Macau gaming stocks began a late-August swoon when Karen Tang of Deutsche Bank, an influential securities analyst in the Hong Kong market, published a report on the casino stocks there.  In it, she predicted that a sharp and protracted slowdown in spending by high-rollers in the Macau gambling market would soon begin.  According to Reuters, she said that revenue growth would slow to +34% year on year in October 2011, +32% in November and +20% in December. Growth might shrink to as little as +10% during 2012.

her reasoning?

Affluent Chinese were no longer spending on European-made luxury cars.  She and the DB economics department felt that this was the harbinger of a widespread pullback in consumption by the wealthy.  Finally, they thought, the affluent were succumbing to the Beijing government’s attempts to rein in economic growth on the mainland.

does the argument make sense? 

In my opinion, no.   There’s been no sign of falloff in any other area of Chinese luxury spending.  Maybe the new cars were ugly, or the potential buyers had no garage space left.  I’m not saying that Chinese gamblers aren’t going to spend less in Macau in the coming months.  That could happen.  I’m only observing that I don’t think the luxury car situation is evidence in favor of this conclusion.

I think Ms. Tang would have been better off arguing that the Macau casino stocks were fully priced for the best possible outcome and therefore had no near-term upside.  That would mean that they could only go sideways or down–reason enough to take some profit in the sector.

Nevertheless, the Tang report was enough to drive the sector down very sharply in late August and throughout September.  At one point, some stocks had lost close to half their value before beginning to rebound.  …and then the Europe-related selling began.

what does all this mean for us today?

Well, the November Macau gambling market results were posted on the website of the Macau Gaming Inspection and Coordination Bureau on the afternoon of December 1st.  Here they are:

Source: Macau DICJ

As you can see from the bold figures, after being wildly wrong about October growth prospects, Ms. Tang seems to have predicted the November results reasonably accurately.

Is there any significance to the November prediction?  My guess is that there isn’t much meaning for the stock market, even if this turns out to be more than a lucky guess.  For one thing, the stocks are much cheaper today than they were when the original report came out.  For another, Beijing has just publicly signaled that it is reversing its money policy to favor GDP growth.  So stocks should now be beginning to discount a reacceleration of the gambling business in Macau–not a slowdown.

It will be interesting to see how the Hong Kong market evaluates this situation.  My hunch is that the mid-November lows will hold, but that the market will want to see at least the December market results before becoming more bullish.

Interestingly, Hong Kong-based analysts didn’t take this as an unambiguously good result.  They point out that, although Golden Week in early October was a rip-roaring success this year, the year on year growth of the market for the month as a whole was the lowest since January.  That’s obviously correct.

They conclude from this that Macau’s wealthy Chinese customers are feeling the pinch of the mainland’s efforts to slow economic growth, and are gambling less as a result.  A corollary, not so clearly spelled out, is that casinos are posting gambling winnings as revenues today that will ultimately have to be written off as uncollectable receivables.  That may also be true, although the bond rating agency Fitch says there’s no evidence of any of this so far. Fitch, in fact, estimates that the Macau gambling market will grow by at least 20% next year, double the rate that the more pessimistic analysts are calling for.

One notable feature of recent months’ results is the market share shift toward the companies with newer casinos, located in Cotai.  This suggests there’s gambling space in other, older casinos that is going unused.  There are any number of explanations for why this may be happening, like transportation bottlenecks that prevent visitors from reaching Macau, or casinos turn away “iffier” credits.  But it’s also possible that we’re reached a phase of market maturity where simply getting to Macau and gambling anywhere isn’t enough.  Some gamblers may be choosing not to go to Macau unless they get a minimum level of service.

If so, we should expect a more sedate rate of growth than the 45% or so we’re experiencing now.  But the more important investment issue may well be to separate winners from losers.  That’s certainly been the case so far in 2011, as Galaxy and China Sands have left other casinos in the dust–especially SJM and MGM.

As I wrote on Friday, the most striking thing to me as an investor about LVS is the huge valuation discount at which it trades compared with its global rivals WYNN and MGM.

