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Counting on Korea

Tourism and gaming the goal of government for gaming expansion

Counting on Korea

South Korea’s US.4 billion foreigners-only casino market has done well by China’s gamblers. Indeed, the PRC’s love affair with Korea and all things Korean has sparked a tourism boom in the tiny republic that finds some big names in the gaming industry anteing up a lot of money on the belief that if you build it even more will come.

Like the Mohegan Tribal Gaming Authority, they’ve come from the other side of the world. The operating arm of the Mohegan Indian Tribe, the company behind Mohegan Sun, one of the largest casinos in the world, the company is seeking a license for a $1.6 billion super-resort with a casino—Inspire, it’s called—adjacent to bustling Incheon International Airport and right on the doorstep of the 25 million souls who inhabit metropolitan Seoul.

Not that any of them will be gambling there. Korean law prohibits it. There will, however, be plenty for them to enjoy outside the casino floor. Inspire is being designed for just that.

“Ninety-seven percent of this project will be occupied by non-gaming amenities,” says MGTA President Bobby Soper. “To attract foreign tourists, and to leverage the Seoul market nearby, is what makes this a very attractive opportunity.”

The neighbors that Inspire hopes to join at the airport are thinking the same thing. Two expansive resort plans with similarly expansive budgets are already licensed for a special economic zone the government is sponsoring in Incheon to pivot tourism growth off the airport. One is led by Paradise, the five-casino group headquartered in Seoul that dominates Korea’s foreigners-only market. The other is led by Las Vegas-based Caesars Entertainment, to date the only international gaming company approved to operate in the country.

Which in itself tells you a lot about how far the central government has come in its recognition of the economic power of destination-scale gambling—and how far it still has to go.

Nationally, tourism receipts surpassed $18 billion last year, and they generate jobs for more than 500,000 people. The industry “will be the growth engine for an improved national economy and quality of life,” says the Korea Tourism Organization.

Accordingly, the Ministry of Culture, Sports and Tourism plans to license at least two more resort casinos at a minimum investment of 1 trillion won each ($925 million). More than 30 bidders have entered the running, and for most of them, it’s all about the potential inherent in a dynamic resort cluster—a mini-Cotai—in the 30-mile Seoul/Incheon corridor.

There is a compelling case for it, given the country’s proximity to the major population centers of northern China, a cheap currency relative to the yuan, a comparatively favorable tax structure, and its allure as a destination, stemming in part from the pop culture phenomenon the country has become—the “Korean Wave,” they call it.

Then there is Kangwon Land, nestled in ski country in the mountainous northeast about 95 miles from Seoul, the largest casino in the country by far (200 live tables, 1,360 EGMs) and the only one open to Korean nationals. It generates gaming revenue equal to the rest of the market combined, and as such is a good indicator of the real potential if the government were to allow domestic play, not that anyone expects that to happen any time soon.

Time for Vigilance

China is already the best customer of the relatively modest offering presented by the existing foreigners-only casinos. Mainlanders account for well more than 40 percent of visits to these properties, three of which are in Seoul, one in Incheon (a Paradise license that will be shifted to the new resort), two in the southern city of Busan, two in the east in provinces bordered by the Sea of Japan, eight on the popular tourist island of Jeju in the Korea Strait, an hour’s flight from Shanghai.

The table drop the Chinese generate per trip is better than the average by one-third, according to 2014 research compiled by investment bank Standard Chartered.

And it would appear the market has hardly been tapped. Less than 2 percent of northern Chinese visited Macau last year. In contrast to southern China, where gaming revenue equates to about 0.71 percent of GDP, revenue attributable to the northeast, Korea’s principal feeder market, amounts to only 0.01 percent.

Overseas travel as a percentage of the population is similarly low. The numbers are big—100 million mainlanders went abroad in 2014, the most in the world—but as a recent study by CLSA Americas shows, the rate of outbound penetration is just 7 percent (compared with 15 percent in Japan, 28 percent in Korea, 45 percent in Taiwan). If Hong Kong and Macau are factored out it’s only 3 percent.

