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.

End game for growth stocks: nasty, brutish but not very short. How does AAPL fit the mold?

the growth stock life cycle, in brief

The Wall Street cliché is that the key to successful growth investing is how skillfully you sell the stock (as opposed to value investing, where the key is how you buy it).

The idea is that most growth stocks have a very short life in the stock market sun–five or so years.  The best growth companies continue to reinvent themselves and create new lines of business–as WMT or MSFT did.  But most aren’t able to.

As the company demonstrates surprisingly strong earnings growth, the stock market attitude gradually changes from one of disbelief to fandom–extrapolating the period of superior profit expansion much farther into the future than will likely pan out.  This tendency shows itself in a huge price earnings multiple–both absolute and relative to the rest of the market.

Normally, the seeds of future earnings disappointment–and consequent price earning multiple contraction–are already being sown in a qualitative sense at least.  But many investors ignore, or explain away, these early warning signs even when they begin to be evident in reported earnings.  At some point, disillusionment, and subsequent underperformance, begins.

MSFT as an example

MSFT is a good example of this phenomenon.  In the four years from 1995 to 2000, MSFT’s reported profits per share grew at a 40% annual rate,  meaning they quadrupled over that span.  The price earnings multiple expanded from 29 to 53, and advance of 83%, over the same period.  Therefore, more than two fifths of the total 10x stock gain came from p/e expansion.

Over the subsequent decade, MSFT’s eps grew at a little more than a 10% clip–and the stock’s p/e contracted steadily from 53 to 13 (or 3.5x the market average multiple to .9x currently).  Despite the doubling in earnings the  stock price has been cut in half, more than all of which is due to p/e contraction.

If we look at MSFT in general conceptual terms, the stock was first driven by the acceptance of the MS-DOS operating system, then by the Office suite, and finally by successive iterations of the Windows graphical user interface–all in an expanding PC market.  Then the market for its products matured, MSFT came late to the Internet, its diversifications earned little money and…  Nevertheless, it’s important to note that MSFT lasted as a growth stock for such an unusually long period because of its successive waves of innovation from MS-DOS on, not just because the PC market was growing quickly.

How does AAPL fit this model?

Looking in the most general terms, AAPL was a moribund personal computer firm with a cult-like following among individuals using PCs that had a change of management.  New leadership introduced a portable music player, the iPod, that was so successful it quickly doubled the size of the company.  AAPL subsequently introduced a revolutionary smartphone, the iPhone, which again doubled the size of the company.  Now it’s introducing a third product, the iPad in a hope of doing the same trick again.

What AAPL has done over the past decade is truly remarkable.  Earnings per share have grown at a 60%+ annual rate, and are now 10x what they were in 2005. The company is now one part PCs, one part iPod, and two parts iPhone, three of which weren’t there five years ago.

Two potential questions about AAPL’s future performance have emerged:

–One is the “concept” observation that to have the same positive effect on the overall company as the iPhone has had, the next product, presumably the iPad, has to be twice the size of the iPhone.  This is just a fact of the company’s recent growth.

–Android phones are emerging as a potential competitor to the iPhone; iPod unit sales are slipping; Chrome-based tablets are potentially going to be on the market for this year’s holiday season.  Wall Street is presumably thinking that Chrome products will end up being a case of the Zune redux.

one big difference

In 2005, AAPL’s stock was trading at 26x earnings per share.  Today, after a period of extraordinary earnings growth, AAPL’s stock is trading at under 17x eps, a pe multiple contraction of 30%.  AAPL’s relative pe was 1.4 in 2005.  It’s 1.1 now.

Unlike the typical growth stock, more than 100% of AAPL’s stock performance has been driven by earnings growth.  The pe contraction means investors have been increasingly forcefully betting that the company can’t continue its present rate of expansion.  In fact, one might argue that a pe multiple of 17- means the market thinks AAPL won’t grow earnings by more than 15% from now on.

my thoughts

Personally, I think tablets will create a new revolution in computer usage.  I’m not sure the AAPL will get the market share with the iPad that it has been able to achieve with the iPhone or the iPod.  Still, if my reading of the stock price dynamics is correct, I think Wall Street is being much too pessimistic about AAPL’s prospects.  Hard as this is to say about a stock that has had 15x the market return over the past five years, that’s what the numbers tell me.

big week for news: NYT the most interesting?

Some aspects of the quarterly financial reporting season now underway are coming in about as one might expect.  The foreign arms of US multinationals are doing better than their domestic counterparts.  Firms whose main customers are businesses are reporting higher earnings gains–and eliciting a more favorable response from Wall Street–than those that cater to the consumer.

Of all the corporate announcements this week, three jump out at me, though.  They are:

–Citigroup announced yesterday the results of one of its periodic surveys of the consumer, based on telephone conversations with 2,005 individuals last month.  The real attention-grabber is the conclusion that almost two-thirds of Americans don’t believe the economy has “hit bottom” yet.  Most think it will take several years for things to return to normal for them.

Normally, ordinary people are much savvier than Wall Street gives them credit for.  And survey participants’ ideas of when the country is back to normal coincides closely with that the Fed thinks.   But it’s hard to figure what to make out of the “hit bottom” idea, since the domestic economy did hit bottom about a year ago and has been bouncing back since.  Maybe it’s just a poorly phrased question.  Maybe it means that most people don’t have clear evidence that their family fortunes have turned up yet (as opposed to the idea the headline portrays that things are continuing to get worse).  Maybe it’s not a comment about the families’ individual situation but about the country as a whole and the size of the government deficit.

In any event, it suggests that a US consumer spending boom isn’t right around the corner.  Le’s hope C goes for less shock value and more information the next time it asks the questions.

–On July 19th, three days before announcing (disappointing) June quarter financial results, AMZN issued a press release about its sales of e-books on Kindle.  Over the past three months, AMZN’s overall unit sales of e-books have been 43% higher than its sales of hardcovers;  in the past month, e-book unit sales have been 80% higher than those of hardcovers.  In addition, the (unspecified) growth rate of Kindle e-readers has tripled since AMZN cut the price from $259 to $189.

The timing of the announcement says AMZN wanted to make sure this information made a separate impact on investors/consumers and didn’t get lost in the welter of data contained in an earnings release.

I don’t think this development can be good for AMZN’s near-term profits from books–not that AMZN’s management it too worried about that.  What’s interesting is that e-books now appear to comprise well over 10% of total book sales in the US–and accelerating.  Only AMZN knows for sure what its market share in e-books is, but the Kindle press release makes it sound like AMZN is getting three-fourths of the business.

–The most interesting announcement, to me anyway, is that made by the New York Times Company in its quarterly earnings announcement yesterday.  NYT’s online advertising revenues, which grew by 21% year over year, were enough to offset a 6% decline in print advertising sales, leaving overall ad revenues flat.  I don’t know NYT well as a company and I’m not sure this does much for the stock.  But I wouldn’t have guessed that the newspaper company’s painful transition into a new world was this far along.