To recap:  if we take the current market price in Hong Kong of the firms’ interests in Macau, and in LVS’s case us the same multiple to value its Singapore casino, we get the following results:

market cap of WYNN  = $17 billion  =  market cap of Macau interests   +   $5 billion

market cap of MGM  = $6 billion = market cap of Macau   +   $2 billion

market cap of LVS  =  $34 billion = market cap of Macau + Singapore   - $11 billion.

LVS shares would have to be trading about a third higher just to have its Las Vegas interests valued at zero.

why?

Q:  Why is LVS trading so cheaply?

A:  I don’t know.  What is striking, however, is not necessarily that LVS is so cheap on an absolute basis (although I think it is) but that is so cheap relative to its industry peers.

Possible reasons:

the financial crisis

LVS was in the midst of aggressive expansion when the financial crisis hit.  In late 2008 the company announced that its auditors were questioning LVS’s ability to avoid being crushed by a mountain of debt.  It took a $2.1 billion capital raising and a modification of LVS’s expenditure plan for the accountants to issue a clean bill of health.  Not LVS’s finest hour.

litigation

Every company is involved in lawsuits or one type or another.  Wall Street typically ignores them.

In LVS’s case, however, even though little, if anything, is put down on paper, a series of legal actions appear to have analysts and investors concerned.  Here’s a quote from the company’s latest 10-K (LVSC is Las Vegas Sands Corp.; SCL is Sands China Ltd.:

After the close of New York trading on October 27th, LVS reported 3Q11 results.  Revenue was a record $2.41 billion, up 26% year on year.  Property EBITDA (earnings before interest, taxes and depreciation and amortization) was up 43.2% to $924.1 million.  EPS were $.55, a 61.8% boost over earnings in 3Q10.  The Wall Street consensus eps estimate was $.52.

LVS shares are up by about 4% in aftermarket trading as I’m writing this.

the details

In what follows, it’s important to remember that what a casino company reports as gambling revenue is not the total amount of money bet, but rather the portion of the money bet that it retains or “wins.”  Over a long period of time, the casino’s winning percentage is relatively steady.  In any given quarter, however, it can move away substantially from the long-run average.  In analyzing quarterly results, we should note any short-term deviations and at least mentally adjust for them.

Singapore

Year on year comparisons for the Marina Bay Sands aren’t that helpful, because the casino/resort complex is so new. I’m using quarter on quarter comparisons, instead.

Gambling activity continues to grow rapidly.  EBITDA, which was $413.9 million for 3Q11 vs. $405.4 million in 2Q11 doesn’t show this clearly, though.  That’s because the high roller winning percentage at Marina Bay was 2.99% in 2Q11 and 2.69% in 3Q11 (LVS thinks the normal range for quarterly win in the VIP segment, by far the casino’s largest, should be 2.8%-3.0%).  The q-on-q decline in winning percentage clipped about $35 million from 3Q EBITDA.  The real quarter on quarter growth rate is 10%+, not the 2%+ the accounts show.

VIPs bet an eye-popping $16.7 billion at Marina Bay during 3Q11.  This compares with $12.2 billion in 2Q11 and $10.2 billion in 3Q10–both breathtaking numbers in their own right.

Macau

Same story here.  EBITDA in 3Q11 was $388.3 million, down $3.3 million compared with 2Q11–at a time when market growth, quarter on quarter, was about 10%.  Adjusting Sands China’s winning percentage up to 2Q11 level adds $40 million to the EBITDA line.  This suggests that Sands China held its own in a growing market, despite not adding any casino space this year.

Sands China’s newest, 13.7 million square foot casino in Cotai is slated to open in five months.

US
I’m going to ignore Bethlehem, PA because it’s so small (EBITDA of $25.2 million in the quarter).

EBITDA in Las Vegas was $94.3 million for the seasonally weak 3Q, up slightly from $92.9 million in 2Q11 but up sharply from $58.3 million in 3Q10.   About $10 million of the increase on a year over year basis is due to higher royalty income from Macau and Singapore.  Most of the rest is a halving in the level of giveaways from the $40 million or so LVS needed last year to get customers to come to its Las Vegas properties.

In short, LVS is holding its own in the US and is making money hand over fist in Macau and Singapore.

valuation remains compelling, in my view

(Remember, I own LVS, WYNN and 1128 (if it weren’t for a software glitch Fidelity can’t find/fix, I’d own 1928, too)).

