Studio City place.
Shen: So, Studio City opened its doors last October. Huge event. They even spent, I think it was $70 million on a short film with Scorsese, De Niro, DiCaprio, and Brad Pitt. It was a 17-minute ...
O'Reilly: Was it an Ocean's 11 rip-off?
Shen: It was just a marketing film about the opening of the resort.
O'Reilly: I kind of need to see this. (laughs)
Shen: The resort looks incredible. It was a $3.2 billion project from the company. And, keep in mind, Melco Crown, their stock is down about 56% since that downturn began in June 2014. So, Studio City has 1,600 guest rooms between its two separate towers, and here is where we're seeing the strategic focus of these companies is shifting to accommodate the fact that a lot of their VIP customers are no longer making it, no longer dropping as much cash on the tables.
So, for example, you have one tower of the hotel, the Celebrity Tower, meets more so a broad swath of customers. Then, they have the Star Tower, which is these bigger suites, much more so for the luxury clientele. Again, they're splitting that in order to accommodate both ends of the market, so to speak. And then, another fact is, right now, they only have 250 gaming tables and about 1,200 slot machines, which is not that much compared to their other properties.
O'Reilly: So, this is kind of where China seems to want Macau to go, and it's definitely where it's going, which is having more entertainment, more family friendly stuff, all that.
Shen: Absolutely. So, Beijing has basically signaled to Macau and said, "We want you to diversify your economy, and we want you to change how you market yourself. We want more family friendly entertainment." And I think Studio City, being the newest opening, I'm pretty sure, in the area, is a really good example of that, because you have, for example, their Golden Reel, a figure-eight Ferris wheel, highest in the world at 130 meters ...
O'Reilly: What's a figure-eight Ferris wheel? (laughs)
Shen: Look up pictures, you'll see it. It's incredible.
O'Reilly: I'm going to Google this.
Shen: And also, they have the House of Magic, it's three separate theaters with magic shows running seven days a week. They have a Batman Dark Flight ride, which you would absolutely love.
O'Reilly: I would totally love to do that.
Shen: It's an interactive amusement ride, essentially. They have their Pacha Macau nightclub. They have a huge event center with 5,000 seat capacity for concerts, theaters, sports, awards ceremonies. They have a 40,000 square foot arcade and playground for kids, which I'm probably sure I would love, too.
O'Reilly: Oh, it's like part of the center of the building -- I'm looking at the figure-eight Ferris wheel.
Shen: Exactly. And, a big thing is, they'll have this thing called The Boulevard. It's supposed to recreate New York street shopping, but in an indoor setting. 377,000 square feet when it's finished. Right now, they're still building that out, as retailers move into the space. So, like I said, only 250 gaming tables, 1,200 slot machines, not that much compared to some of their other properties in Macau. So, all those other things I mentioned is the shift in terms of where, hopefully, their revenue is going to be coming from the resort. But, when I say that, I don't want listeners to believe it's like an even split. Still, the bulk of every one of these businesses, their revenue is coming from the casino.
O'Reilly: I'm itching to get your thoughts on this. I knew the most about the City of Dreams, which opened in 2009. That's not terribly big. It was started right before this stuff happened, so they've been doing well. Did you get a read on how they're performing lately?
Shen: They announced their fourth-quarter results. Net revenue was about $669 million. Unsurprisingly, it's down year over year about 25%. Non-gaming revenue made up about 10% of that number. So, you can see how much it's still focused on the casino. But that's up from 8% in the year-ago quarter. And the thing is, Studio City is a very different picture, where non-gaming revenue was about $37.8 million of total $123.2 million, which is about 30%.
O'Reilly: City of Dreams was built for the rich millionaire who comes in there ...
Shen: Yeah, not only was it built more so focused on the gaming side, but on the VIP clientele as well. So, Studio City, that 30% split coming from non-gaming gives you an inclination of ...
O'Reilly: It's a big divergence, for sure.
Shen: Exactly. And though Studio City was only open for about two full months in that quarter, the resort generated about $123 million, adjusted EBITDA of $12.6 million. Those numbers will certainly go up as the resort ramps up its operations. Moving on, the next resort that is coming.
O'Reilly: This is the drum roll.
Shen: This one, I will say, a lot of people will associate the name were talking about now, Wynn Resorts. Steve Wynn ...