“The demographics, we believe, are phenomenal,” says Soper. “(Incheon) is the closest gaming destination to northern China, including Beijing and Shanghai. There are more than 700 million Chinese residents within two hours of Seoul. Incheon Airport will be the gateway to what we think will be the tourist hub of North Asia.”

Official numbers out of China show that South Korea was the most visited country by mainland travelers last year, a trend that’s taken off since Seoul began easing visa restrictions a decade ago. Of the more than 14 million foreigners who visited the country in 2014, 43 percent were from China (52 percent counting Hong Kong and Taiwan).

The Chinese also spend more than everyone else—$2,200-plus per capita, says the KTO—and, not surprisingly, they account for the lion’s share of total tourism income, 55 percent last year, according to English-language monthly Business Korea.

The government’s goal is 20 million visitors by 2017—the year the Paradise megaresort is slated to open—and it’s expected that upwards of 10 million of those visitors will come from China. CLSA forecasts the number of mainlanders venturing out into the world to hit 200 million by 2020.

But will they gamble? More to the point, will they gamble a lot more than they are now?

There are skeptics. The debt analysts at Fitch Ratings, for one, are “cautious” in the absence of a domestic market to support the $5 billion or so of projected cap-ex on the table—that’s counting the Paradise and Caesars projects in Incheon and a Genting Singapore resort under construction on Jeju.

Fitch asserted in a May research report that even if foreigners-only revenue doubles, assuming a 20 percent profit margin, the ROI for the new resorts works out to less than 10 percent. The report also noted, “Competition for northern Chinese players will intensify over the next few years with legalization looming in Japan and Vladivostok’s first casino due to open this year. In addition, $20 billion of capital is being deployed in Macau through 2017, along with improving transportation infrastructure.”

At the same time, there is no certainty that current visitor rates will continue indefinitely. China is South Korea’s largest trading partner, and relations between the two governments are as warm as they’ve ever been. Their respective clashes with Japan in recent years over territory and other issues have a lot to do with this. That said, there is concern about the country’s growing dependence on its giant neighbor.

Since Jeju went visa-free for PRC nationals in 2006, life on the once-sleepy island has been overrun. Last year, 2.9 million Chinese descended upon it—four times the number of people who live there—pressuring infrastructure, depleting shop shelves and bringing with them traffic congestion and long lines. Tensions between locals and tourists haven’t risen to Hong Kong levels, but they are on the rise.

In 2010, the local government began offering the benefits of permanent residency to foreigners who invest KRW500 million ($450,000) or more in property in certain areas. More than 1,000 have applied for the program, 98 percent of them Chinese, according to a recent Wall Street Journal report. Since 2011, the amount of land they own has increased sevenfold. Predictably, prices and rents have skyrocketed.

Last June, a newly elected reformist governor ordered a review of the Genting project, holding up the groundbreaking for months. He has since called for the creation of a national regulator modeled along Singapore’s strict lines, and he’s pushing for an increase in the local gaming tax.

In a radio interview shortly after his election, he spoke of the risks from “unscrupulous operators.”

“Given international casino operators are flocking to Korea with an aim to open casinos for Korean nationals in the future, we must be vigilant about protecting our citizens,” he said.

Defensive Model

Needless to say, all is not well in China either, as anyone who’s followed last month’s stock market crash knows, and the aftershocks will do nothing for falling property prices and a slowing economy in general. Macau has been feeling the pain for more than a year as these factors wreak havoc with liquidity in the VIP trade that has driven 70 percent of the market’s world-leading revenues.

As Macau also is painfully aware, what Beijing gives it can readily take away, and it’s difficult to believe the Communist Party has gone to the trouble it has to cut off illicit money flows through the South China Sea only to have it slip out the Yellow Sea.