Look first at WYNN, which I consider to have the strongest gambling company management.  Its interest in 1128 is worth about $11.5 billion at today’s market price.  Therefore, the market is valuing the US interests of WYNN at about $5.5 billion.

Next, MGM, the weakest of the big firms.  Its interest in MGM China is worth $3 billion, implying its other interests, including its entanglement with Pansy Ho, are worth $2.7 billion.

What about LVS?  The market in Hong Kong values its interest in 1928 at $17 billion.  Arguably, Marina Bay should be valued at a premium to Sands China.  But capitalizing its earnings on the same basis as 1928 yields a value for the 100%-owned Singapore subsidiary of $25 billion.  This would mean the market values the rest of LVS–Las Vegas and Pennsylvania–at minus $9 billion.  LVS shares would have to be almost 30% higher just to get the needle out of the minus column.

is there a reason for the apparent undervaluation?

A friend who’s a regular reader of PSI asked about ongoing litigation involving LVS, based on a Wall Street Journal article a week or so ago.  I’ll write about this on Sunday.

The litigation may well be a serious issue.  I don’t know.  On the other hand, the stock price already seems to me to be discounting a very unfavorable outcome.

Also, arguably LVS’s leading position in two major Asian markets and its tourist/convention emphasis make it attractive to other countries interested in creating a tourism/gaming industry.  Both WYNN and LVS are seeing synergy effects in Las Vegas from their Asian exposure;  LVS is seeing this in Singapore.  One might therefore expect LVS to be trading at a premium to its competitors, not a steep discount.

WYNN reported 3Q11 results after the closing bell for trading in the New York market on Wednesday.  Revenues were $1.3 billion, up 30% from the comparable period of 2010.  EBITDA (a measure I don’t particularly like but which some investors use) was $381.1 million, up 39% year on year.  Eps were $1.05 vs. $.39 in 3Q10.

The report came as a disappointment to Wall Street, which had been expecting a tripling of earnings per share to $1.18.

details

Wynn Macau

Revenues for Wynn in the SAR were $951.4 million for 3Q11, up 42% year on year.  What disturbed the market, however, was not that eye-popping number, but the fact that the figure was down slightly from the $976.5 million Wynn Macau posted in 2Q11–in a market that was up about 10% quarter on quarter.

Win percentages for various games were within normal ranges, so Wynn being unusually unlucky wasn’t the reason it lagged behind the market.  Rather, it seems that at least some high rollers who might otherwise have visited 1128 were instead checking out the newer casinos that have opened this year.  To some degree, 1128 benefited from this tendency when the Encore opened.  Now the shoe is on the other foot.

Typically gamblers ultimately return to the venues where they feel most comfortable and get the best service–which means Wynn.  The company says it is seeing this happen in October.

Nevertheless, it’s also possible that 1128 is bumping up against the limits of its ability to take in money in Macau with the hotels and casino space it has now.  That amount will gradually rise, with economic growth in China and with inflation.  But if capacity constraints are an issue, comparisons may be pedestrian (+10% or so?) until 1128′s new casino in Cotai opens in 2014-15.

Wynn Las Vegas

On the 2Q11 earnings conference call, WYNN was very enthusiastic about prospects for 3Q11, which in normal times (which these are clearly not) would be a seasonal low point.  Hotel bookings were unusually strong and the company was musing that its table games win percentage might be permanently drifting northward.

I guess non-casino revenues turned out to be pretty much as anticipated, at $266 million.  That was up 11% year on year and down slightly from the 2Q11 figure of $276 million.  From WYNN’s tone three months ago, though, I’d expected a bit more.

Casino revenue for WYNN came in at $126.9 million for the quarter.  The compares with $158.3 million in 2Q11.  It was also slightly less than in the comparable period of 2010.  But the amount bet in the WYNN Las Vegas casinos’ table games was up sharply.

What happened?  The company was simply very unlucky at baccarat last quarter.  The company’s win percentage on table games for 3Q11 was 18.3%.  That’s sharply below the expected level of 21%-24%, and the 27.6% achieved during 2Q11.

