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.


 

walking around in Las Vegas last week

My wife and I went to San Francisco to see the Giants play two weeks ago.  Then we drove down the coast to Los Angeles to visit relatives.  And we stopped in Las Vegas for a day on the way home, just to see how the city looked compared with our last trip early in the year.

Over the years, I’ve learned that you have to be careful in drawing any firm conclusions about the hustle and bustle you see.  As I’ve already mentioned a long while ago in this blog, I once was in Caesars in Atlantic City at a time when the casino was packed to the gills.   (By the way, I’m not a big casino gambler myself.  I find it too much like work.  But the stocks are simple to analyze and usually generate huge amounts of cash flow.)

I called the company the next day and found out that their profits in Atlantic City were weaker than usual, not stronger.  A main set of doors had broken and no one could get in or out easily.  Few people were actually gambling; most were just stuck, and preventing fresh money from getting in.

Nevertheless, for what it’s worth:

–the city seemed to have far more foreign visitors than in January

–WYNN had a lot more casino patrons

–the Fashion Mall across the street was bustling

–the Bellagio seemed quieter; the visibly worn carpeting in retail areas hasn’t been replaced

–CityCenter appeared a lot quieter than in January

–I didn’t detect much difference with LVS

–every retail complex I saw had at least one vacancy, even WYNN;  CityCenter, understandably had the most empty space.

 

One of the odder aspects of my trip was the controversy that flared up last week over the yet-to-be-completed Harmon hotel in the CityCenter.  MGM is proposing to blow the structure up. (VegasInc has a comprehensive account).  It says the building is a potential hazard in an earthquake, because of construction defects.  Contractor Perini Building Co., which says MGM owes it $200 million+ for its work on the building, asserts any problems are design defects caused by MGM.   Just another day in the desert.

MGM China (HK:2282) came public on June 7

the IPO price

The offering price for the 760 million shares in the offering was HK$15.34, at the absolute high end of the range of HK$12.36 -HK$15.34 determined by the Hong Kong Stock Exchange..

a secondary offering

As I’ve written in more detail in other posts, this IPO is unusual in that it does not involve the sale of primary shares (ones newly issued by the company).  Rather, it’s a secondary offering.  That is, all the shares being sold to the public come from the already-existing holdings of company equity holders.  In this case, the sole seller is Pansy Ho, who owned 50% of MGM China before the sale.

fundamentals

According to the offering documents, MGM China lost money in 2008 and 2009.  It earned HK$1.566 billion last year.  It projects that at a minimum it will have a profit of HK$1.4501 billion for the six months ending June 30, 2011.  This would equate to eps of $.38 per share.

Let’s assume MGM China earns $.80 a share for the full year of 2011.  The offering price would then represent a multiple of 19x current year earnings per share.  When the offer’s pricing range was being set in mid-May, a 19x multiple represented parity with, or perhaps a slight premium to, the multiple investors were awarding to Wynn Macau (HK: 1128), the company I regard as the market leader–and the highest multiple casino stock on the Hong Kong exchange.

early price action

After trading briefly above the offering price, 2282 ended its first day trading at HK$15.16, on volume of a tad below 77 million shares.  It closed overnight in Hong Kong at HK$13.12, or about 14% below the IPO level.

I don’t regard this decline as particularly surprising, since the entire casino sector in Hong Kong has under gone a sharp correction that began in early May (Wynn Macau, for instance, is now trading at about 15x earnings).  What’s more noteworthy is the investment bankers’ ability to get the MGM China issue off at an unusually high price.

my take on the stock

I haven’t seen any sell-side research on MGM China.  The offering documents suggest, however, that the sales pitch for the company is that it represents a blending of the best of East and West–the local market knowledge and connections of Ms. Ho and the technical know-how about glitzy upmarket gaming of MGM Resorts International, which now has a controlling 51% interest in MGM China.  There’s a whole laundry list of related-party transactions between Ms. Ho and 2282 in support of this idea.  The documents do refer to the regulatory problems Ms. Ho has encountered in the US.  But they point out that she has never formally been declared to be “unsuitable” to hold a casino license in the US–although MGM appears to have ceased operating in Atlantic City to avoid this result.

