on a winning streak

Macau gambling stocks have been on a tear recently.

During the past three months, the S&P 500 is up by 4.5%, the Hang Seng down by 1.8%

Over the same time span, Galaxy Entertainment (HK: 0027) is up by 24.4%; MGM China (2282) is up by 30.3%; Sands China (1928) has gained 32.8%; and the current star of Hong Kong (although a severe laggard until the current run), Wynn Macau (1128) is up by 40%.

The three months have seen advances by the US parents of the Macau gambling stocks, as well, but of a lesser magnitude.  MGM is up by 12.5%. LVS by 21.5% and WYNN by 21.9%.  MPEL, an unusual situation, is ahead by 25%.

arbitrage situation?

This performance differential has created an unusual valuation situation:

—WYNN, for the first time I can remember, is trading at a slight discount to the value of its interest in Wynn Macau, meaning the company’s US holdings–the brand name, royalty/management fees from 1128, and the Las Vegas operations–are being valued on Wall Street at right around zero.

—LVS is a less clear case, since its valuable Singapore gambling subsidiary is 100%-owned, and therefore not publicly traded.  Still, LVS’s interest in 1928 represents about 3/4 of the parent’s market cap.  Even if we valued Marina Sands at 40% of the worth of Sands China, a figure I think is too low, the total of the two subsidiaries represents about 115% of LVS’s worth on Wall Street.

—MGM, in my view still by far the weakest of the Las Vegas Big Three, doesn’t get my hands racing to fill out a “buy” ticket.  But MGM does look far less risky than it has seemed to me in the past.  That’s because the value of its holding in MGM China now represents over 70% of the parent’s market cap.

why the strength in Hong Kong?

…and why should 1128 be leading the pack?  After all, Wynn Macau is presently capacity constrained, and its new casino complex won’t open until 2015.

I think the ongoing rebound in the Macau gambling market is part of the reason the stocks are strong.  Wynn Macau has been getting attention because it has been a severe laggard among the Macau casino companies in Hong Kong trading over the past year.  But I think there’s another important reason as well:

To my mind, the Hong Kong market has already understood the enormous potential size of the mainland gambling market in a way it failed to do initially.  I think it also has come to appreciate the earning power of the Las Vegas gambling model, which it woefully underestimated at first.  Now, the mind of the market, realizing that Macau has a superior product, is turning to the possibility that the Macau gambling companies can duplicate their success in other areas.  The catalyst for this is the introduction of a bill in the Japanese Diet to legalize casino gambling in that country.

What I think we’re seeing now is an anticipatory reaction to the possibility that one or more of the Macau gambling companies will get a Japanese casino license.

buy the parent or the subsidiary?

This is an age-old question–the pure play or the place where the brains of the operation have their own money.

The standard answer is that the safer place is with the parent, but the greater initial sizzle is with the subsidiary.

this situation is a little different

1.  It isn’t clear that everyone in Macau has the money or the inclination to apply for a license in Japan.

2.  It’s not a lock that everyone who applies will pass the local “suitability” tests.

3.  It isn’t clear what part of some of the various companies would hold a Japanese license.  A lot probably depends on the tax regime, but my initial thoughts are:

–for Galaxy Entertainment (0027) there’s no issue

–for WYNN, I presume a license would be held in 1128

–in the case of MGM, having a license inside 2282 means holders of the parent only have a half interest

–for LVS, it’s harder to say, since the company already has two completely unconnected Asian subsidiaries.  It could easily establish a third, meaning that Sands China holders would be left out in the cold.