Monthly Archives: October 2010

The Macau gambling market: September 2010 results

October 7, 2010 By in Asian economic development, Casinos, China, Current Market Thoughts, Entertainment, Hong Kong, Industry Analysis, Stock ideas, Uncategorized Tags: , , , , , , , , Leave a comment

The Gaming Inspection, and Coordination Bureau of Macau, the casino regulator in the SAR, posts total market casino win statistics monthly on its website.

The 2010 figures, year to date, along with comparisons with the comparable periods of 2009, are as follows:

* 1 HKD = 1.03MOP (Unit:MOP million )
Monthly Gross Revenue from Games of Fortune in 2009 and 2010
Monthly Gross Revenue Accumulated Gross Revenue
2010 2009 Variance 2010 2009 Variance
Jan 13,937 8,575 62.5% 13,937 8,575 62.5%
Feb 13,445 7,912 69.9% 27,383 16,488 66.1%
Mar 13,569 9,531 42.4% 40,951 26,019 57.4%
Apr 14,186 8,340 70.1% 55,137 34,359 60.5%
May 17,075 8,799 94.1% 72,211 43,158 67.3%
Jun 13,642 8,269 65.0% 85,853 51,427 66.9%
Jul 16,310 9,570 70.4% 102,163 60,997 67.5%
Aug 15,773 11,268 40.0% 117,935 72,265 63.2%
Sept 15,302 10,943 39.8% 133,237 83,208 60.1%
Oct – – – – – –
Nov – – – – – –
Dec – – – – – –

Source:  Gaming Coordination and Inspection Bureau, Macau SAR

The pataca is worth about US$0.125.  So the market win in September is about US$1.9 billion.

To me, the most interesting aspect of the report is how quickly Wall Street picked up on it.  The figures were posted on the GCIB website at around 7am, New York time, on Monday.  Yet, the strong positive response to the figures in New York trading could be seen in the stock prices of the US firms with Macau interests–WYNN, LVS and MGM–from the opening bell.  US gaming analysts’ reports (I’ve only seen abstracts on the internet) commenting on the figures were apparently circulating among professional investors earlier than that.

the September figures

They’re really good.  That’s the bottom line.  Beyond that, the statistics aren’t completely straightforward.

Year over year comparisons are affected by the financial crisis, which severely reduced casino patronage in the first half of last year.  The market was still up for 2009, but only by about 10% vs. 2008.  If we look at the two-year growth rate for the market, as a way of offsetting some of the recession distortion, the advance comes in at a heady 30% annual rate.  That’s probably a better indicator of the market’s expansion than the 60%+ growth some first-half 2010 months showed.

In addition to the recession, government regulation has had an effect on the longer-term growth figures as well.  For one thing, it’s much easier today than it was a couple of years ago for a Chinese citizen to get a government ok to visit Macau.  For another, the SAR has stepped in over the past couple of years to slow down capacity expansion, capping the installation of new table games in Macau to an extra 10% in total.  And it intervened early in a potentially profit-devastating price war over VIP junkets, setting a ceiling on the incentive fees a casino could pay to organizers for steering clients their way.

The result of government policy, both the mainland and Macau, has generally been to slow revenue growth, meaning that above-average growth will continue for longer, but to ensure better profit performance.

where to from here?

One of the beauties of the casino business is that it’s relatively simple to analyze.  If we assume that the share of their income that gamblers wager in casinos is relatively fixed, then market revenue growth should be a function of expansion of nominal GDP and of growth in the number of gamblers.  In a mature market, the growth in gamblers is simply a function of the growth in the working population.

For Macao, the predominant source of gamblers is the mainland, at about 50%, followed by Hong Kong at around 25%.  Let’s say that nominal GDP will expand at around a 10% rate for the next few years in both places.  Put working population growth at 1%.  This would mean that in a mature state, Macau gaming revenues would rise by about 12% annually.

But the number of visitors to Macau is rising at close to a 20% annual rate, indicating that there are still gamblers, especially in China, who are potential Macau customers but who have yet to visit.  How long can this rapid annual increase in visitors go on?  That’s the big question for this market.

