G2E: On Value Investing and Macau Casino Stocks

"You want to predict the future five years from now? Roll the dice."
-- Michael Leven, President and COO, Las Vegas Sands

This time last year at the Global Gaming Expo (G2E) in Las Vegas, MGM Resorts International (MGM 0.90%) CEO Jim Murren suggested that it didn't make much sense that Macau casino operators such as MGM, Las Vegas Sands (LVS -0.92%), Wynn Resorts (WYNN -1.16%), and Melco Crown (MLCO -1.28%) were carrying EV/EBITDA multiples that had fallen into the high single-digit range, regardless of whether the Macau gaming market was going to grow 45% in 2011 or 30% (it grew 42.6% to $33.5 billion) (see "G2E: Macau Casino Stocks Look Cheap"). A year later, those stocks have since both rebounded strongly and then fallen back again on hiccups in the growth of the Macau gaming market.

Fears of a slowdown in the Chinese economy -- and thus Macau -- abound. The Macau gaming market saw revenues grow a paltry 1.5% in July, and only 5.5% in August, before rebounding to a 12.3% increase in September (still short of analyst estimates calling for a 15% to 17% increase). This, after growing only 7.3% in May before rebounding to 12.2% growth in June.

In other bad news, visitation to Macau dropped 0.6% in August.

So now three of these stocks -- Wynn, MGM, and Melco -- have fallen to the point that they carry single-digit or near-single-digit trailing EV/EBITDA multiples. Meanwhile, Las Vegas Sands -- which opened Phase I of Sands Cotai Central in April and Phase IIA in September, and with the completion of Phase IIB will have added nearly 6,000 hotel rooms to the market this year -- is trading at less than 10 times estimated 2013 EBITDA of $4.5 billion.

Source: Yahoo! Finance, through Q2 2012. TTM = trailing 12 months.

The problem, though, isn't that there is anything fundamentally wrong with the Macau gaming market -- if there is a problem, it is that everybody is watching monthly reports too closely.

Value investing in growth
Even though growth is a big part of the picture for these companies, I try not to think about these things as growth stocks. The danger in labeling anything a "growth stock" is that -- by virtue of labeling it a growth stock -- you can convince yourself to pay any price when you should always be looking to get value (and I don't use the word "always" lightly).

The key to investing in growth is to not pay for the growth. As an investor, you really only have three jobs over the lifetime of an investment:

1. Buy the stock at the right price, which ideally would be some reasonable discount to fair value range.
2. Monitor the company, and account for adjustments to valuation.
3. Sell when the price reaches a certain point, which ideally would be something above fair value after holding the stock for at least a year (to avoid paying costly short-term capital gains taxes).

The advantage that we -- as in you and I -- have as individual investors is that we don't have to sit here and make quarterly forecasts and worry about how accurate they are on a quarterly basis. That's a sucker job for Wall Street.

Nor do we have to sit here and fret over month-to-month results in the Macau gaming market. That's a sucker game for financial reporters.

We only have to buy right, and maybe eventually sell right. Everything else is noise.

If you value a stock in a range of $15 to $20 per share based on current forecasts and you buy at $10, you don't have to sweat potential 30% drops in valuation. This is Ben Graham's "Margin of Safety" principle.

Moreover, if the stock appreciates in value -- or even just approaches fair value -- buying at a discount will yield higher returns on investment. For example, if you value a stock at $15 to $20 per share and the price reaches $30 in five years, this represents a 200% return on investment if you paid $10 per share, but only a 50% return on investment if you paid full value at $20 per share.

So in a sense, all investing is value investing, whether you are looking at a company that is growing cash flows at a slower rate or a faster one.

Which brings us to Macau.

Macau: The big picture
As Murren pointed out again last week at this year's G2E, 60% of visitors to Macau are from mainland China; however, these visitors only account for 1% of China's population. Meanwhile, once Las Vegas Sands' Cotai Central is complete, there will be no substantial openings in Macau for another three years.

Essentially, there is a lot of upside and no new supply to divide it for three years.

In addition, Macau's infrastructure continues to improve to handle growth well beyond an estimated 30 million visitors in 2012. These improvements include the completion of intercity rail to Macau, the widening of the China-Macau border gate, and the completion of the Cotai Ferry Terminal in 2013. According to Wynn Resorts, the border gate expansion will allow up to 500,000 movements per day -- up from 300,000 -- while the Cotai Ferry Terminal will have double the capacity of the Macau Ferry Terminal at 10,000 passengers per day.

Looking further down the road, the Hong Kong-Zhuhai-Macau Bridge is slated for completion in 2016, and will cut travel times by car from Hong Kong from four to five hours to 30 minutes. This by itself should multiply day-trip visitation.