O'Reilly: Yeah, that's what I wanted to say. Your friend and mine, Steve Wynn. He's famous, and he recently made comments in his conference call about how he considers Wynn to be a high-end premium brand that markets to the millionaire that comes into play baccarat or whatever. So, is he toeing the line in doing what China wants him to do with this thing?
Shen: I think there's a balance, but you're absolutely right. In terms of the brand name, and in terms of the way they're billing out the resort, it's still going to be very much a luxury resort, and catering to that kind of clientele. So, Wynn Palace is what is currently under development. It's a $4.1 billion project. Wynn Resorts, their stock -- just to paint the trend for you -- is down 55% since the downturn began.
O'Reilly: Same as ...
Shen: Very similar. But, they are actually up 40% year to date.
O'Reilly: So, they were down even more, is what you're telling me.
Shen: Yeah, absolutely. That's after a 40% run so far in 2016. So, the Wynn Palace is projected to open, I believe, this summer. There's been several construction delays. I think it was June, and it got pushed out again to August; 1,700 guest rooms projected. There's going to be this eight-acre performance lake as an attraction. And, again, if you look at a lot of the marketing behind it, they are very focused on dining, retail, meeting spaces. And in a recent investor presentation, the company is projecting, depending on the market share that they can claim on the strip, about $630 million to $850 million in adjusted EBITDA of this property, which essentially doubles their base in Macau, because they only had one other resort, the Wynn Encore. That opened in 2006, there was an expansion in 2010. Just to give you an idea, Macau has recently placed a cap on these new resorts, how many table games they can install. With Encore Macau, it's about 450 gaming tables, about 700 slot machines. These new resorts are probably going to get about 250 table games per.
O'Reilly: Oh, wow! And that's one of the ways China is like, "OK, stop it with the gaming, be more ... "
Shen: I think the regulatory body in Macau is just trying to keep things balanced. And the thing is, these companies can reshift the tables from one property to another, so it's not like it's static. But, it just gives you the idea, it's a smaller base. That's why Studio City, even though it's the newest resort, doesn't have as many table games as City of Dreams. So, the Wynn Encore is smaller in terms of its guest rooms, about 1,000. It has about 57,000 square feet of retail space. Adjusted EBITDA in 2015 was $708.6 million, which represents about 60% of the total company EBITDA. So, based on those projections I mentioned, they're doubling the base for the region.
Something to keep in mind, too -- in 2015, non-casino revenue made up about 20% of the top line at Wynn. It's up from 21% the previous year and 20% in 2013. Again, the company is grappling with the changing dynamics, and the fact that the casinos are not going to be this incredible source of growth bread and butter that they were previously.
O'Reilly: So, Studio City Macau opened up last October. You've got Wynn Palace about to open up this June, supposedly. Got another one coming up ...
Shen: There's several more, but just for the sake of time, I'm focusing on the ones for 2016. The one that's coming later this year is really incredible. I've seen a lot of the pictures following development, and one of our writers, Bradley Seth had some ...
O'Reilly: He's probably been there. (laughs)
Shen: ... when he was based in Macau, he had some really cool pictures. But, the Parisian from Las Vegas Sands.
O'Reilly: The Parisian Macau.
Shen: Las Vegas Sands, this is a $2.7 billion project. And Las Vegas Sands, their operating base is spread out through more regions. They have Macau, Singapore, Las Vegas, and other regions. Their stock is down about 35% since the downturn. I think they're just a little bit more diversified.
O'Reilly: And they do very brisk business in Las Vegas on conventions. They have like 3 million square feet of convention space at The Venetian and stuff, a massive amount of convention space. But, I digress.
Shen: I stayed with them when I was in Vegas a few years ago at The Palazzo. Las Vegas Sands owns a 70.1% stake in Sands China, which operates all these Macau properties.
O'Reilly: Does the government get the other cut? Or just locals? Yeah, you're giving me this look like ... (laughs)
Shen: Yeah. (laughs) So, this is all part of the deal. I don't know all the details in terms of the way Macau auctioned off these rights when the monopoly ended, but it all has to do with ...
O'Reilly: Whose beak are you going to wet there, yeah. (laughs)
Shen: The Parisian is projected to open its doors in the second half of 2016. Again, there's been some construction delays. This one is really big in terms of guest rooms. 2,900 guest rooms expected ...
