As one of the industries hit hardest by the pandemic, the gaming industry appears poised to rebound amid the ongoing economic recovery in the U.S. While Las Vegas is recovering, Macau has become a key determinant to the credit fundamentals for American casino operators. Economic reopening does not seem likely in China in the immediate future given the COVID surge, but the eventual resumption of travelling activities will provide credit upside for the casinos.
From the U.S., Las Vegas Sands Corp., MGM Resorts, and Wynn Resorts operate three of the six casinos in the Chinese city of Macau, with ownership stakes of 70%, 56%, and 72%, respectively. Over the last two decades, Macau became the world’s largest gaming locale as disposable income in China ballooned amid strong economic growth. The surging growth in Macau’s gambling industry, which accounted for 84% of the enclave’s fiscal revenue as of 2019, translated into significant returns on the operators’ investments and facilitated reinvestment opportunities as well as significant dividend payments to investors.
Indeed, these firms used to get as much as 70% of their total revenue from Macau before the pandemic. Las Vegas Sands, the world’s largest casino operator by market capitalization, attributed half of its $31 billion valuation to its stake in the Sands China venture.
The pandemic over the past two years, coupled with China’s strict COVID restriction policies, has caused havoc to the bottom line of the Macau casinos. Further complicating the profitability of the business was the prospect of license renewal as the initial licenses were set to expire after two decades. When Macau’s government released a paper outlining potential changes to the license was made public in September last year, casino stocks slumped as much as 40% and bond prices dropped 4 to 7 points as the paper covered unexpected proposals, including amending the terms of the license, regulating dividend payment, and increasing local shareholding of the casino companies. Investors’ fears were assuaged four months later, and asset prices partly recovered, when the actual amendment outlined changes that were much less stringent, although the new law still imposes new restrictions on casino business.
Figure 1
Relative Equity Performances of U.S. Casinos During the License Renewal Process (June 30, 2021 = 100)
PGIM Fixed Income, Bloomberg.
Key features of the bill:
• The term for casino licenses is shortened from 20 to 10 years. Note that Singapore, home of Marina Bay Sands, also grants 10 years of concessions.
• Companies need pre-approval by the Macau government on “material transactions”, but the proposal to regulate dividend payout, a key concern for U.S. casinos, was backtracked.
• A four-fold increase in the minimum registered capital to $5 billion Macanese pataca ($630 million). This is a sizeable increase and it’s still not clear how companies will source the capital, as the capital will need to be in the form of cash and not just the book value of equity, according to tax experts. There is a chance that casinos may end up selling debt to shore up capital, but it is also possible that equity financing is required.
• Junkets are no longer allowed to share revenue with concessionaires. Furthermore, concessionaires will be legally liable for any wrongdoings by the junkets.
To make sure the law has time to go through congress and partly due to COVID disruptions, the government has postponed the license renewal by six months to December this year.
U.S. Credit Implications
Unfortunately, China’s stringent COVID-related travel restrictions remain in place amid the latest widespread surge, keeping Macau gaming results well below historical levels and their U.S. peers’. The deteriorating operating performance also resulted in the curtailment of dividend distributions from the Macau operations. However, we expect that once COVID pressures subside, operating performance in Macau will return to historical levels, and dividends will resume as well. In fact, investors are showing some nascent optimism on such a prospect, based on reports that China is exploring ways to exit its zero-tolerance approach to COVID.
Also, we are positive about the credit profiles of these U.S. gaming giants because they have diversified their assets geographically, completed or in the process of completing asset sales, and are not solely reliant on their respective Macau subsidiaries to meet debt service requirements, an advantage that is reflected in the relatively mild selloff of the parent company debt versus their respective Macau subsidiaries.
Among the three parent companies, the credit profile of Sands should concern investors the least given its solid balance sheet, while MGM generates most of its cash flow from domestic assets and relies the least on its Macau operations. Wynn would be the one credit to watch closely given the high leverage at the parent level, which could present further problems when the company attempts to direct cash earned in Macau back to the U.S. under a potentially more restrictive regulatory environment. To bolster its liquidity, Wynn announced the sale of the real estate of its Boston-area casino in February for $1.7 billion.
Liquidity conditions for the operators are robust, and we think there is value in accumulating the lower-rated players after the overall credit market stabilizes, such as debt issued from Wynn Macau, which is currently yielding around 10% on a yield-to-worst basis. Meanwhile, in contrast to its parent company, Sands Macau’s debt issue was downgraded, and its fallen angel status may lead to forced selling and hence eventually some attractive trading opportunities as it is currently trading at around 450 bp spread.
Conclusion
The gambling industry is heavily scrutinized and regulated worldwide, so we do not necessarily see the latest move by Macau as a sign of the Chinese government radically tightening its grip on the industry, as it has done in the technology and education industries. Even though the new law was considerably scaled back from its initial proposal, we continue to pay close attention to how the gambling industry adapts to the changing operating environment. We believe the casino industry will offer attractive relative-value opportunities once the prospect of economic reopening in China becomes clearer and when the outsized selloff stemming from geopolitical conflicts abates.
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