2Q12 for Wynn Resorts (WYNN) and Wynn Macau (HK:1128)

the results

After the New York close on July 17th, WYNN reported its financial results for 2Q12.  Revenue for WYNN, which includes 100% of the revenue of Wynn Macau, was $1.253 billion vs. $1.374 billion in the comparable period of 2011.  Earnings were $139.0 million vs. $200.8 million in last year’s 2Q (before subtracting a $107.5 million charge for the present value of a planned charitable contribution by Wynn Macau to the university there).

EPS were $1.38 in 2Q12, compared with $1.60 in 2Q11.  The reason the eps comparison looks better than the net profit comparison is that the forced sale of Aruze USA’s 24.5 million shares in WYNN to the company reduced the number of shares outstanding to by about 25% 101.0 million.

The immediate reaction of the market to the results was relief that the numbers weren’t weaker than they were.  Of course, on the other hand, it’s not that long ago that WYNN was closing in on the $140 mark, as Wynn Macau received permission to build a new casino in Cotai.

details

Las Vegas

Business is up around 5% year on year, both in the gambling and non-gambling parts of WYNN’s operations.

The hotel/entertainment/shopping gain is straightforward.  It’s not so easy to see the improvement on the gambling side, however.  The industry accounting convention is not to measure revenue by the amount that gamblers bet–which was up around 5% yoy for Wynn in 2Q12–but rather by the share of that amount that the casino wins from them.

For slot machine play, which consists of huge numbers of small transactions, the odds almost always even out during a given quarter.  It’s not the same for table games, particularly for the high-roller segment of the market that WYNN specializes in.  The typical table game “win” percentage for Wynn is about 23%.  But in the June quarter of 2012 that figure was a mere 15%.  And the comparison is against 2Q11, when the win percentage was a whopping 27.6%.  The negative win comparison for high stakes baccarat was even worse.

I don’t think this is anything to worry about.  It’s just a fact of life.  Over the coming quarters, the win percentage will doubtless return to normal–and results will look more favorable than they do now.  The bottom line, however, is that the trend for WYNN’s Las Vegas operations is up.

Macau

Wynn Macau’s results are flattish.  That’s mostly because, for the moment, that market has run out of steam.

Two reasons:

–slowdown in the Chinese economy has translated into a flattening out in business for Macau casinos from mainland gamblers, and

–at the same time, casino floor space in Macau has expanded significantly as operators begin to develop Cotai.

The result is increasing, price-driven competition for junket operators to steer customers to a given casino.  Either customers are offered larger credit lines, or junket operators are offered higher commissions.  Wynn Macau’s position is strong enough that it isn’t compelled to participate.  However, until the economic environment in China improves, Wynn Macau will be doing well simply to maintain the current level of operating profit.

my take

WYNN is the strongest operator in an industry that I think has attractive investment characteristics.  On the other hand, I think LVS is the cheaper stock. And, although I have no desire to sell either WYNN or LVS (I have switched a little money from the former to the latter, however), I think all the Macau-related stocks will mark time until the Chinese market begins to pick up again–probably in early next year.

Are Mac owners wealthier and more glamorous than their PC counterparts? …they certainly spend more

studying web visitors by browser

I use Sitemeter, a service that counts visits and page views on PSI for me.  Among other pieces of information Sitemeter tosses in for free is the operating system visitors use.  In my case, it’s 65% Windows, 22% Mac and the rest Linux.  (In case you’re interested, the blog has several hundred regular readers through email and Twitter, plus a large number I can’t detect who receive it daily through readers.  Half of the blog’s visitors live in the US.  About a quarter come from Europe.  Most of the rest live in the Pacific Basin, with a smattering of page views from Africa and the Middle East.  No Antarcticans that I’m aware of.)  The service costs me less than $100 a year.  Wordpress, which hosts PSI, provides a similar, but less detailed set of data for free.

the Orbitz experience

According to the Wall Street Journalanalysis by Orbitz shows that Mac users who buy hotel rooms from the website pick trendier, and more expensive, hotels than their PC counterparts.  Mac users also spend up to 30% more for their overnight accommodations.

Having figured this out, Orbitz has begun to show Mac users a hipper and more expensive set of hotels when they visit than it offers to PC users.  It does this both by altering the selection of the hotels you see and their placement order on the page.  Orbitz says it doesn’t show the same room at different prices, based on the OS shoppers use.  Mac users just see different merchandise higher on the page.

I have two–no, three–reactions

–Good for Orbitz.

–More reinforcement for the high-status image of AAPL products.

–The chances of Mac users getting a bargain when shopping online will soon be only slightly north of those of a guy who rolls up to a bricks-and-mortar store in a Panamera and uses an Amex black card to pay.

mor evidence of AAPL status

The Orbitz phenomenon isn’t the only sign cited by the Journal of the higher wealth and higher willingness to spend of Mac users.

