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Perception is Reality

It's Bizzaro World where regional casinos prosper and Macau struggles

Perception is Reality

First-quarter earnings reports are out, and they present two divergent worlds—recovering regional gaming markets in the United States, and the reality of the impact of a declining Macau.

In a way, it’s a poetic-justice kind of irony, given how U.S. regional gaming markets have struggled during the same years that Macau surged to become the world’s biggest gaming market. Regional companies reporting better than expected earnings as of this writing were Penn National, Pinnacle, Boyd and Monarch Casino.

Their stories were the same—cost efficiencies combining with rising revenues among all tiers of players creating profit growth greater than revenue growth.

The big question was how much of the improvement was attributable to better weather this year and how much to recovering consumers. The answer is that we don’t know, though improved business continued into the early part of the second quarter when weather comparisons made negligible difference. That offers hope that the recovery is sustainable.

Macau operators Las Vegas Sands and Wynn Resorts also had similar tales: the disappearance of VIP players from Macau devastated profits.

Beyond, their founder-CEOs took decidedly different views.

Feisty LVS CEO Sheldon Adelson talked of his commitment to investing even more money in the city. The company is already asking to build 2,500 more hotel rooms, independent of gaming, he said in remarks that seemed as much aimed at persuading Macau officials of LVS’ worthiness as to reassure investors.

Steve Wynn, on the other hand, painted a bleak picture of Macau in strong, even harsh language. He also called the recovery of Las Vegas exaggerated. Wynn’s strong words were followed by action as the company slashed its dividend by two thirds.

LVS is maintaining its dividend. Return of capital is a prime Adelson theme, illustrated by his now-famous cry “Yeah, dividends.” However, LVS has suspended its program to buy back a minimum of $75 million a month in stock. It bought no shares in the first quarter and says it will be opportunistic in the future.

The reaction to Macau earnings was a violent sell-off in the stocks, especially WYNN, which fell more than 16 percent on the day after earnings were released to $108 a share, less than half of its 52-week high of $222.

The sell-off created an irony for LVS. It was buying its stock when shares were in the $70s and $80s, but is not buying them now in the $50s.

That, of course, is the risk of stock repurchasing.

One thing that Adelson and Wynn have in common is prudently resisting the call of investors to borrow money to buy shares or pay dividends.

Our perspective, as readers of this space know, is that we had long warned that Macau is a high-risk market thanks to the antipathy towards gaming of the mainland Communist China government. However, the steep sell-off of Macau casino stocks had the whiff of capitulation about it, which suggests the worst might be over.

Indeed, gaming revenues appear to have leveled out in recent months even though they are still well below last year.

And there are signs that attitudes of Macau government officials might be turning.

Their callousness toward casino woes appears to have been replaced by concern. We now see reports about the government, which once ran surpluses it couldn’t reasonably spend, talking about the possibly of having to cut its budget.

Talk of capping mainland Chinese visitation appears to have faded. And why not? Current visitation is running well below the floated annual 21 million-visitor cap.

Investors who previously saw nothing but clear skies ahead now see only gloom, another indication of a possible bottom for Macau stocks.

Back in the U.S., the improvement among regional operators also has company-specific elements that bode well.

Penn National has its new racinos in Ohio, and soon will own a several-year monopoly on gaming in Massachusetts when its slot casino opens June 24 in Plainridge.

Pinnacle is successfully driving revenue at the Ameristar properties it bought 20 months ago and is enjoying the grow-the-market effect of Golden Nugget opening adjacent to L’Auberge in Lake Charles, Louisiana.

PNK stock is also benefiting by its plan to spin off real estate into a REIT, and the offer by Gaming and Leisure Properties to be its REIT vehicle. Yet another strength for PNK is its free cash flow and dedication to using it to pay down debt.Monarch is benefiting from growth in Black Hawk and Reno, but the big story is the transformation of Monarch Casino in Black Hawk into a destination resort. That long-discussed project is drawing near.

Its impact can be considerable. Chad Beynon of Macquarie calculates that a 13 percent to 14 percent EBITDA return on the Monarch Black Hawk expansion translates into $3.50 a share for a stock trading at just 6.9 times estimated 2016 EBITDA.

Boyd has been cutting costs while slowly transitioning to greater non-gaming amenities to make its casinos more entertainment destinations.

Thus, investors are presented with situations both in regional markets and in Macau that suggest the most prudent action is to wait.

In another three months, we’ll know if Macau gaming revenues have leveled off and if the government’s tightening of the screws is finally over, or has even reversed.

In the U.S., we’ll know whether improvements in regional markets are being sustained, and whether they bode well for the remainder of the year.

Making bets on a Macau bottom and a U.S. recovery might be risky now, but those bets also offer more rewards today than they will when everyone knows the answers.


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