buying Sands China (1928:HK): why, troubles, developments…(lll)

background

The Macau has been very proactive–and very astute–in cultivating the gambling business in the SAR.  It has, for example:

–introduced sophisticated competitors like WYNN, to spur growth and innovation,

–regulated the pace of capacity expansion, to maintain a balance between supply and demand as well as to regulate the number of construction workers imported into the economy at any one time, and

–prevented destructive price competition initiated by weaker entrants, to maintain a minimum level of overall market profitability.

The main area of planned capacity expansion for the Macau casinos is Cotai, an area that, as I see it, is more or less landfill.  Development of new properties there has two steps:

–an informal one, which consists in preliminary government approval, followed by land remediation and preparation for new construction, and

–a formal one, the preparation of a detailed casino plan and receipt of final government approval.

the Sands China situation

The Macau strategy of LVS, the parent of Sands China, appears to be to create as much new capacity as it can, as quickly as possible, so it can have a dominant relative market share in Macau.  A side benefit of this idea is that it may discourage others from adding plant and equipment themselves.

To this end, Sands China is already actively developing plots #5 and #6 in Cotai, and awaiting labor availability to complete the task.  And it has already spent US$110 million in preliminary work on sites #7 and #8 and applied to the Macau government for formal planning approval to go ahead with construction on both plots of land.

last week’s 8-k

LVS filed a form 8-k with the SEC on December 2nd in which it said that the Macau government had refused planning permission for China Sands to go ahead with development of sites #7 and #8.  1928 has the right to appeal.

What does this mean?  How did the Macau government reach this decision?

I don’t know.

Three possibilities occur to me:

1.  This has nothing to do with 1928, but is an attempt by Macau to slow the growth of the market, so that supply and demand for gambling will stay roughly in balance.   In this case, the issue would be timing, and there’s a chance that Sands China will get planning permission after a while.

2.  Something about Sands China’s strategy, or LVS’s aggressive use of financial leverage, bothers the government.  If so, a pause in its expansion might give LVS a chance to reduce leverage.  That’s arguably good for the firm.  Again, permission may come in time.

3.  According to theWall Street Journal, other factors may be at work.  Sands China dismissed its top management earlier in the year.  The Journal says that the former CEO, Steve Jacobs, alleges in a wrongful termination suit that he was ordered to arrange for secret investigations of Macau government officials.  The Journal doesn’t state, but seems to me to want readers to infer, that these inquiries, legal or not, are behind the denial of permission to go ahead with site #7 and #8.  But this alternative would imply that LVS has a lot of fence-mending to do with the Macau government.

a caution

In addition, the WSJ also maintains that SJM Holdings, the Stanley Ho-controlled incumbent casino operator in Macau, has already applied for permission to take over the two sites for itself.  This will be an interesting development to watch.  To me, it seems that the effect of virtually every gambling-related decision of the Macau government since reverting to Chinese rule has been to diminish the power of SJM, the former monopoly casino operator.  I’ve concluded that this is the intent of Macau’s actions.

I think this is a good thing.  It also gives me greater comfort in holding stock in a casino group that a) isn’t locally owned, and b) can pass muster with the regulators in either New Jersey or Singapore.

Conversely, a decision in favor of SJM, while not perhaps a signal to abandon the Macau market immediately, would make me more concerned about holding stocks doing business in the SAR.

Note:  the pedigree of SJM doesn’t appear to faze MSCI, which has just added the casino operator to its Hong Kong index.

Stay tuned.

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