Gambling on China & Macau (not just yet)
New York markets are still setting the pace for international bourses and the major U.S. indexes have finally enjoyed a few good days. But we’re not popping champagne corks at China Stock Digest just yet. Keep in mind, a few days of hyperactive gains by the DOW and S&P Indexes have also been marked by strong intra-day volatility. Wild daily swings indicate that heavy (and possibly desperate) redemptions by over-leveraged hedge and mutual funds are still crashing any recovery momentum on New York markets.
As I said on my most recent conference call, we have experienced a number of false market bottoms, followed by many so-called “dead-cat bounces†as over-eager investors jumped in. Fear of missing a recovery train appears to be driving radical surges. Massive redemptions by various funds under severe pressure invariably destroy every rally. I believe we won’t be seeing a true bullish trend before the S&P 500 has tested levels in the mid-700 range.
Major news flashes like the bail-out of Citigroup tend to spur temporary over-confidence.But for the time being, what comes up must still come down.
That’s why I’m remaining very cautious about recommending new investments in Chinese equities for the time being. Even companies reporting double-digit revenue growth or major income increases are still being punished by the markets. It is a sad fact of life that American market trends continue to be the tail that wags the dog overseas.
Nothing demonstrates the huge effects of global volatility than the stunning declines in companies like Melco Crown after we sold our China Stock Digest stake in that firm. Shares of Macau’s gambling giants have been spinning wildly lately, much like the wheels of an old-fashioned slot machine.
But, whether it’s one of our long term favorites, like Melco Crown (MPEL) or the gargantuan Las Vegas Sands (LVS), controlled by billionaire Sheldon Adelson, the payout this month has been the same. Zero. Or less than zero.
The problem with these multi-billion dollar investments is not Macau itself. The former Portuguese colony has tripled gambling revenues since the Ho’s family’s iron-fisted monopoly was broken by the Chinese government back in 2002. As eager gamblers pour in, Macau’s revenues continue to soar. Better yet, no new casino licenses are being granted.
In this roaring environment Melco Crown is building new its properties at a break-neck pace. Amazingly, Melco has approximately $1.5 billion available to finance projects like the dazzling new City of Dreams, slated to open its first half in 2009.That’s one reason we have been bullish on Melco in the past.
Compared to Las Vegas Sands, Melco is in clover. The Sands’ Sheldon Adelson, (who became famous for the sprawling Venetian project in Las Vegas) has suspended construction in Macau of a stunningly expensive $12 billion project after a third-quarter loss. Las Vegas Sands actually earns two thirds of its cash in Macau, not in Nevada.
Macau is still growing but not as quickly as in the past. Melco Crown more than doubled its revenue intake in its most recent quarter to $295.2 million. That’s more than a quarter of a billion dollars in three months. But the take was shy of analyst expectations. Melco also failed to cross the break-even mark during this expansion phase, losing $0.04 cents a share. That was also below expectations for a company that has set a goal of cornering the high-roller market.
If you had seen Melco’s first property on my most recent investor field trip you would see first hand why that strategy is beating the competition. Melco’s flagship casino is eye-popping.
There are two basic problems preventing Macau’s casinos from achieving the supercharged performance that Wall Street expects from China’s gambling passion. The most important is credit. Adelson’s Las Vegas Sands company has had trouble funding its multi-billion dollar ambitions during today’s credit crisis. There are only a few sources willing to fund casinos in today’s environment.
The failure of the Sands’ mega project to achieve necessary financing has thrown cold water on investors’ expectations for all Macau casinos and that has knocked down share prices. Even though Melco has enough cash for the foreseeable future, there has been speculation that the company may need a new cash source to achieve its ambitions in the next decade. Some of Melco’s debts will begin to mature with the completion of the $2.1 billion City of Dreams casino project and the company may need to issue new stock in 2010.
In the case of the hapless Sands corporation, Adelson’s own family will have to pony up more than half a billion dollars of its own money and it plans to raise $1.62 billion more by selling shares. Of course, that raises the prospect of dilution.
One of Macau’s strengths has been its customer base of 100 million Chinese who live within a three-hour drive of the Special Administrative Zone. But widespread factory closings in Southern China may put a damper on expansion. What’s more, Beijing has clamped down on travel junkets to Macau, limiting mainland visas to just six visits per gambler per year.
That brings us to the bottom line. In today’s market, the slightest scent of risk sends share prices on a slide straight to the cellar. The current financing squeeze and the regional slump in China has cast a pall over well-run operations like Melco and mega-dreams like that Sands spectacular equally. That’s why we’re shying away for the time being.
The perception of investor risk may not be fair to Melco, but it has hurt the entire gambling enclave of Macau.
We’ll be watching the sensational management and performance of Melco from the sidelines for the foreseeable future. It would be shame to miss the spin of the wheel when Melco proves the skeptics wrong and the profits expand in a very big way. As the best Chinese companies continue to report double-digit profit increases, we’re watching for one of two things to happen. One possibility is that U.S. markets will finally hit a bottom and over-leveraged funds will exhaust their need for redemptions. The other possibility is the much discussed word “decoupling.†Asian and Chinese companies may not be at the mercy of U.S. indexes forever.
If the profits of our favorite Chinese companies continue to rise there is a possibility that their severe undervaluation will be recognized globally.
In either case, we have our sites set on the companies that stand to benefit from China’s economy (which continues to expand as the rest of the western world sinks into recession).
Watch your email inbox for buying alerts. When the market for Chinese stocks takes a turn, it will involve explosive short-term profits just like those we experienced with our quick trades on seven big gainers during the past month.
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