–Forrester says the average annual household income of Mac users in the US is $98,000+ vs. $74,000+ for PC households (the US average is about $60,000).

–according to BIGinsight.com, iPhone uses are wealthier than Android or Blackberry users

–social gamers on APPL devices spend 6x as much as Android gamers (Newzoo)

–tablet users, which effectively means iPad users, place bigger online orders than laptop- or desktop-piloting customers (Forrester, Shop.org)

–same thing for iPhone users vs. others (IBM).

my take

Personally, I find the psychology of status goods to be fascinating.  People want to exhibit their wealth by paying (a lot) extra for luxury brands vs. non-luxury-brand merchandise.  Virtually no one thinks this reflects badly on their inner sense of self-worth or on their economic judgment.  In my experience, most luxury buyers are either indifferent or unaware that exhibiting these symbols of lack of price sensitivity is a big minus when trying to negotiate over price.

I think the Orbitz research has no negative effect on AAPL.  Quite the contrary.  It simply burnishes the AAPL brand reputation. That should be good for the stock price.

I use a mix of AAPL, Asus and Samsung computer products.  I’m writing this on a Mac.  But I’m certainly never going shopping on an AAPL product again.

hotel stocks: why I think they’re attractive now

not hotels themselves

It’s not that I think owning a hotel is a great investment.  Generally it isn’t.

Like most real estate, hotels can be (and almost always are) leveraged financially using non-recourse debt–meaning that if you can’t repay, the lender can only seize the property, and has no claim on your other assets.  That’s a definite plus.  But office buildings have the same deal and sport much higher and more stable ROIs.

As far as I can see, the typical hotel developer/buyer is an individual or family that views them as symbols of status, signs that they’re “arrived.”

a mature industry in the US

I began covering the hotel industry in the US 30 years ago.  Even then it was a mature industry whose major firms were beginning to develop by:

–segmenting the market by not only offering generic “hotels,” but also resort, luxury, boutique, low-end, extended stay, suites–all the varieties that we have today, and

–selling their hotel properties, while retaining the hotel management contracts that deliver them the bulk of the cash flow the properties generate.

The rest of the developed world has since begun to follow suit.

today’s hotel stocks

The result is that today’s hotel stocks are by and large multi-brand property management companies that control brands and distribution networks (reservation systems and loyalty programs).  Yes, they may own some hotels directly.  But, through their management agreements, their profits are tied to those of all the hotels they manage, even though they don’t have the capital burden of building or maintaining them.

why today?

What makes them interesting to me as investments today is that they’re already comfortably profitable because of the post-recession resumption of business travel.  But they’re also very sensitive to the recovery in leisure travel that I expect will follow the pickup in hiring we’re now seeing in the Bureau of Labor Statistics reports.  (Meetings and conventions are the third big source of income for hotel stocks.  I’m not counting on that getting any better this year.  But it might.  On the other hand, it can’t get any worse, so it’s at least a neutral influence.)

I think the return of leisure travelers (which we’re already beginning to see in results from DIS) will have three aspects:

–a shift from staycation to vacation,

–a move of current Motel 6 stayers to, say, Marriott, and

–gently rising room rates.

According to HotelNewsNow.com, US hotels raised occupancy rates (the percentage of available rooms actually rented) to 60.1% and average daily room rates by 3.7% (to $101.64) last year.  HNN predicts that the combination of rising occupancy and room rates will lift industry revenues by 4.3% in 2012.  I think this is too low.

operating leverage

The key to my positive case for hotel companies is that they have immense operating leverage.  An example:  MAR has achieved an operating margin above 10% only once (in 2007) during the past decade, according to Value Line. 

Consider what happens if room rates rise.  The hotel has almost exactly the same costs if it sells a room at $102.64 as does at $1 lower.  So the margin on that extra dollar is close to 100%, not 10%.  Similarly, if the hotel rents an extra room for one night, its out-of-pocket expense is basically the cost of cleaning it post-stay and putting in new little soaps and shampoos.  That’s about $15.  So the margin on having an extra guest is around 85%.

Let’s say the overall margin on an incremental dollar in revenue is 90%.  If we figure a hypothetical $100 in revenue for a hotel firm at an operating margin of 10% last year, operating profit was $10.  If the extra $4.30 that HNN predicts for 2012 comes in and has a margin of 90%, then it yields operating profit of $3.87.  That’s a 38.7% year on year increase in profit from a 4.3% in revenue.

In reality, no company is going to show that much extra profit.  There’ll always be room refurbishment or other maintenance projects to pay for.  Employees will get raises, new staff will be hired, executives will get bonuses.  But that’s the general idea.