I’m not sure the synergies the market seems to expect will work out.  It’s not 100% clear to me how Ms. Ho will balance her obligations to MGM China with those to the much larger Ho family-controlled rival, SJM.  I’m also not convinced that many talented Las Vegas executives will want to link their fortunes to the Ho family.

Whatever qualms I may have about the Ho family connection, however, MGM and the Hong Kong market–where the price of MGM China shares will ultimately be decided–appear to have none.  In addition, the Macau gaming market appears to me to be still in the rapid growth phase where the rising tide lifts all boats.  So I suspect that despite the fact I won’t be a shareholder the stock will be an above average performer in the Hong Kong market from this point on.

Macau gambling market results: another record high in May 2011

The Macau Gaming Inspection and Coordination Bureau reported on June 2the monthly win for the SAR’s casinos during May 2011..  As the table below shows, thanks both to a successful Golden Week and to the opening of new venues, the take was a record $24.3 billion patacas, almost 20% ahead of the previous record posted just the month before, in April.


Monthly Gross Revenue from Games of Fortune in 2011 and 2010     MOP millions
Monthly Gross Revenue Accumulated Gross Revenue
2011 2010 Variance 2011 2010 Variance
Jan 18,571 13,937 +33.2% 18,571 13,937 +33.2%
Feb 19,863 13,445 +47.7% 38,434 27,383 +40.4%
Mar 20,087 13,569 +48.0% 58,521 40,951 +42.9%
Apr 20,507 14,186 +44.6% 79,028 55,137 +43.3%
May 24,306 17,075 +42.4% 103,334 72,211 +43.1%
 Source:  Macau Gaming Inspection and Coordination Bureau

The biggest winner during the month  appears to have been Galaxy Entertainment, which opened a giant new casino, the Galaxy Macau in Cotai, around mid-May.  The largest market share loser seems to have been Wynn Macau.

Reaction by Hong Kong investors to the May record  has, so far, been muted.  Several reasons why:

–There have already been a series of months of 40%+ year on year gains in casino win recently; the fourth no longer carries the same positive surprise value that the first did.

–MGM is meeting with investors as part of its IPO process, and other publicly traded Macau casino companies have been presenting at investor conferences.  So the news of a strong Golden Week and the expansion of the market due to the Galaxy Macau has already been disseminated.

–I think we’re reaching, at around 20x current year results, the limits of the price-earnings multiple expansion that the Hong Kong market is willing to permit for Macau casino stocks.  Unless/until the market changes its mind, it seems to me that no stock will trade at more than 20x, no matter what current profit growth may be.  If so, the stocks will either tread water, or move simply in line with the market, until investors begin to discount 2012 prospects.

the big three Las Vegas casino companies

My post last Friday outlined the upcoming IPO for MGM China, which will show us the Hong Kong market’s view of the value of MGM’s Macau exposure.  At the top of the price range for the IPO (already specified by the HKSE), and based on last Friday’s closing prices, a 51% stake in MGM China would be worth about $4 billion (all amounts are in US$) and would represent just over half of MGM’s market capitalization.

A reader asked what the rest of MGM–its Las Vegas interests–might be worth.  That’s not an easy question to answer.  So I thought I’d write about what I think are the significant issues for all three of the big casino operators in the Las Vegas market.

the basics of the big three Las Vegas gambling companies

All three have subsidiaries in the booming Macau market.

All three are situated on the Las Vegas Strip, where about half the city’s 149,000-odd hotel rooms are located.

In addition to their expansions into Macau, all three have made major hotel/casino capacity additions in Las Vegas over the past few years–just as the economy was peaking.  These were all multi-billion dollar projects, funded primarily with debt.

three points about Macau

1.  This market is already many times the size of Las Vegas, measured by the amount of money bet in the casinos.  So far this year, Macau gambling is expanding at a 40%+ rate.  I think the market will get to at least double the current size before it gives any sign of maturing.

2.  The obvious source of profits to each of the Las Vegas parents is its share of the Macau subsidiary’s profits.  But that money isn’t readily available for use in the US.  For one thing, it will likely remain in Macau to fund expansion there.  For another, the way shareholders receive income from their stocks is through dividends, which have to be declared by the management (only Wynn Macau has done so) and would be subject to US corporate tax if repatriated.

