Gambling on growth: A postcard from Macau
The evolution of Macau’s gaming sector continues, and after a period of severe underperformance, the prospects for growth once again look appealing in a sector where we first invested in late 2012.
There are parallels between the current environment and that of 2012, when gaming revenue growth was decelerating and the junket operations and VIP segments were coming under pressure. Now, as then, we are seeing green shoots of recovery, and we are again prepared to take a contrarian stance towards this out of favour sector, via our position in Galaxy, whose share price rose four-fold and then halved all in the space of 3 years, like the casino it is.
The changes in business dynamics for Macau’s casino operators are easily visible. Premium customers are a rare breed nowadays, following the crackdown on corruption, and their spending is lower. The low-hanging fruit from the high-end segment is now fully monetized, and the growth engine has moved from these high rollers to the mass market, where bets are lower but margins are higher, due to the absence of the junket operators taking their cut. Visitors to Macau are also demanding a more sophisticated experience, with increased emphasis on high quality non-gaming facilities – good hotel rooms, luxurious dining and entertainment facilities. This fits with the preference of policymakers, who would like to reduce the economy’s reliance on gambling and ensure the sustainable development of Macau. Improved access via high speed rail links into mainland China, and the completion of the Macau-Hong Kong bridge will both drastically reduce travel time for visitors, sustaining the inflow of new customers on a long term view.
Construction along the Cotai strip is in full swing, the standout development being the Galaxy Macau Phase 2, opened in May 2015 and doubling its capacity on completion, which blends in seamlessly with the existing Phase 1 structure and stands opposite its re-opened Broadway Macau mass market casino. Phases 3 & 4 of the same project will add growth and continuity over the next 3 to 5 years, helping Galaxy capture both visitor growth and margin expansion as its mix shifts towards the mass market, transitioning from its previous VIP-centric model. Our 2012 investment thesis for Galaxy of diversification into the mass market boosting both revenue and profitability remains broadly intact, and its potential to expand its non-gaming operations into the neighbouring Hengqin Island is well aligned with the government’s policy and social objectives, namely alleviating issues relating to land shortage and over-crowding.
The base mass market is where we see the highest multi-year growth potential in Macau, and we believe that visitor and spending levels will continue to rise in this segment, which is less affected by President Xi’s crackdown on corruption than the VIP or Premium mass markets. That is not to ignore the headwinds to growth that have surfaced in the past 18 months; tightening transit visa arrangements, curbing the usage of cross border Union Pay card machines, and imposing a smoking ban on public floors. Share prices have factored in the negative impact on growth from these changes, and the subsequent drop in spending and visitor levels in the high end segment. Macau gaming revenue is back to 2010-11 levels, models have adapted and expectations have been reset.