Another, non-fundamental, aspect to the story is that the US stock market has begun to shift its focus from investment ideas that depend only on continuing consumption by the affluent (the major theme since early 2009) to those that are keyed more to recovery of the average consumer.  So the market response to any signs of positive operating leverage of the type I’ve just described may be unusually enthusiastic.

I should point out that this isn’t analysis; it’s the germ of an idea.  That hasn’t stopped me from taking a small position in MAR while I do my homework.  I’ll write more when I finish my work.

cyclical real estate rhythms: where we are now in the US

I recognize that the internet is making important structural changes in the shape of the real estate market in the US.

The most clearly visible to me is that e-commerce is fast making lots of retail space superfluous.  Many strip malls seem to me to be today’s equivalent of the old ghost towns of the Wild West that were all that remained after the local gold or silver mine petered out.  At the same time, fast broadband communication means that a small, but increasing, number of workers are able to live where it suits them rather than near a specific piece of corporate property.  Hence, the rising value of “vacation” or “destination” real estate.  And, of course, in mega-cities like New York we’re beginning to see the presence of wealthy mainland Chinese buyers of second homes.

the business cycle development pattern

Longer term influences aside, there is also a distinct business cycle rhythm to the real estate industry, which is what I want to write about today.  I think we’re at a cyclical turning point.

My experience comes from watching publicly traded real estate companies in the EU and in Asia, where–unlike the situation in the US–they can be important factors in stock market performance.

The pattern is easiest to see with urban office buildings, but it holds for residential and commercial real estate as well.

1.  As the economy begins to expand, demand for space in prime office locations begins to rise.  Vacancy rates shrink.  Price discounting disappears.  Rents begin to rise.

2.  As rents continue to move up, new construction projects are launched.  Some of these will be in prime locations.  But builders also know that as prime areas are filled up, businesses will be forced to consider secondary areas.  Land is usually more easily available there–and it’s cheaper, to boot.  So the secondary locations are a big thrust of new development.

3.   Companies in the central business district respond to higher rents by shipping some employees off to new, lower-cost office space that’s springing up in the secondary districts.  Firms that formerly occupied the secondary districts respond to redevelopment and higher rents there by locating further afield.

4.  Seeing these successive ripples of outward movement, speculators begin to anticipate the next iteration of the process.  They acquire land and perhaps build in anticipation of a tide of firms moving farther and farther from the central business district in search of more reasonable rents.

5.  The outward ripples stop–and the whole process shifts into reverse.  At some point, the combination of new space developed in the central district + existing tenants shifting increasing numbers of employees to cheaper locations causes an excess of prime office space in the center.  The economy may by this time be in cyclical slowdown, as well.  Landlords in the central business district begin to lower rents to lure customers back from secondary locations.  This kicks off successive waves of contraction, as lower rents and greater space availability move firms back to more convenient space.

6.  On the extreme periphery, speculators are left high and dry.  They’re stuck with raw land and, possibly, completed office buildings that they will be unable to use until–at the very earliest–when the next business cycle starts another outward pulse of development.

where we are now

The Wall Street Journal published a front-page article on Monday titled “US Farmers Reclaim Land From Developers.”  In it, the newspaper reports that large amounts of peripheral agricultural land–it cites parcels lying 30 miles and 65 miles outside of Phoenix–are being rebought by farmers out of foreclosure at small fractions of what development speculators paid for them a few years ago.

This is typically the last shoe to drop in the real estate cycle.

I don’t imagine that a new outward pulse will begin in the US anytime soon.  But it also seems to me that there’s virtually no potential for further bad economic news coming from the real estate sector.

thoughts on Las Vegas Sands (LVS)

a big valuation discount

As I wrote on Friday, the most striking thing to me as an investor about LVS is the huge valuation discount at which it trades compared with its global rivals WYNN and MGM.

To recap:  if we take the current market price in Hong Kong of the firms’ interests in Macau, and in LVS’s case us the same multiple to value its Singapore casino, we get the following results:

market cap of WYNN  = $17 billion  =  market cap of Macau interests   +   $5 billion

market cap of MGM  = $6 billion = market cap of Macau   +   $2 billion

market cap of LVS  =  $34 billion = market cap of Macau + Singapore   – $11 billion.

LVS shares would have to be trading about a third higher just to have its Las Vegas interests valued at zero.

why?

Q:  Why is LVS trading so cheaply?

A:  I don’t know.  What is striking, however, is not necessarily that LVS is so cheap on an absolute basis (although I think it is) but that is so cheap relative to its industry peers.

Possible reasons:

the financial crisis

LVS was in the midst of aggressive expansion when the financial crisis hit.  In late 2008 the company announced that its auditors were questioning LVS’s ability to avoid being crushed by a mountain of debt.  It took a $2.1 billion capital raising and a modification of LVS’s expenditure plan for the accountants to issue a clean bill of health.  Not LVS’s finest hour.

litigation

Every company is involved in lawsuits or one type or another.  Wall Street typically ignores them.