The short answer is there’s no way to tell.  We can try to extrapolate from experience in the US in Las Vegas.  The worry is that the size and structure of the US and Chinese economies is so different.  But here’s my guess:

Let’s say half the population of the US is affluent enough to afford to gamble in Las Vegas.  That would be 140 million people.  About 36 million, or about a quarter of the total, visited Las Vegas last year.  If we say that 10% of the population of China is affluent enough to gamble in Macau, that would be a potential market of about 130 million.  Of that number, about 10 million, or 7.7% of the total, are likely to visit Macau this year.

So, if mainland Chinese had the same propensity to gamble as Americans, then there are about another 20-25 million potential customers on the mainland yet to be tapped.

Even if that number is twice the real size, that would mean that mainland visitation to Macau could double from the current level, which could add 10% to the annual growth rate of casino revenues for the next seven or eight years.

signs capacity is getting tighter

We’ll know more when LVS, WYNN and MGM report September quarter earnings, but I’ve heard reports that hotel rooms are becoming harder to find between now and the end of the calendar year.  If true, that would be god for the non-casino side of the Macau businesses run by Americans.  The casinos might benefit as well, since an excess of patrons in a static capacity environment means table stakes may rise–leading by itself to a revenue boost.

lots of stock choices

So far, a quickly rising tide has supported all casino boats, year-to-date at least.  More than doubling, the Hong Kong-controlled companies have been the best performers.  Foreign-controlled firms have made about half those gains.

To me, the most basic questions are:

–do you want an American company trying to being Las Vegas-style gaming to Macau?  Americans think this is superior technology; Hong Kong investors, so far, see strangers who don’t know the market that well.  Hong Kong’s Disneyland probably didn’t help the Americans’ cause.

–do you want the baggage the Ho family brings with it?  Again, so far, this has been no problem for Hong Kong investors, although it has always been one for me.

My answers:  stick with either Wynn Macau or Sands China, or their US parents.

short selling as an investment tool: risk arbitrage

October 4, 2010 By in Basic Concepts, black knight, hedge funds, Investment firms, Risk Arbitrage, short selling, white knight Tags: , , , , , , , Leave a comment

what it is

Risk arbitrage is an investment strategy based on exploiting pricing anomalies in mergers and acquisitions.  It’s one of the older hedge fund-like activities in the financial markets.

Let’s say that company A, which is trading at $30 a share, announces a bid to acquire company B, which is trading at $50 a share.  The bid is for stock, at a proposed rate of two shares of company A stock for each share of company B.

after a bid is announced

The bid will have two consequences:

–company B is “in play.”  Chances are it won’t survive as an independent company.   B’s top management and board of directors will be focussed on obtaining a higher price than A has initially offered, and possibly on finding a more suitable (or la least, different) merger partner (see my post on black and white knights).

–the way professional investors evaluate B’s stock changes.  Right now, and for as long as acquisition is a possibility, B’s stock no longer exists as an independent thing.  In the simplest case, one where the merger is friendly, no other bidder is in sight, regulatory and shareholder approval appears assured and the date for merger is also reasonably certain, B’s stock is already A’s stock under a different name.

In this case, the arbitrage is straightforward.  Shares of A are trading at $30.  Shares of B, which are really A shares in disguise, are trading at $25.  Therefore, the arbitrageur buys B and sells A short until the two prices–adjusted for the cost of money until the merger is completed–converge.

Life isn’t always this simple.  Arguably, a skillful risk arbitrageur doesn’t want it to be, either, since in the plain vanilla case just described, the arbitrage opportunity is gone in a flash.  The arbitrageur’s analysis of a bid situation typically has three parts:

1.  What is the true value of company B to a trade buyer, or–arbitrageur’s nirvana–a private equity firm?

2.  What are the chances of achieving this value?  In particular, who would pay the full price?  …will that entity bid?  …what regulatory obstacles would he face?

3.  What happens if the bid on the table is withdrawn?

The calculation of the price B should be trading at is a straightforward expected value.  The arbitrageur’s decision to buy or not will be a return on invested funds keyed off it.

what the price of B is saying

Figuring that it would take six months after announcement for an agreed merger to take place, the cost of funds should only amount to one or two percent of the price paid for B shares.  In this case, B shares should initially trade, I think, somewhere around $57 (remember it’s a 2-for-1 deal) and gradually drift up toward the $60 offer price.

