Good (not great) June quarter from Wynn Resorts and Wynn Macau: negative stock market response

WYNN’s 2Q2010 results

WYNN reported second quarter earnings results after the market close in New York yesterday.  Revenue for the company during the three months ending June was $1.o billion.  Earnings per share, adjusted for unusual items, were $.52 vs. $.09 in the comparable quarter of 2009.  That’s way above analysts’ estimates of $.41 (even just using the back of an envelope, I don’t understand how the consensus could have been that low, however).

As has become usual, there’s a stark contrast between the performance of the WYNN casinos in Las Vegas and the operation in Macau.  The former continue to limp along, showing positive cash flow but bottom-line losses; the latter continues to rake in money at an astounding rate.

WYNN fell by about 3% in after-hours trading in the US.  1128 (Wynn Macau) dropped by about 3.5% in Friday Hong Kong trading (which began at 9pm EST on Thursday).  “Weak” results from Macau are probably the reason.

details

I should mention at the outset that I’ve tried a number of times to access the replay of the company earnings conference call, without success.  So what I’m writing comes just from looking at the numbers.

Macau

The amount gambled in the Macau market rose a mind-boggling 80% year on year in the second quarter.  That figure “sagged” to 65% in June, apparently as Asian high rollers decided to concentrate on watching the World Cup.  Don’t worry, though.  Business has recovered in July.

The market numbers aren’t a secret, by the way.  They’re posted on the Macau casino authority (in Chinese, Portuguese and English) on its website.  Each month, they also manage to be leaked early by a Portuguese news service.

If we look at the first quarter, the Macau market grew by 57% vs. the beginning of 2009 and the amount gambled at the Wynn casino almost doubled.  In contrast, despite the opening of the Wynn Encore in the former Portuguese colony, so Wynn had more capacity, the amount wagered at 1128 grew “only” by 72%.  WYNN’s win percentage in Macau during the June period, which is what the WYNN income statement shows as revenue, was higher than normal.  So the fact that 1128 lagged the market–while very clear from the company press release–is hard to see from the income statement figures alone.

The high roller market can be very quirky on a short-term basis.  So there isn’t really any reasonable conclusion to draw out of one quarter’s performance.  I think 1128 is still on track to earn at least HK$.80 a share this year, putting it on a multiple based on today’s price of under 17.  I think the stock would easily trade at twice that if it were a US stock–but, of course, it’s not.

Las Vegas

After eliminating unusual items, it seems to me that WYNN lost about $40 million in the first quarter and just over $30 million in the second.   Hotel occupancies were up by about 6% year over year but room rates were down by almost 10%–a reflection of the overcapacity that is affecting the market, and also of the juggling act between room rate and occupancy that hoteliers constantly perform in a time like this.

Table game play was down slightly and slot machine play (less important for WYNN) dropped by close to 20%.  But an increase in nightclub business and entertainment more than offset this.

The current lackluster situation for WYNN in Las Vegas should come as no surprise to investors, since the offering documents for a recently completed bond refinancing contain the essential information.

my thoughts

For WYNN, it’s thank goodness for Macau, where the company is waiting for government permission to build a third casino in Cotai.

1.  If we were to take an aggressive stance and project HK$1 in eps for 1128 for this year and assign a 20 multiple to that, then WYNN’s 72.3% interest in the subsidiary would have a value of just under US$10 billion.  This compares with a total market cap for WYNN (as I am writing this) of about US$10.5 billion.

That’s the optimist’s view.

2.  As reflected in the current 1128 stock price, however, WYNN’s holding is worth US$6.4 billion.  Add cash of US$1.7 billion on the balance sheet and you get an implied US$2.6 billion value for the Las Vegas operations.  This is too high, in my view.  As I mentioned in my post on WYNN’s March quarter 2010 results, US$1.8 billion would be a better estimate for today.

3.  A more realistic–maybe even conservative–assumption for 1128 would be earnings of HK$1 over the coming 12 months and a multiple of 18.  That would imply a value for WYNN’s holding of about US$9 billion.  Add to that mild recovery in Las Vegas that might boost asset value to US$2.3 billion, toss in the US$1.7 billion or so the company has in cash on the balance sheet and the total WYNN value would be US$13 billion.

What does this all mean?

Valuation #2 suggests that WYNN is fairly valued at today’s price if we incorporate just the here and now.  If we think nothing particularly good–or bad–will come out of Las Vegas in the foreseeable future, then WYNN should trade based on movements in 1128.  Each dollar change in the 1128 share price would imply a $500 million change in WYNN’s asset value.

Wall Street is a futures market, though.  Valuation #3 is my base case.  This would imply about 20% upside for WYNN in the coming year, with better potential–but greater risk–for 1128.