But South Korea is a very different market, as observers are quick to point out.

Says Sean King, a senior vice president with Park Strategies, a New York-based business advisory firm with offices in Taipei, “It’s hard to make projections, as overall tourist arrivals don’t always correlate to gaming tourism—especially at a time when Beijing’s cracking down on high rollers taking money out of the mainland. But Korea’s less susceptible to such crackdowns, as Korean casinos largely target Chinese tourists already there for shopping and other activities. In other words, Korea’s more low rollers and VIPs versus the VVIPs you see in Macau.”

Grant Govertsen, a principal with the Macau office of brokerage Union Gaming Research, agrees. “Clearly, Beijing can and does have an impact on the decision-making process of VIP customers. It has much less of an influence on mass-market customers. Hence, given the millions upon millions of Chinese mass-market tourists to Korea, it would make sense to me that an IR operator who targets the mass-market consumer could be very successful. Investors, I think, will feel the same way. The mass-market business model is much more defensive, it is higher-margin, and it has more visibility, less volatility.”

The foreigners-only industry is smallish—around 660 table games and 925 machine games in total—and not altogether attractive by Macau or Singapore standards. Yet the China factor had Standard Chartered bullish when it initiated coverage last year of the shares of Paradise and No. 2 foreigners-only operator Grand Korea Leisure. The bank forecasted revenues to surpass $3.2 billion by 2016, implying annual growth in the double digits.

Things have soured noticeably since then. In December, a report in a Beijing newspaper quoted mainland officials on the evils of Chinese citizens going abroad to gamble, and that was enough to send shares in Paradise and GKL tumbling. GKL’s revenue dipped 3.7 percent last year, despite juicing its marketing spend by KRW22 billion, and the softness continued into the first quarter, which was up 6.9 percent year-on-year but flat compared to the final months of 2014.

Paradise is No. 1 in gaming revenue because half of its VIP table play is Chinese. They account for more than 60 percent of drop group-wide. But as in Macau, as more big mainland players stay away, anxious to avoid the spotlight of the party’s crackdown on corruption and capital flight, the more expensive the smaller play is becoming. Revenues at Paradise rose 8 percent last year, but the company spent 19 percent more than the year before to get it.

It’s since gotten worse. In February, word came down from no less than the deputy director of China’s Ministry of Public Security that law enforcement was going after “illicit” marketing activities by foreign casinos in China, specifically by Koreans. “Paradise earns more from Chinese customers than its rival GKL,” an analyst with Samsung Securities said at the time, “meaning the former will be hit harder by the tightened state monitoring.”

Sure enough, by the end of the first quarter, Chinese VIPs had cut back on their wagers by 20 percent. Gaming revenue fell 13 percent. Operating profit plummeted 29 percent. Table game turnover is down 22 percent through the first half. The MERS scare no doubt played a role, but so did the arrest in China in June of 14 South Koreans accused of trying to lure Chinese citizens to Korean casinos. Employees of Paradise and GKL were among those jailed. Paradise’s June revenue fell a whopping 50 percent against the same month in 2014. Compared with May, the decline was nearly two-thirds. It may have been the company’s worst month ever.

But what all this points to are larger problems the government needs to address if it’s serious about shepherding the country into the elite of the world’s gaming destinations.

“One thing that hasn’t changed is the regulatory and legal environment,” says longtime Asia hand Jonathan Galaviz, now a principal with Global Market Advisors, an industry consultancy. “As much as there has been talk about liberalization, the regulatory, legal and strategic sense of casino gaming in South Korea has essentially remained the same.”

He is speaking of the entrenched ban on domestic play, but it could apply with equal vigor to the assumption that all it takes to build a major resort market is to license it.

“The biggest problem at the moment with the South Korean gaming industry is it’s completely unregulated,” says Paul Bromberg, chief executive of Spectrum OSO Asia. “They have made noises over the years about regulating it, but they haven’t done it. It’s not seen by government as a priority issue.”