Sometimes, the price of B spikes above the offer price.  This usually indicates that arbitrageurs believe a better bid is in the offing, either from company A or from another party.

Sometimes, the price of B goes up, but only modestly.  This typically signals arbitrageurs’ beliefs that regulatory or other hurdles diminish the chances of the combination ever taking place.

Occasionally, the price of A will drop sharply, indicating the stock market doesn’t like the deal at all.  In an agreed merger, this will drag B’s stock down with it.  Often, there’s good reason for investor worry.  On the other hand, a bid announced in March of last year would doubtless have unleashed a torrent of selling in A’s stock.

before a bid–prospective arbitrage vs. value investing

Actual arbitrage is event-driven.  What do arbitrageurs do all day if all their capital is committed to deals?  Like other professional investors, they go to conferences or to the gym.  Maybe they blog, although that would be hard to get past the compliance department.

On the other hand, what if there are no deals?  Sometimes, arbitrage firms try to anticipate areas where merger and acquisition activity may be brewing and buy shares of likely acquisition targets.  When I started writing this section I was tempted to say that in doing so, these firms act just as ordinary value investors would.  While it’s true that growth investors end up holding acquirers and value investors their targets, I don’t think my thought is quite right.

It is possible, I think, to identify broad areas where, conceptually at least, industry consolidation is likely.  For example, when the EU began to drop customs controls at the borders between member countries, this unleashed a multi-year wave of mergers and acquisitions in the grocery industry.  Supermarkets wanted to rationalize their distribution networks and achieve larger scale to give them more bargaining power with their suppliers.  This, in turn, triggered a second wave of consolidation, this time among packaged goods companies, as they sought to reestablish their negotiating advantage over the supermarkets.

At present, the computer hardware and software industries strike me as ones where consolidation will continue.  Also, China seems to me to be very eager to turn its dollar holdings into physical assets by buying companies that either will provide that country with natural resources or that will be distribution outlets for its finished goods.  Washington, however, like Paris, seems bent on preventing this from happening in the US.

Causes of the May 6th “flash crash”: the SEC/CFTC report

October 3, 2010 By in day trading, hedge funds, Recent Market Action, securities markets, stock market, Trading Tags: , , , , , , , Leave a comment

Last Friday, the Securities and Exchange Commission and the Commodity Futures Trading Commission issued their joint report on what caused the sudden drop in stock prices on Wall Street in mid-afternoon on May 6th.  The full report is 87 pages–plus some colorful charts–long.

The first eight pages give a summary of the findings, which MarketWatch has edited–that is, deleted the footnotes–and presented in two pages that are easier on the eyes.

some background…

1.  I posted twice about the mini-crash when it occurred.  Here are links to the first and second post.

2.  Traditional investment management companies, seeing the appeal of hedge funds to their client base, have created their own hedge fund-like offerings over the past half-decade.  Some have become very popular and are now very large.  One of these, unnamed in the report, triggered the market fall when it placed a large computer-controlled order to sell a specific stock index futures contract, the E-mini S&P 500.

3.  One of the tactics day traders use is to scan the market for unusual movement–up or down, it doesn’t matter–in stocks whose trading patterns they feel familiar with.  When they see abnormal pressure, they’ll step in to take the other side of the trade.  They figure the pressure is temporary and that when it ends the stock will revert to its normal trading level.  They’ll then unwind their position at a profit.  For longer-term market participants, day traders provide a useful liquidity-enhancing service that allows them to shift money from one stock to another more quickly.

4.  Brokers, and especially the big discount brokers catering to individual investors, have their own internal market-making operations.  They try, if possible (they have to abide by rules on searching for better prices from third parties), to match, in-house, one customer’s buy order with another’s sell.  This way, they earn the bid-asked spread, which can be much more than the commission they charge.

The report calls firms that do a lot of this “internalizers.”  There’s nothing necessarily wrong with doing this, either.  After all, someone is going to earn the spread.  The relevant point is, though, that  under normal conditions this order flow never hits the NYSE or other exchanges.