Las Vegas Sands: an interesting June 2010 quarter

LVS 2Q2010 results

LVS reported 2Q2010 results after the close yesterday.  On a GAAP basis, the company was just slightly below breakeven vs. a loss of $.34 a share in the second quarter of last year.  Operating income was $166.8 million for the three months vs. a loss of $171.3 million in the comparable period of 2009.  Removing non-recurring items, net income was $129.3 million or $.17 per share vs. $8.8 million, $.01 per share, in the year-ago quarter.

The biggest reason for the improvement was the huge increase in income from the company’s casinos in Macau, where the overall market revenues in the first half grew strongly enough to eclipse the full-year 2007 results, with only about a 10% increase in the number of slot machines and table games.  LVS was also helped by the opening of its Singapore casino during the quarter.

my takeaways

I don’t have an investment opinion about LVS.  It’s a complex, highly financially leveraged company, with a lot of moving parts, and I haven’t studied it enough.  My thumbnail sketch:  LVS is a highly competent casino operator, with an emphasis on middle market and convention business.  The company overstretched itself in expanding aggressively–in Las Vegas, Macau, Singapore and Bethlehem, PA–going into the recent economic downturn and was hurt badly by that decision.  Conversely, although risky, it stands to be an outsized beneficiary of economic recovery, as it progressively gets its debt under better control.

Because of its geographical diversity, LVS can give good insight into global gaming trends.  That’s what I’m writing about today, based on the 2Q financials and the earnings conference call.

1.  The Singapore gaming business is off to a better start than expected.  The mass market is very strong, thanks in part to the efforts of LVS’s competitor in the market, Genting.  The highroller business is showing a greater geographical reach, and better credit experience, than LVS thought it would. The company is attracting gamblers from Malaysia, Indonesia, Vietnam and Thailand, as expected, but also from Hong Kong, China, Taiwan and Korea.  It’s still early days for this market, but so far, so good.

2.   In Macau, LVS’s high roller business was good and its stores sold a lot.  The mass market segment lagged, though.  Despite its two main casinos posting operating income up 155% and 44% year on year, LVS seems to think it should be doing even better.  Recently, LVS fired its Macau chief executive, Steve Jacobs.  Commenting on this in the conference call, LVS CEO Sheldon Adelson said he would “opt for him to go to a direct competitor.”  The company also said the Macau “problem” was not in the layer of staff below Mr. Jacobs.  The Hong Kong market reaction to the Sands China earnings was muted.  Despite opening up about 4%, 1928 closed down HK$.04.

3.  Convention business is beginning to revive in Las Vegas.   Demand from groups for convention/meeting space is strong.  The biggest issue is that there’s so much overcapacity in Las Vegas that rates remain depressed.  (LVS, WYNN and MGM all launched major expansions just as the downturn was beginning.  The last of these, MGM’s mammoth City Center, only opened late last year.)

WYNN reports tonight.  We already know from offering documents for a proposed bond refinancing that WYNN’s results in Las Vegas were weaker in the second quarter of this year than last.  Hotel occupancies were up but rates were down.  It will be interesting to compare the Macau results of WYNN with those of LVS< however.

Is Wall Street’s “tactical” efficiency fading?

strategically inefficient…

Any student of Wall Street, or any other world stock market for that matter, knows that investors periodically fall under the sway of manias or panics.  In my professional life, I’ve lived through–among others–the mania for oil stocks in the early Eighties, for Japanese stocks in the late Eighties, for Asian stocks in the early Nineties, the Internet bubble of the late Nineties and the run-up to the recent meltdown of financial stocks, during which period commercial and investment banks could do no wrong.

In the aftermath of these episodes, markets can become quite depressed.  Occasionally, as in early 2003 and early 2009, stocks can temporarily fall so far in price that the dividend yield on the stock market of a country exceeds the coupon on its government debt.  Inevitably, a sharp rally follows.

Another way describing this behavior pattern is that in a strategic sense stock markets are very inefficient.  Investors have very little consciousness of the forest.

—but tactically efficient

On the other hand, in my experience, stock markets have always been very tactically efficient.  That is to say, publicly available information about specific companies is either anticipated by investors prior to public announcement–from, say, the results of private surveys or by inference from industry data–or at the very least, very quickly incorporated into stock prices.  In the Eighties, for example, Kyocera was the sole source for ceramic casings that Intel used to hold its newest microprocessor chips.  Kyocera’s production plans were publicly available in Japan.  So analysts soon learned to give a call to Kyocera’s investor relations department to find out this valuable leading indicator.  More recently, during the iPod boom, one could get a good handle on Apple’s production plans by looking at orders for the micro-motors that turned the small form factor hard disk drives that every iPod contained.  iPods were virtually the only users of these tiny drives, which were made almost entirely by a single company, Nidec.  No need to call Japan; Nidec had a New York investor relations office.

what about now?