He compares this to Macau, where “anybody can be a junket operator, unless they have a criminal record.”

“It’s the same in South Korea,” he says. “There’s very little interest in junket operators and where they come from, and very little concern about where the money is coming from.”

Well-known as an adviser to governments and operators on compliance and related issues, Spectrum counted Singapore as a client back when the city-state was crafting an industry that would go beyond anything the East had seen up to that time.

Much like South Korea is looking to do now.

So Bromberg has seen the promise and the potential of the IR model firsthand. As he states it, “Casino gaming has really just scratched the surface in much of Asia. And when you look internationally, the American market is saturated. Europe is a basket case. Asia is the place to be.”

——————————————————————————————————-
Korean Projections 
Dozens of plans to establish casinos have been submitted

Thirty-four entities, Korean and international, have submitted proposals to Korea’s Ministry of Culture, Sports and Tourism in hopes of winning licenses for the two integrated resorts with casinos the government plans to award by the end of this year. The sites are to be determined in the course of the ministry’s review of the proposals and could be announced as soon as this month, according to Korean media reports.

The last year has seen the governments of seven of the country’s nine provinces—Incheon, the southern city of Busan and the popular holiday island of Jeju top contenders among them—either planning or actively courting a gaming resort. And for good reason. Envisioned on a Macau scale with a minimum investment requirement of KRW1 trillion (US$925 million), the IRs will generate thousands of local jobs and billions more in spinoff benefits for the host communities.

The potential for developing a mini-Cotai around the country’s principal gateway at Incheon International Airport is driving most of the prospective investment.

The airport, on Yeongjong Island about 49 kilometers (30 miles) west of the capital of Seoul, is the hub of a government-sponsored special economic zone conceived as a destination in its own right with an array of commercial, retail, entertainment and residential attractions.

To date, two IR proposals have been awarded provisional licenses to bring casinos to the island: Paradise City, a 55-45 joint venture between Paradise Group, the country’s leading operator of foreigners-only casinos; and Sega-Sammy, a Japanese developer of video and pachinko games, and an as-yet unnamed property being developed by a consortium led by Las Vegas-based casino giant Caesars Entertainment. Together with a resort backed by Genting Singapore and China developer Landing International that broke ground on Jeju in February, the total investment in the works stands at around $5 billion.

It’s a prestigious list of bidders in all. It includes a number of regional gaming leaders alongside some well-known names in the wider world of corporate Asia:

• Genting Group, in partnership with the multinational Lotte conglomerate, is vying for a Yeongjong license, as are Phnom Penh’s NagaCorp and Manila’s Bloomberry Resorts.

• Macau’s Galaxy Entertainment Group is eyeing a Seoul suburb.

• Suncity Group, Macau’s largest junket operator, has entered the ring at a location that hasn’t been disclosed.

Hong Kong retail and property giant Chow Tai Fook is pursuing a license on Yeongjong.

• Grand Korea Leisure, the country’s No. 2 foreigners-only operator, has a land use agreement with Incheon International Airport Corp. for an IR on Yeongjong, and as a Korea-listed subsidiary of the government is likely to be somewhere near the front of the running.

• Mohegan Tribal Gaming Authority, a leading casino operator in the Northeastern U.S., has secured a partnering of its own with IIAC on a Yeongjong proposal pegged at $1.6 billion for the first phase.

The government of Incheon is bidding for an IR in partnership with a division of China’s Macrolink Group. The scope of the project and its projected cost were still being determined, according to reports.

• 20th Century Fox is looking at Yeongjong for a destination-scale theme park similar to what it’s developing at Malaysia’s Genting Highlands. It’s not known as yet if the plan includes gaming, but a casino was to have been included as part of an abortive agreement between the company, the government of South Gyeongsang province and other partners to build a movie-themed amusement park at a $3.5 billion entertainment complex near Busan.

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