…to understand what happened on May 6th

At 2:32 pm on May 6th, the unnamed mutual fund company initiated an order to sell 75,000 E-mini S&P 500 futures contracts (about $4 billion worth, or a few percent of typical daily trading volume).  They told the SEC/CFTC they did this to try to protect stock positions against losses in a market that had been drifting downward for about two weeks.  The E-mini, traded on the Chicago Mercantile Exchange’s Globex electronic trading platform, is preferred by many to other contracts that are traded using the older “open outcry” (that is, yelling) system.

The portfolio manager who placed the order gave two instructions to his trading desk:

–the order was to be executed by computer, not by a human trader, and

–the order would be fed into Globex in amounts no more than 9% of what had been traded in the prior minute.

The manager could have given other instructions–say, put in a price limit, or a specification of a maximum amount of the order to be done before checking with him/her–but didn’t.

The institution had apparently done an E-mini sell this large only once before.  On the prior occasion, the trade was done partly by humans, partly by computer, and took five hours.  Maybe it didn’t work out as well as the initiating portfolio manager would have liked.  In any event, this time the manager put the order right to the computer, cutting out the human fail-safe.

Either by accident or portfolio manager design, the May 6th trade was completed in 20 minutes, leaving a securities market train wreck in its wake.

(The SEC/CFTC report simply records the fact of this trade.  As someone who has worked with various kinds of trading rooms for three decades, however, I find the account of the trade really strange.

This was a $4 billion order, so a senior person placed it.  Yet, he/she doesn’t seem to have realized how huge it was–it and the earlier sell order were two of the largest three one-day sells in the E-mini of the prior year. At the very least, he/she seems to have made no provision to monitor the trade, even though a new procedure was being used.

No one at the firm seems to have sensed that the trade was having negative ripple effects on the financial markets.  Apparently, no one tried to stop the trade before the 75,000 contracts were sold.  The issue isn’t necessarily that one should have a social conscience, although the firm may well have damaged its professional reputation.  Again, no comments from SEC/CFTC, but the trade execution must have been at terrible prices. Comments in the SEC/CFTC report do suggest that the portfolio manager involved had little grasp of basic features of the E-mini market.)

the order hits the market

As the order began to be executed, short-term traders did their thing.  They took the other side of the trade and sat back to wait.  When the selling stopped, they planned to reverse their positions at a profit.   That would pay for the big lunches they’d just had, or maybe for summer camp for the kids.  Some day traders also looked for discrepancies between futures prices and the physical market and hedged–transmitting, as usual, the futures market action into physical stock trading.

But the mutual fund computer didn’t stop.  Day traders started to get worried, and started to offload some of the risk they had taken on that day, both from this trade and others.  In other words, they started selling, too.  Their defensive behavior had the perverse effect of increasing E-mini volume, however. That meant that, although counterparties were signaling that they didn’t want to trade any more, the mutual fund computer obeyed its instructions and upped the speed of its selling.

Several things happened next:

–market makers either stopped making markets entirely or set bid-asked spreads that they thought only a crazy person would act on,

–which caused a trading halt in the E-mini, helping that market to stabilize and recover.

–retail investors, nervous after two weeks of decline, bad economic news and the market dropping that day, panicked and placed market orders to sell physical stock as well, and

–at least one big “internalizer” effectively shut down in-house operations and directed a big wave of sell orders to third parties–where the loony bids and asks resided.

After twenty minutes, punctuated by the saving grace of the trading halt, the mutual fund computer was sated and shut itself down.  The market rebound was already under way.

lessons learned

I imagine that one person has learned that you shouldn’t put in an order to sell $4 billion worth of anything–especially something new–without watching for a while to see what happens.

The rest of the world has learned that accidents like this can happen.  Presumably, the next time the markets won’t panic as much.

At the end of the day, the exchanges and FINRA (Financial Industry Regulatory Authority) huddled together and decided to void all trades that were more than 60% away from a reference price they determined.  Two aspects of this decision troubled market participants:  it came after the fact, and the process wasn’t clear.  Since the exchanges and FINRA represent the brokers, the natural suspicion–correct or not–is that they cancelled mostly trades they lost money on.  Not an idea that encourages buyers during market declines.

The SEC and FINRA have since developed a set of rules to cover what trades, if any, will be voided as/when this kind of market decline recurs.