If table games win for the quarter had been normal, eps would have been about $.20 higher than actually reported;  win at the 2Q11 rate would have meant eps about $.45 higher.

The company says that win percentages have returned to normal in October.

my thoughts

1128 has lost about a third of its market value on worries about the mainland economy, and on concerns that Wynn and Encore may lose customers to newer casinos.  I still think that 1128 has a shot to make $1.50 a share this year, and (worst probable case) $1.65 next.  Maybe the subsidiary will come in $.10 short for both periods, but not much more than that.  12x earnings seems much too cheap to me.

1128 represents two thirds of WYNN’s market value.  The remaining $5 billion is the Las Vegas operations, which though still anemic are showing progressively stronger results.  Cash flow generation in the US is running at about $400 million, and rising–meaning that domestic operations would be yielding 8% if considered as a stand-alone income vehicle.  The US operations aren’t being run simply to generate cash.  In fact, it sounds as if WYNN would welcome the opportunity to build a casino in Miami, if asked.  But looking at them as a quasi-bond suggests (to me) that they have considerably more value than the market is now awarding them.

All in all, I’m happy to hold the WYNN and 1128 shares I own.  At the moment, however, it’s hard to see where near-term earnings acceleration is going to come from.

In fact, an aggressive trader–which I’m not–might think of switching some money into LVS.  I don’t think LVS is as strong a company as WYNN, but it’s cheaper and it has more potential near-term earnings momentum–coming from Singapore and its soon-to-open new casino in Macau.  But market sentiment can be a funny thing.  It’s tide can quickly reverse.  Even news on possible resolution of EU financial problems might be enough to swing investor attention back toward the Wynn family of companies.  For me, I’m content to be patient with what I consider two undervalued issues.

On October 4th, while the Hong Kong stock market was closed, Macau’s Gaming Inspection and Coordination Bureau announced total gambling “win” for the SAR’s casinos for the month of September.  Brokerage house analysts in Hong Kong had hinted broadly that the number would be weak, due to supposed financial reverses being suffered by affluent mainlanders.  There was also the negative effect of Typhoon Nesat, which forced a shutdown of schools, businesses and most transportation (but not the casinos themselves) in Macau on September 29th, to consider.

Nevertheless, the reported figure was another excellent one, as can be seen from the chart below:

If we adjust the figures for the negative effects of the typhoon, on the idea that Macau lost a day’s gambling business (I think two days might be more realistic), then the gross gaming revenue for the SAR in September would be MOP 21.977 billion, and the year on year gain would be 43.6%.

massive selling ahead of the report

There has been huge selling of the Hong Kong-listed Macau gaming stocks since a report from a prominent analyst at Deutsche Bank predicted that a sharp slowdown in the growth of the Macau gaming market was imminent.  Even though Las Vegas Sands was quoted in the Wall Street Journal and the Financial Times on October 2nd as saying that the company saw no signs of weakness in September, selling in Hong Kong seems to have reached a crescendo on October 3rd.  On that day, most Macau gaming stocks fell over 10%; SJM, whose casinos generate about a third of Macau’s total gaming revenue, lost 25% of its market value.

Yes, this was a little (more than a little, in my view) crazy.  The only sense I can make of the sharp declines is that short-term traders feared weak revenue numbers would be released by the Macau DICJ while Hong Kong was closed on October 4-5.  Maybe they had no time to read the papers.

where to from here?

It seems to me that the recent selling in world equity markets, including Hong Kong, has been driven by fears of an implosion in the EU financial system, leading in Lehman-like fashion, to a freezing up of world trade and a consequent severe global economic turndown.  However unlikely this scenario may be, a turn in the mood of short-term traders will probably require concrete evidence that this won’t happen.  Hence the focus of eyes and ears on Germany and France.

For the Macau casino stocks, the idea that a substantial downshift in gambling by affluent mainlanders is “just around the next corner” is a difficult one to disprove, no matter how many corners are successfully negotiated.  In addition, the market participants who dumped out casino shares at, say, 5x normal volume and at prices 25% below today’s prices will have a hard time convincing either themselves or their clients that they should buy the stocks back any time soon.

So the bearish mood surrounding these stocks may remain for a while.

On the other hand, the companies seem to me to have excellent long-term (and short-term) prospects and to be trading at unusually low valuations.