I’m not sure I want to make a strong claim for Wall Street’s tactical efficiency any more.  Three recent occurrences that have really stock out to me:

–Fed Chairman Bernanke recently gave congressional testimony that caused Wall Street to drop sharply as it heard his words.  But he was just repeating what had been said in the minutes of the Fed’s Open Market Committee meeting, which had been released the week before.

–The New York Times Company reported results last week (I wrote briefly about this on July 23).  The company said that ad revenues were basically flat–for the first time in a long while–because online ad growth was big enough to offset the decline in print advertising.  Two days later, after this was flagged in the newspapers and by news services online, the stock reacted by rising 4% or so.

–In mid-June, FedEx was the first of a series of transportation companies to announce that its international business was booming.  It felt good enough about its prospects to begin restoring employee compensation cut during the downturn (I also wrote about this, on June 20).  The stock went down on the news–and stayed down amid a series of similar bullish announcements by other transport firms.  It rose sharply yesterday when it said (surprise, surprise) that the trends it spoke of in June were continuing in July.  As a result, near-term earnings would be higher than FDX’s original guidance.

why no discounting?

First of all, it may be that these are anomalous incidents.  It’s possible that what I see as the market not discounting important information is actually the discounting mechanism working in a much more sophisticated way than I perceive.  I don’t think so, but I’ve got to keep this in mind.

I think two factors are at work:

–large-scale layoffs of veteran researchers by investment banks has reduced the quality and quantity of research output by the sell side.  The same is likely true, to a lesser extent, of the buy side.

–the absence of individual investors in the stock market, either through direct stock purchases or through investment in actively managed mutual funds.  Computer-driven trading, an important factor in market movements since the Eighties, may have lost part of the counterbalance provided by stock-picking activity.

conclusions?

If my perceptions are right, the risk character of individual stock selection may be changing.  The rewards may be greater, but their timing may be less predictable.  The biggest practical result may be that you will either be way ahead of the market in buying a stock (and may need a lot of patience) or way behind it (and be playing an idea that’s long since discounted in today’s price).  More on this topic in later posts.

developments on the e-book front

There are two interrelated struggles going on over the potential revenues from e-book publishing.  One is among the sellers of dedicated e-readers, like the Kindle, the Nook or the Sony e-reader–each with one another, and all with AAPL, the creator of the iPad.  The last is a general internet content consumption device that hopes e-books will be one of many profitable sales opportunities for it.

The second is between authors and their publishers over who possesses the e-book rights to older “backlist” titles, whose contracts don’t spell out explicitly who owns them.  This “software” situation is at least as muddled as the “hardware” one.  Some literary agents and publishers have made their negotiations public; most have not.

The ones I know about on the publishing side seem to separate into two camps:  Random House and everyone else.  The issue is the royalty rate at which authors will be paid for backlist titles sold as e-books.  Authors’ agents point out that the incremental cost of selling an e-book is negligible, and that the e-book question is not addressed in the book contracts.  They conclude that their clients should get a higher percentage of such sales revenue than their contracts specify, since those implicitly factor in a physical publishing cost element.

Smaller publishers have been quietly striking deals with agents.  Random House has not.  It has taken the stance that it already owns the e-book rights to older titles because the contracts don’t explicitly exclude them.  It has also been conducting a gentle op-ed campaign to suggest that a book is really a collaboration between author and editor–and that the final product may be far different from the original manuscript acquired by the publisher.  I take it the suggestion here is that the book may not be the sole intellectual property of the author, to do with as he pleases, even if Random House were to be eventually found in court to have misinterpreted its older book contracts.

Last week, both battles reached a higher public profile when powerful literary agent Andrew Wylie, who represents a stable of hundreds of prominent authors, agreed to sell the exclusive e-book rights to twenty classic novels, including Norman Mailer’s “The Naked and the Dead,” Philip Roth’s “Portnoy’s Complaint,” and Salmon Rushdie’s “Midnight’s Children” to Amazon for the Kindle.  These are all titles under contract to Random House.

Random House has responded by stopping all new English-language book negotiations with Wylie.

This will be an interesting situation to watch.  The Wylie action only includes twenty books.  The Amazon deal is for a limited, two-year, time.  Presumably Wylie has chosen the titles with care–meaning authors/estates with the weakest ties to Random House.  So it is more a shot across the bow than a declaration of all-out war.  Random House’s action seems to me to be an overreaction.

Both moves may have unintended consequences.  I don’t see what Wylie has to lose, however, or what Random House has to gain, from their current positions.

Suppose sales of the twenty titles through Kindle are much better than anyone expects?  Then more authors will want to jump on the Kindle bandwagon and Random House will either have to backtrack or make a more draconian response.  If the latter, will it risk angering Wylie clients and losing them permanently to other booksellers .

Suppose sales are awful?  This is the “good” outcome for Random House–discovering that the e-book rights it is so ardently defending have no value.  I suspect this won’t be what happens, though.