O'Reilly: Which is double Studio City's, because theirs was 1,600. They're talking about 1,700 at Wynn Palace. So, the Parisian is an 800-pound gorilla in the room. That's a lot of rooms.
Shen: And, touching on those guests room numbers, I'll get to that toward the end, why that's important. They're expecting like 150 retail boutiques and shops. Again, 250 gaming tables, like I said, because of the cap that Macau has instituted. I think the coolest thing here is, they're going to have a 1/2 scale replica of the Eiffel Tower.
O'Reilly: Oh, wow. So, it's not going to be small like the one in Vegas.
Shen: I think they just put up the final piece of that, the spire at the top. There was a big ceremony for that. But Macau properties contributed about 53% of adjusted EBITDA in 2015, down from 60% in 2014, just because of the fact that they're struggling. The casinos made up about 82% of net revenue in 2014. That fell to 78% in 2015. Casinos overall saw revenue fall 24% for the year. Some smaller losses in the casino revenue in Singapore and Las Vegas, kind of were able to offset the larger declines in Macau.
So, the Venetian and Sands Cotai, which is Las Vegas Sands' other big two properties in the region, they fell 29% and 33% respectively. So, they're feeling the pain, absolutely. They're definitely experiencing the same downtrend that everybody else has. But the thing is, they were able to offset that a little bit more also in terms of Las Vegas coming in with occupancy rates and average daily room rates were up. Vegas kind of boosted the results they reported recently. Also in mall revenue. The shops and Venetian and the shops at Cotai Central, huge retail spaces. And they posted high single-digit gains in 2015. It was a slowdown from the previous year, but a bright spot when you're looking at all this red in terms of the casino revenue.
Putting everything together here, Macau has forecasted another decline for 2016. 2015 was 230 billion patacas, they're expecting for 2016 about 200 billion. A lot of people are wondering now, are things bottoming out? We've seen some of these company stocks have recovered year to date, I think because investors are getting bullish, especially with the more positive result in the beat in February, they think, maybe this is the sign that things are going to be on an upswing. But that's really hard to say. There's a lot going on. The thing is, with each new resort, you're adding a ton of supply. So, room revenue is often the second-largest source of income after gaming.
O'Reilly: Ah-hah! Therein lies the rub.
Shen: It's often the second-largest source of revenue for these businesses, but the thing is, tons of new supply coming soon, as each property is completed. And, a trend that we've also seen is, falling occupancy rates, and falling average daily room rates. So, that hurts them. Some people see it as positive, but at the same time, Studio City has the buzz right now because it's the newest. Then, Wynn Palace will have the buzz, because it will be the newest. And that will absolutely -
O'Reilly: And in five years, it'll be ...
Shen: And after that, you'll have the the Parisian, and after that, you have MGM Cotai... there's several new resorts coming in 2017 as well that we can cover on another episode. This is just the tip of the iceberg.
O'Reilly: It seems to lend itself to the idea that, maybe as a whole, the bottom is occurring. But per casino, more pain may be coming.
Shen: Yeah. The thing is, are we going to reach the peaks we saw in 2014? Probably not, not for many, many years. So, even if you say, "OK, I agree with the idea that the market is stabilizing and these losses are stemming off," the market is now going to be spread among more and more tables, slots, and rooms. And that really makes you have to consider how these companies are positioned. You have to look at each company now and really think, are they marketing themselves well? Are they going to hit the segments that will be the biggest money drivers for each business? I think that also has a lot to do with why Macau is capping the number of table games, for example, at each new resort. Otherwise, the pie is just being split into thinner and thinner slices.
O'Reilly: Cool. All right. So, bottom line, the bottom may be in for the market as a whole, but for shareholders of all these companies ... tread carefully. (laughs)
Shen: Also, for me personally, I think Macau is probably in my top three places I'd really like to visit because the development there is incredible, and I've heard so much about it from people who have been there who say it's worth the visit, even if you're not a gambler, like I said, the entertainment options, the shopping... it's definitely a sight to be seen.
O'Reilly: Cool. Thanks for your thoughts, Vince.
Shen: Thanks, Sean.
O'Reilly: Have a good one. If you're a loyal listener and have questions or comments, we would love to hear from you, just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. As always, people on this program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Vincent Shen, I am Sean O'Reilly. Thanks for listening and Fool on!