3.  WYNN, LVS and MGM all receive management fees from their Macau operations, in return for their operating expertise and for the use of their brand names.  This is the partents’ major source of cash from the subsidiaries.  In 1Q11 these fees amounted to $34.5 million for WYNN, $23.8 million for LVS and $38.0 million for MGM.  (The LVS number seems too low to me, but that’s what’s in the company release.)

the Las Vegas problem

It’s hotel room overcapacity, specifically in the high-end rooms on the Strip where the big three are.

In 2006, the Las Vegas market had 132,600 hotel rooms and served 38.2 million visitors.  By last year, visitor numbers had shrunk to 37.3 million, but expansion projects had increased the number of hotel rooms to 140,429.  Together, the need to repay construction debt and the fact that the out-of-pocket costs to a hotel from having a room occupied for a night are less than $20, mean price competition to sign up guests has been wicked. The Strip accounts for about half the room base, but virtually all the expansionso the trouble has been most acute there.

Although the situation for the big three is gradually improving, I think it could be several years before the market grows into the existing capacity.

valuing the big three (all capitalization figures are as of the close on 5/20/2011)

  • WYNN:  The company’s market cap is $18.1 billion.  Its Macau holdings have a market value of $12.6 billion, leaving a $5.5 billion value assigned by the markets to the Las Vegas operations.  In 1Q11, WYNN was right around breakeven in the US, with $60 million in cash flow.  IN the US, WYNN has $87 million in cash on the books and $2.6 billion in long-term debt.
  • MGM:  The company’s market cap is $7.5 billion.  Its Macau holdings are likely worth $4 billion, leaving $3.5 billion in value assigned by the markets to the US operations–which are all over the place, but mostly in Las Vegas.  In 1Q11, MGM operated at a loss but had positive cash flow from operations of about $24 million.  The balance sheet showed $431 million in cash and $12.1 billion in long-term debt.  Until the IPO documents are available in the US, we won’t know how much of either of the last two figures is attributable directly to MGM China.
  • LVS:  The company’s market cap is $30.4 billion.  Its Macau holdings have a market value of $15.1 billion, leaving $15.3 billion in value assigned by the markets to Singapore + the US.  In 1Q11, US operations appear to me to have made a loss but hovered around breakeven on a cash flow basis.  The balance sheet shows $3.1 billion in long-term debt against US operations and just under $800 million in preferred stock.  The biggest issue with LVS is how to value the Singapore operations, which are in their infancy and which are wholly-owned by LVS–so there’s no separate market quote.  A very simple approach would be to say that Singapore is earning about 20% less than Macau, and apply a Macau multiple to Singapore operations.  Since LVS owns 100% of Singapore vs. about 70% of Macau, this would imply all the $15.3 billion is being allocated to Singapore and the US is in effect worth zero.

my thoughts

Take WYNN first.  It’s the strongest company of the three, with its finances under much better control than the other two.  Still, are the Las Vegas operations, generating $250 million in cash flow at an annual rate, but servicing $2.6 billion in debt, worth paying 22x cash flow for?  I’d prefer 10x.

I see two possible justifications for the current WYNN valuation:  the consensus expects a faster recovery in Las Vegas than I’m thinking, or (more likely, in my view) US investors regard WYNN as a more liquid and easier to buy version of Wynn Macau, and are willing to pay a premium to the Hong Kong price, simply to get exposure.

MGM.  If you’ve read any of my previous posts about gambling in Macau, you know I find having to be a business partner with the Ho family to be a deal-breaker.

The hedge fund Paulson & Co has recently become a large shareholder in MGM, apparently betting on the large upside leverage MGM will have as/when Las Vegas turns for the better.  After all, the company owns a ton of Strip real estate.  Over the years, it bought the former Mandalay Bay as well as Mirage Resorts, and has built the gigantic CityCenter complex.  Still, $12 billion in debt and cash flow of $110 million a year are a very risky cocktail to be involved in.  Too risky for me.

LVS.  This company’s financials are almost as complex as MGM’s, but I find it much more intriguing.  Depending on how you value the Marina Sands in Singapore, you could think–as I suggest above–that the present stock price gives you the US operations for free.  …less than that, if you buy the argument that LVS should trade at a premium to the value of its Asian holdings because its the only liquid and convenient way for Americans to buy them.