In LVS’s case, however, even though little, if anything, is put down on paper, a series of legal actions appear to have analysts and investors concerned.  Here’s a quote from the company’s latest 10-K (LVSC is Las Vegas Sands Corp.; SCL is Sands China Ltd.:

“On October 20, 2010, Steven C. Jacobs, the former Chief Executive Officer of SCL, filed an action against LVSC and SCL in the District Court of Clark County, Nevada, alleging breach of contract against LVSC and SCL and breach of the implied covenant of good faith and fair dealing and tortious discharge in violation of public policy against LVSC. Mr. Jacobs is seeking unspecified damages. This action is in a preliminary stage. The Company intends to vigorously defend this matter.
On February 9, 2011, LVSC received a subpoena from the SEC requesting that the Company produce documents relating to its compliance with the Foreign Corrupt Practices Act. The Company has also been advised by the Department of Justice that it is conducting a similar investigation. It is the Company’s belief that the subpoena emanated from allegations contained in the lawsuit filed by Steven C. Jacobs described above. The Company intends to cooperate with the investigations.”
LVS fired Mr. Jacobs in mid-2010.  He sued for wrongful termination.  Press reports indicate that in his lawsuit Mr. Jacobs maintains that LVS asked him to compile files on prominent Macau politicians and to offer some of them improper benefits.  These assertions appear to have prompted a number of regulatory inquiries, both in the US and in Hong Kong/Macau.   As far as I’m aware, Singapore, which runs a very strict regulatory regime and which awarded LVS one of two casino licenses there, has taken no action.
An article in the Wall Street Journal from October 21 outlines the issues.  This article prompted the question from a reader which has led to this post.
As an investor, not a lawyer, I find it impossible to predict an outcome to all this.  I do have a number of observations:
–It seems to me that LVS has done the right thing by beefing up its legal staff with Washington regulatory experts.  This gives them people who understand the regulatory environment and whom the regulators presumably trust.
–As a stock, LVS is up less than 5% over the past year.  This compares with a gain of 8.8% for the S&P 500 and 28.8% for WYNN).  Sands China, on the other hand, is up 46.1% over the same time period, vs. +32.7% for Wynn Macau and a loss of 13.3% for the Hang Seng index.  So investors closest to the Macau situation don’t seem troubled by the legal issues surrounding LVS/Sands China; if anyone, it’s US investors who are.
–To my eye, Sands China’s results have perked up considerably since Mr. Jacobs was replaced.
–If the discount to its peers is due solely to legal worries, then the numbers above imply that Wall Street is anticipating a negative outcome on the order of $15 billion.
The correct number for legal damages may be zero, it may be a significant figure.  I don’t know.  I own LVS, which means I’m betting that $15 billion isn’t in the right ballpark, or even in the right town.  (This isn’t how I usually invest.  Normally, I’d want to have a precise downside estimate, which I don’t have here.  So my position is small.)
family control
About half the stock in LVS is owned by CEO Sheldon Adelson and his family.  As the 10-K notes, Mr. Adelson’s financial interests may not be fully aligned with those of other shareholders.  In particular, I’d characterize Mr. Adelson as a very aggressive investor in mammoth new projects who has gotten his fingers burned recently. He’s not one to quietly sit by and let his financial leverage decrease to zero.
That doesn’t bother me so much.   It’s just a fact of life.
Based on my limited observation, though, because it’s “his” company, Mr. Adelson doesn’t seem to go to great lengths to cultivate the global securities analyst community.  In his latest conference call, for example, he says he’s going to send analysts towels in the mail, so they can wipe the egg off their faces for underestimating LVS’s prospects.  Maybe that’s a joke and I don’t realize it.   Yes, it’s emotionally satisfying for Mr. Adelson.  But it’s not a gesture aimed at making analysts feel all warm and cuddly about LVS shares  …quite the opposite.
analysts are skittish
This is only partly because of the “us vs. them” undertone the company seems to foster.  Analysts on this stock seem to me to divide into two types:  Wall Street analysts who know a lot about Las Vegas-style gambling but nothing about Asia; and Singapore or Hong Kong analysts who know the local market but nothing about the hotel or gambling industries.  The biggest risk to either group is to be too bullish.
what to do
LVS has a special situation aspect to it, to my mind, because I think it trades at an undeserved discount to its peers.  Operations around the world are going better than expected.
On the other hand, maybe I’m wrong.  Although the stock has performed relatively well recently, it may take time for the discount to narrow.  Negative news on the legal front probably won’t help performance, either.
LVS shares aren’t for the faint of heart, but I’m content to own them.  They may, or may not, have a possible place in your portfolio.  Don’t make this your largest position, though.