AMZN’s initial strategy for e-books was to compete on price.  In fact, it started out offering e-books as a loss leader.  It was paying the publishers $12.50 for a new release and selling it as an e-book for $10.

The book industry didn’t like this one bit, however, because it feared the tactic would destroy the independent bookstore distribution channel.    So it forced AMZN, by threatening not to sell books to the company, to charge $13-$15 an e-book for new releases and keep 30% for itself (see my posts on Kindle economics for more details).  Take that, AMZN!

As I pointed out then–nothing requiring much insight, only having watched Jeff Bezos operate over the years, I thought AMZN would likely shift to using its hardware as a loss leader to build up sales volume.  The process took a little longer than I anticipated, but the Kindle Fire is the result.

According to iSuppli, the components in the Fire and their assembly cost AMZN about $210 a unit, meaning the company gets no recovery of its research and development costs, and loses $10+ for each unit sold, to boot.  If AMZN marked up the Fire the way AAPL does the iPad, it would sell for $275-$300.  Vintage Bezos.

Presumably, though, the early devices have a lot of redundancy built in (what a disaster if the first ones broke a lot).  But component prices will fall, and the device will gradually be simplified.  My guess is that AMZN will cross the breakeven line in the second half of next year.

2.  Fire is the star, but there’s a mini-explosion of regular Kindles as well. 

Along with the 7″ color-screen Fire, AMZN is introducing a new 6″ e-ink Kindle with audio and text-to-speech.  The latter comes in touch screen and physical keyboard models.  With 3G connectivity, they cost $189.  They’re $40-$50 less with wi-fi only (which is what the Fire has).  You can knock another $30-$40 off is you’re willing to accept advertising.

And, of course, there’s still the original 6″ Kindle at $109 and the jumbo-size 9.7″ Kindle DX at $379.

3.  AMZN is already offering Fire extras.

For example, there’s:

–a two-year extended warranty, that also covers three instances of accidental damage, for $44.99,

–a cover for, $24.99-$44.99, and

–streaming of TV shows and movies through Amazon Prime–which costs $79 a year and also gets you free two-day shipping on all AMZN purchases.

4.  AMZN’s formidable cloud computing capabilities back the Fire, too. 

AMZN is promising super-fast internet browsing with the Silk browser every Fire comes equipped with.

How so?

AMZN’s on-line retailing operations require massive server banks.  Because the company has to have enough capacity to handle surges in demand during peak selling periods, it can often be left with as much as 90% of its servers idle.  Years ago, it turned to providing cloud computing services to third parties as a way of using this asset better.  Its careful study of its customers’ behavior while on the Amazon site has also given it the ability to anticipate their needs–meaning it will be able to pre-load onto a Fire device likely next pages even before the user tells the browser to request them.

More about this tomorrow.

my thoughts

Fire may not have the upscale cachet of the iPad.  But the price is right at the level where surveys of US consumers suggest they’re willing to buy a tablet.  It’s small, weighs less than a pound and has a battery life that AMZN puts at 8 hours of active use. 

It seems to me the Fire will prove very attractive to consumers on the go, just as the early netbooks drew traveling businessmen for their light weight and essential functionality.  I doubt the form factor will stagnate in the way that netbooks did, though, and I don’t expect the iPad will move downmarket to challenge.  AMZN could easily be a very big winner with the device.

In yesterday’s trading in New York, MPEL, a pure play on Macau casinos, fell steadily during the day end ended down 9.3%.  WYNN, down more than 10% intraday, closed with a loss of 7%+.  LVS, which had fallen almost 8% during the afternoon, closed down 5.3%.  MGM, the third Las Vegas/Macau conglomerate–but a company with other issues–shed a “mere” 3.3% of its value.

That was just a warmup act for Hong Kong overnight.  Wynn Macau fell more than 17% overnight and Sands China 14%.  The “best” of the Macau casino performers among Hang Seng stocks was SJM Holdings, which lost 8.4%.

All these issues have given up about a third of their value in the past couple of months–although almost all remain strong year-to-date outperformers.

Why?

