Our long-held contention is that when you buy shares in Melco Resorts & Entertainment Limited (NASDAQ:MLCO) you are fundamentally placing a bet on its CEO and principal shareholder, Lawrence Ho, scion of the legendary Asian gaming family. This is one smart gaming guy who knows how to balance the size of his stomach to the wideness of his eyes.
Despite a so-so 1Q19 result, there is much to like about MLCO stock in general, and in particular, Ho’s vision. You want to be partners with a guy like this – but not perhaps yet. The stock needs time as the US/China tariff war must go through its long period of marination of threats, counter threats, and make nice promises kept or broken.
The long-festering dispute is cited by most observers of the Asian casino business as the principal headwind among several others, suppressing the sector. Yet a longer term look at MLCO is highly encouraging.
In brief, MLCO’s 1Q19 produced $407m in property EBITDA, up 1% y/y. Luck adjusted property EBITDA was down 10%, y/y to $362m. Favorable VIP hold affected City of Dreams Macau, Altira, and City of Dreams Manila. (Favorable VIP hold contributed to performance at City of Dreams Macau, Altira and City of Dreams Manila). Yet MLCO’s VIP segment contributed only 10% to its total GGR for the quarter, indicating its swerve to strong premium mass and mass in the coming quarters will positively impact its cost profile and provision for bad debts.
Melco has taken a beating with the sector, but long term looks like a big winner given its strategy: Source: Google finance
The company’s bad debt provision for the quarter rose to $11 million, up substantially y/y from $4m which negatively affected EBITDA by $14m. In their earnings release, MLCO executives pointed out that a range of $8 to $12m in bad debt provision falls within historical norms. As always, it is a reflection of a more aggressive marketing effort in the VIP sector where a gaming property tends to edge more flexibly in using credit as a tool.
In this case it was related to the still ongoing ramp-up of the dazzling new Morpheus Tower at City of Dreams, an expansion aimed at building MLCO’s VIP base. However, the property is ramping a bit slower than anticipated, but is doing very well in attracting premium mass segment customers where the credit exposure is significantly lower.
In its continuing effort to keep abreast of some of its larger competitors’ property upgrades, MLCO has set a $50 capex spend for 2019, all aimed at upgrades at City of Dreams.
At City of Dreams Manila, MLCO felt the bite of intensified competition from Universal Entertainment’s Okada property and an addition to the room inventory by Genting’s Resorts World. Its EBITDA there declined 9%y/y. The city’s special Entertainment Zone has spearheaded that country’s vibrant 13% y/y growth in GGR. Longer term, Manila will be a good place to be and we expect MLCO’S performance to improve in 2Q19 and 3Q19 by its adding 10 VIP tables there next quarter.
Some analysts expressed concern that while the overall Macau mass segment in the quarter was up a healthy 7%, MLCO’s mass was only up 2%. What is key here is that the company’s new Morpheus Tower focused on premium mass and VIP and is where we expect increases going forward. Mass is a function of supply and supply increased at competitive properties.
Total MLCO Macau market share in the period dipped 2bps, feeling the normal impact of rapidly expanding room inventory from new supply. The new tower is about 9 months from its opening and expects a return profile to around 20% when fully ramped to forecast. Overall, we anticipate 2Q showing improved overall results.
Financially, MLCO is sitting on $630m in cash with a gross debt of $2.5b, excluding Studio City in Manila. Its net interest $75 expense provides considerable flexibility to take on its ambitious global strategy.
Short term MLCO is a good hold
The fundamentals of the company are sound despite the so-so 1Q19 results. The Macau May GGR was up a modest 1.8% indicating that the market may be in the early stages of a turnaround. Our sources indicate that early June numbers in terms of occupied gaming positions by shift and average bet ratios we follow with our internal metrics, indicate we could see June posting another increase. If this materializes, the consensus view among a majority of analysts that MLCO will see a nice 2Q rebound seems to us to be valid.
Longer term MLCO shares have endured Asia headwinds. They continue to both benefit from its expansions and investment in Macau and also absorbed hits to the company’s market share as supply has dramatically increased. As the chart shows the stock has taken a beating this year. Over the past five years, long-term shareholders have absorbed around a 40% decline despite turning in periodic bullish as well as bearish performances. This performance is linked directly to the succession of macro headwinds from late 2014 through 2015 junket crackdowns and beyond that, China woes which have buffeted the entire sector.
Despite this, we see MLCO at writing at $19.89 a share in a range between a hold and for more adventurous types, a decent entry point. If you lean toward dipping a toe, bear in mind you are betting above all on what we think is the core story of this stock.
The global strategy of Lawrence Ho.
From that perspective we see a strong bull case for long-term investors with the confidence level that Ho’s asset allocation decisions auger well for his company’s future.
Present Analyst Consensus PT: $27.83. Taken as strictly an anticipation of improved performance for the balance of this year, we think it falls within a realistic range.
But longer term, over the next 18 months, we see MLCO reversing its long-term trend of price stagnation and earnings misses resulting more from macro conditions than any shortcomings of management. Factoring in what we see as Lawrence Ho’s firm and realistic grip on where global gaming is trending, we see a far more bullish cast to the stock.