Yes, there’s $3.1 billion in debt linked to the US casinos + construction obligations that were suspended during the darkest days of 2008.  But management fees from Macau and Singapore seem to me to be potentially large enough to service the debt, even without an uptick in the US business.  Not for widows and orphans, however.

By the way, I own WYNN, Wynn Macau and a little bit of LVS.





MGM China’s IPO in Hong Kong

the IPO details

According to Bloomberg, details, including pricing, for the IPO of MGM China, have been set.  MGM China is currently a 50/50 joint venture between MGM Resorts International and Pansy Ho, daughter of Stanley Ho.   The stock is going to debut on the Hong Kong Stock Exchange–presumably next week–through a secondary offering of 760 million shares by Ms. Ho.  The IPO price will be set by underwriters at between HK$12.36 and HK$15.34.

If we assume that the high end of the range represents a 20x multiple on expected 2011 earnings per share, which is where I view Wynn Macau as trading today, that would mean MGM China could earn HK$.75-HK$.80 this year.

timing of the offer is very favorable

The Macau gaming market is booming.  The publicly traded stocks have been exceptionally strong performers, year to date.

the IPO means cash for Pansy Ho, not MGM

In this respect, the offering is different from the listings of WYNN’s and LVS’s Macau gambling subsidiaries, where the shares sold in the offering came from the US-based parent.

a bit of history

Stanley Ho, Pansy’s father, controlled the monopoly casino company in Macau when it was a Portuguese colony.  After the handover to China in late 1999, the government of the new Macau SAR decided to end the monopoly.  It issued a new gaming concession to Mr. Ho, but also awarded one to Wynn Resorts and to Galaxy Entertainment.  Subsequently, each of the three was allowed to sell a sub-concession to another party.  Mr. Ho chose MGM.  He originally proposed a 50/50 joint venture between himself and MGM.  The Nevada gaming authorities apparently told MGM this was unacceptable because of Mr. Ho’s alleged underworld connections, and Pansy Ho replaced her father as the Ho family partner.

structure of the sale

Pansy Ho will provide all the stock being sold.  1% will go to MGM, giving it a 51% stake and making it the majority owner of MGM China.  Another 20% will go to the investing public (Paulson & Co. and Kirk Kerkorian, the largest shareholders of MGM, are together putting in for about 8% of the issue)It also appears that Ms. Ho has agreed to a 3% overallotment, meaning that the underwriters can increase the size of the issue by that amount, if demand is strong.

So, rather than having a large cash inflow from selling stock, MGM will pay Ms. Ho about US$75 million to gain legal control of the venture.

The news isn’t really so bad for MGM, however.

Not content with keeping the transaction simple, Ms. Ho has apparently agreed to invest several hundred million dollars of her IPO proceeds in securities of MGM Resorts.

Also, pricing at the top end of the range (which is where I would guess the IPO will end up) implies that MGM’s stake in MGM China is worth just under US$4 billion, or about half of the parent’s market cap.  From now on, we’ll probably see the same sort of “tail wagging the dog” effect on MGM shares as we’ve witnessed over the past year with WYNN and LVS.  Given the still parlous state of the Las Vegas market, this is perfectly understandable.  I interpret the recent strength in MGM shares as the start of this behavior.

Pansy Ho’s role in MGM China?

The IPO will confirm Ms. Ho’s status as a multi-billionaire.  Other than that, your guess is as good as mine–maybe better.

As I wrote in more detail a little while ago, in a bizarre sequence of events earlier this year, control of the Ho family gambling concession–by far the largest in Macau, accounting for about a third of the market–appears to have been taken away from Stanley Ho by, among others, Pansy.  Press reports suggest Pansy has resigned from the board of MGM China–though I understand the IPO documents say otherwise.  As I indicated in my earlier post, my reading of the situation is that Ms. Ho wants to present herself as a passive investor in MGM China while she fights for control of the family company.

It’s ironic if the IPO is the vehicle Ms. Ho is using to distance herself from MGM China.  That’s because the IPO seems to me to undermine the argument of the New Jersey gaming authorities that Ms. Ho is completely financially dependent on her father–and therefore unsuitable to hold a casino license.

My guess is that a smaller role in MGM China by Ms. Ho will make little operational difference, and may make both MGM and MGM China more palatable to US investors.