The ostensible reason is that growth in China may be slowing–maybe even to the point where, at the bottom, the country will be posting only a 5% GDP advance in a year or two.  Casinos weren’t the only decliners on this worry.  TIF fell almost 7% yesterday, after having been down over 10% intraday.  In contrast, Signet Jewelers, which has only US and UK operations, rose slightly.

my thoughts

It seems to me that there’s no rational basis for the declines.  Affluent Americans haven’t stopped buying at TIF, for example, despite the fact that the US economy is barely north of zero.  Quite the opposite.  Jewelry comps throughout the industry are at 10%+–and rising.  So I don’t see the logic to the argument that because affluent Chinese citizens will have “only” 20% more income next year rather than being up 35%, their consumption patterns will change markedly.

Two caveats:

Bad markets aren’t rational.  They’re emotional.  In hindsight, they may make little sense.  But that’s cold comfort if you get run over by a runaway locomotive barreling down a track where nothing logically should be.

The depth of these declines has got to suggest to a growth investor like me that I might be wrong in my assessment of future earnings.

what to do

A value investor would add to his positions.

A growth investor who owned none of these stocks would buy a little–and then watch for a while.  A growth investor like me, who has a large enough holding in this sector already, tries to take the point of view of the seller to try to discover what he knows that I don’t.

On that score, I’m coming up empty so far.  For me, then, the best course is to stay on the sidelines.

The next important data point will be the release of September Macau gaming revenue by the SAR government, possibly over the coming weekend.

I don’t know NFLX well, other than as a user of its products.  I’m still annoyed at myself for not having bought it two years ago.  But I haven’t been motivated to do the work I’d need to own it, so I mostly just watch the price as a barometer of the market’s feelings about growthy, techy consumer stocks.

Clearly, the recent plunge from the $300+ high to the current $130 runs sharply counter to the experience of most consumer-oriented secular growth names (more about this tomorrow).

the recent price increase…I know that the company has other issues.  I have no opinion, positive or negative, about the stock.  I just want to make a comment about the mess that the company made about the price increases it recently announced.  My take is that the move is actually a good thing.  The way NFLX went about it, however, shows a stunning lack of basic management skill.

…is a good thing…

Why good?  Yes, there are some cases where consumers actually want to pay more for an item–like buying an $8,000 Hermès handbag– to display their wealth or sophistication.  This isn’t one of them.  So for NFLX raising prices inevitably means losing customers.  There’s no way around that.

If the early returns are reliable, however, upping prices by 15% has lost the company 4% of its subscribers.  Revenues are still at least 10% higher than they would otherwise have been.  And NFLX can presumably build from there. Also, customer defections, relative to the company’s expectations, have been concentrated in users of DVDs only, the segment that NFLX wants to de-emphasize.

…done in awful fashion

Top management of most consumer companies spend a great deal of time thinking about prices.

They know that there are tipping points where regular customers of the products/services may dramatically slow down usage if the price exceeds a certain level.  They also know that these points are virtually impossible to predict in advance.  In the casual restaurant business, for example, a venue with a $17 per person average check may have diners lining up all around the block.  An $18 per person check-less than a 6% difference, on the other hand, may translate into lots of empty tables.

They also know that any really visible price rise–one that forces the consumer to think about how much he’s actually paying in total–is particularly perilous.  As NFLX has found out the hard way, $8-$10 a month isn’t that significant for its customers.  An extra $2, or the choice of remaining at the old price for a lower level of service, is.  It focuses attention on the fact that NFLX can cost $150 or more a year.  And, of course, there are probably a certain number of people who don’t use the service but have forgotten to remove the fee from the recurring payments on their credit cards.

As well, higher prices not only can spur customers to look for substitutes; they can provide a pricing umbrella under which rivals can prosper.

Also, techy things typically don’t go up in price.  They either stay the same for a new model that’s a lot better, or they go down.  As a result, for NFLX  any price rise comes as a shock.

NFLX appears to have been completely clueless.

what could NFLX have done instead?

Remember, I haven’t studied NFLX closely, but there are a at least a couple of tried-and-true marketing tactics that companies use to raise prices.  For example:

–new and improved.  Companies often offer additional features–better content, preferred access, faster access, a wider selection, other stuff you may not need/want–as at least a psychological justification for customers paying more.