Our PT in 18 months: $36
The move on Crown Resorts
We saw evidence of Ho’s deft moves late last month when MLCO announced it was acquiring 135.35m shares of Australia’s Crown Resorts (OTCPK:CWLDF) (ASX:CWN) at US$12 a share for a total investment of $1.22bn. This deal came just under two months after an abortive early probe by Wynn Resorts, Ltd. (NASDAQ:WYNN) to buy Crown. Crown saw a very motivated seller in James Packer, Ho’s former Macau partner. At $12 the deal represented less than 10X2019E EV/EBITDA, which, according to Morgan Stanley (NYSE:MS), will be accretive to MLCO. We go a step further by noting that in acquiring the 19.99% stake, Ho is clearly positioning his company to increase that position and longer term, perhaps buy control.
We like this deal because it gives MLCO an immediate, powerful presence in Australia’s always vital gaming market. Crown’s two properties in Melbourne and Perth will be joined by a trophy level third integrated resort in Sydney due to open 2020.
From a marketing perspective it now opens the prospect of moving MLCO’s premium mass and mass customers to properties in Australia and vice versa. Australia ranks at the top of the globe’s per capita gaming spend by region, even above that of Macau.
The deal once again shows how Ho will move in and out of jurisdictions quickly where he sees opportunities at the right entry price. It is to be recalled that Ho, once a big fan of the potential of the Russian Far East, took a major position in Summit Ascent’s Tigre de Crystal casino in Vladivostok. Under two years later, noting deep concerns about the attitudes of Moscow on gaming taxes, and the lack of critical mass development deals, he promptly sold his 20m share position, exiting the market. He was in and out, seeing better opportunities elsewhere.
While the Crown deal might slow MLCO’s buyback and/or dividend programs, shareholders in our view have a far better upside longer term when its Crown position begins to churn out EBITDA for the Ho position.
Japan: Relentless enthusiasm and presence
Ho has been one of the most active, vocal bidders presumptive for one of the three Japan IR licenses to be issued between late this year or early next. Through the muck and mire of Japan officialdom’s seemingly grudging slog through one stage after another as the process moves forward, Ho remains the supreme optimist. He knows he is up against global giants like Las Vegas Sands (NYSE: LVS) and MGM Resorts International (NYSE:MGM) in pursuit of what could be a $10bn integrated resort project.
Yet he has already deployed lots of executive boots on the ground in Tokyo. He has been on the public record as stating that Japan is the number one corporate priority going forward. Beyond that he has promised to move MLCO’s corporate headquarters to Japan if he scores a winning bid or partnership. Moreover, he has responded with a direct and very smart appeal to a clearly paranoid Japanese officialdom, terrified by a rise in problem gambling with a hard promise.
Last year he announced that MLCO would bring to a Japanese gaming project a highly sophisticated tech tracking early warning system to tease out potential problem gamblers well in advance of normal trends.
Whether MLCO prevails in Japan as either a majority partner, and operating partner with a financial institution, or perhaps a partner with another gaming operator, it is clear that the company is checking a lot of boxes with Japan officialdom.
Its initiatives on key ESG issues match or exceed those of its most likely competitors. And this too will check a key box for officials making final decisions on RFPs.
Westward HO in Cyprus
(Above: Ho’s eye on an EU first mover position on an IR/ Source: MLCO)
As further evidence of MLCO’s global perspective, we have its announced plan to build a $770m integrated casino resort on the island of Cyprus. The company won a license for the project over 5 years ago. It is currently operating five temporary slot casinos on the south part of the island. It expects to open an integrated resort to be named City of Dreams Mediterranean in late 2021. The property, a partnership with Greek construction company CNS, is designed with 500 rooms and suites, 136 gaming tables and 1,200 slots.
Here’s why we like this move:
- Cyprus attracted over 3.9m tourists last year, up over 7.8% y/y. Of these the dominant two feeder markets were the UK and Russia, which combined to produce nearly 2 million of the total. The populations of both countries have a high gaming proclivity.
- If you scan the gaming map of Europe and the Middle East you find that typically casinos there are either free standing modest sized properties, or large spaces in hotels, or traditional resort centers like Monte Carlo. But nowhere on the continent is there a single integrated resort of the scale and leading edge resort design as that planned by MLCO. Add to that a weather element that is likewise a year-round draw for tourists from Europe in particular and you have the potential of a very significant producer of accretive earnings for MLCO in 2022.
- China tourism to the EU is up double-digits three consecutive years, indicating the traditional destinations in France, England, Italy and Germany continue to grow. They totaled 12.4m visitors in 2018. Attaching a visit to Cyprus to an EU itinerary makes strong marketing sense for China visitors, especially those teased out of a MLCO Macau database.
There are some companies which are such screaming buys based on a disconnect between their potential and share price that they are patently obvious bull case winners short term. There are others, like MLCO which will perform well in the short term if macro headwinds dissipate, but which have their eyes on a far bigger prize: It’s a smart global footprint looking at the world traveler as he or she will be five years from now.
Most big gaming operators have staked out their geography as is apparent from their moves now. Wynn and LVS are clearly pointed to as Asia centric. MGM sees itself as a fortress Las Vegas dominator, with a strong regional US network plus a footprint in Asia. MLCO is veering off on another route. It is moving to solidify its Macau/Manila base without question. But its moves both in Australia and in 2021, in south Europe, tell another story. And we believe it is a good one.
Having Lawrence Ho, 41, as a partner to us makes very good sense for investors in the gaming space as an equal weight presence over the next two quarters and then an overweight position if and when Asia headwinds diminish. On top of that there is a strong case to be made that its investment in Crown will be accretive quickly and that when that is proven, Ho will go to the well again and build his stake.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.