And then there is the planned development of Henquin Island adjacent to Macau, which will include nine theme parks, 13 resort hotels with 10,000-plus hotel rooms, two yacht clubs, three golf courses, and the world's largest aquarium. This is the kind of development that will further widen the ultimate market for visitors to Macau beyond hardcore gamblers and drive mass visitation in the future.

This is the big picture.

Macau is a story that is far from being told. It's not about what the growth rate is this month or the next, but what the market will look like when the infrastructure is in place, and what it will look like as the market continues to open up to more potential visitors. And if this is what Macau looks like with 1% penetration of China's population, imagine what the next 1% looks like? (Almost certainly not as valuable as the first 1%, but still probably enough to run multiples around the Las Vegas Strip.)

These are the key points that -- over the long run -- trump any monthly revenue figures, any concerns about a slowing Chinese economy, and any concerns about market share losses at the property level due to recent openings.

That is, they trump any of these concerns so long as you buy at the right price.

The right price
To that point, with 2013 EV/EBITDA multiples in the nine times to 10 times range, these stocks are not priced for long-term bonanza. Rather, they are priced for relatively pedestrian growth.

By way of comparison, the always value-conscious Penn National Gaming (PENN 2.48%) earlier this year agreed to purchase Caesars Entertainment's (CZR) Harrah's Maryland Heights (St. Louis) property for $610 million. According to Penn, that purchase price translates to 7.75 times trailing EBITDA, for what is essentially a no-growth property with little upside. In fact, it's not even the best player in the market -- Ameristar Casinos' Ameristar St. Charles property right down the river is, while Pinnacle Entertainment owns and operates two top- (read: higher-than-Harrah's) quality casinos on the other side of the market.

Moreover, if you figure that Harrah's Maryland Heights benefited from Caesars' history of operational efficiency (which Penn will lag), along with Caesars' Total Rewards network and its ability to scoot customers to Caesars' Las Vegas Strip properties (a capability that Penn will not have), then you have to figure that property EBITDA will decline at some point after Penn completes the acquisition this month. As such, the effective purchase price will likely end up being north of 8.0 times EBITDA, and probably more like 8.5 times or 9.0 times EBITDA.

And so, if Penn is willing to pay eight times to nine times EBITDA for a second-best casino with little-to-no upside, then the stocks of the Macau casino operators as a group have to look really attractive at nine times to 10 times EBITDA.

The value basket: LVS, WYNN, MGM, MPEL
Generally speaking, I say pick the best player and go with it. But if there is such a thing as a textbook case of when it might be appropriate to pick a basket of stocks, this might be it. Because in Macau, we have a situation in which economics of the market favor the group as a whole, and rather than pick one company and risk losing to variance (you might have bad luck with one company), you might instead bet on the opportunity and the value of the group, much like buying an index fund.

If I had to pick just one stock, I'd be willing to pay a small premium to the others and start with Las Vegas Sands. But then again, I wouldn't pick just one because I really like the long-term prospects for Wynn at these prices as well, so I'd start by taking them both. Meanwhile, I think there's a bit more upside in Wynn by virtue of the fact that Wynn is a much smaller company with about one-third the EBITDA of Las Vegas Sands.

That said, these two companies are the cream of the crop, which will make them attractive operators as more Asian markets -- most notably the potential super-market in Japan -- open up to gaming. Las Vegas Sands has already demonstrated itself as a desirable partner by getting into Singapore with its Marina Bay Sands integrated casino resort, while the company's plans to build a Las Vegas Strip in Spain is something that nobody else is really in a position to even attempt. And then Wynn is just Wynn, which is a cut above the rest.

In addition, both Las Vegas Sands and Wynn have healthy balance sheets with net debt/EBITDA multiples of 1.7 times and 2.4 times, respectively.

I also think MGM looks like a decent buy at these levels, though Las Vegas -- which, by the way, is on pace for record visitor numbers this year -- is a bigger part of the story for MGM. At this point, there is a lot less uncertainty surrounding MGM's future than there was at this time last year. In fact, just a few weeks ago, MGM was able to raise $1 billion in debt at 6.75%, a rate that I think speaks volumes to the perceived health of the company and its ability to generate cash and deleverage even with net debt at 6.4 times EBITDA.

And then, if you want a stock with a bit more upside but also a bit more risk, you might add Melco Crown to the mix.

Among players outside of Macau... well, let's just not even talk about Caesars right now, except to say that the stock is worth more than zero. On the other hand, if Harrah's Maryland Heights is worth 7.75-plus times EBITDA, then Ameristar Casinos looks like a pretty good value at somewhere between 6.5 times and 7.0 times 2013 EBITDA and is probably worth a look.