–a program of small but steady price rises.  To eliminate sticker shock.

–a public relations campaign in advance, interviews in the media, or communication with customers, to explain the economic necessity for raising prices.

–more conservative guidance.  This may simply have transferred the negative Wall Street reaction to the earlier point in time when NFLX gave guidance, rather than when the company lowered it.  But it would have suggested that NFLX has a better feel for its customer reaction to higher pricing.

where to from here?

The Wall Street analysts’ earnings consensus for NFLX for 2011 is about $4.50 a share, meaning that the stock is trading at slightly under 30x current profits.  While the stock doesn’t appear cheap to me, the company does appear to be growing at a pace much faster than 30%, even after its current stumble.

I think a buyer has to believe two things:

–that NFLX will continue to grow profits at 30%+ for as far as the eye can see, and

–either that management has made an isolated mistake, or that having sharp people at the top isn’t crucial to the company’s success.

The company is presenting at a conference today.  We may get more input from that.

Last Monday in Hong Kong, Wynn Macau announced that it had received a 25-year concession from the government of the SAR to develop a new casino in Cotai.  The concession consists of 51 acres of land.  1128 will pay a land premium of US$193.4 million and annual rent of US$771,738.

The planned casino, which WYNN has been talking about for the past six months, will likely cost US$3.0-$3.5 billion and will probably debut in 2014 (the concession requires the casino to be in operation within five years).  Given that 1128 already has about US$ 1 billion in cash on the balance sheet and will probably earn another US$2 billion from its existing Macau casino operations before the new venue opens, financing the project will not be a problem.

market implications

I think there are four:

1.  Macau, which I think has done an excellent job of developing the casino industry in the SAR, has been very careful in recent years grant new casino concessions slowly enough that supply doesn’t outpace demand.  The WYNN concession indicates that it believes strong demand from the mainland will continue for at least the next several years.

2.  There had been speculation in Hong Kong that Beijing was upset at the relatively greater success of US casino groups in Macau vs. the incumbent Ho family.  The WYNN concession shows me that this isn’t the case.  All along I’ve believed that the SAR has actually been eager to have US casino operators (why else give an initial concession to WYNN?), for two reasons:  to get the convention/resort expertise of Las Vegas, and to break the power of the triads in the market.

3.  The Hong Kong stock market has apparently begun to worry about what happens to the casino industry in Macau after the concessions granted to current operators end in 2022.  I think these worries are silly–as if Macau would set onerous new terms that would compel operators either to leave or to run their casinos to extract capital rather than expand.  That would turn the SAR from the Las Vegas of China into its Atlantic City–an outcome that would be disastrous both for the casino operators and for Macau.

For those who think that pieces of paper are more important than common sense in these matters, the WYNN Cotai concession agreement requires the company to remain in Macau and run a casino for the next twenty-five years.

4.  There have also been market worries that, because current concessions end in about ten years, western banks won’t finance casino expansion.  For the incumbent operators, this is not a big issue.  For one thing, casinos are so cash generative that a company like 1128 won’t need financing.  For another, mainland Chinese banks are likely the preferred lenders to the casinos.

thoughts on WYNN and 1128

Both WYNN and Wynn Macau have been spectacular performers, year to date.  I don’t think anything is “wrong” with either stock.

WYNN hasn’t participated in the market rebound of the past few days, mostly, I think, because it resisted the preceding downdraft.  1128 is suffering from (misplaced, in my opinion) jitters in the Hong Kong market about the possible rapid deceleration of growth of the Macau gambling market.

For the moment, the US market is, understandably, concentrating on stocks that have been severely beaten down in the market’s fall.  I expect investor interest will return to WYNN soon enough (although I have written October $170 calls on a small part of my holding).

1128, which I also hold, is a more difficult situation to assess.  To US eyes, it’s a fabulous stock.  It’s trading on well under 20x forward earnings, with easily 25-30% earnings growth is prospect–much more if the Macau gambling market remains as strong as I think it will. And there’s the capacity expansion in a couple of years, as well.  Yet Hong Kong investors, who will make or break the market in the stock, appear unwilling so far to differentiate 1128 from its much weaker competition.  And they’re clearly worried about a possible downturn in Macau gambling.  More patience may be required here.