Macau Casinos Play Tough Hand Until Good Times Roll Again

Macau’s second quarter numbers don’t paint a pretty picture for the world’s largest casino gambling destination. Investor sentiment that June’s year-on-year gaming revenue decline signaled the bottom may prove premature.

First, the good news: year on year gaming revenue, 90.9 billion Macau patacas (MOP; $11.4 billion), was up 5.5% for the second quarter. For the first half, revenue rose 13%, heady for anywhere but Macau. Now the dark side: second quarter casino revenue fell by 11% from the first quarter. The last sequential quarterly revenue drop came in second quarter of 2012. The decline had been telegraphed by the June revenue decrease of 3.7%, the first monthly contraction since June 2009.

Las Vegas Sands and Wynn Resorts , which rely on their Macau operating subsidiaries for big chunks of their profits, each missed their second quarter earnings numbers. Second quarter Ebitda at Wynn Macau, which reported Tuesday, increased 6% to $307 million, 11% below Union Gaming Research Macau’s estimate. While Macau’s long term story remains solid, momentum has slowed, and there appear to be plenty of bumps in the road ahead.

Declining VIP play was the prime suspect in June’s revenue decline, and the numbers provide the evidence. Second quarter VIP quarter revenue of MOP54.6 billion was down 5.8% year on year, the first such decline since the third quarter of 2012, and dropped 16% from the first quarter. VIP revenue comprised 60% of total revenue in the second quarter, compared to 64% in the first quarter, 66% last year and 69% in 2012.

Morgan Stanley Asia analyst Praveen Choudhary notes that Macau’s rival destinations are having success in the VIP segment. They pay lower taxes on gaming revenue than Macau’s 39%, so can offer higher commissions to junket promoters. By government supervised agreement, Macau casinos limit commissions on VIP play to 1.25%. Rates in other jurisdictions range from Singapore’s 1.4% to as much as 2% in Cambodia. South Korea, a shorter trip for Northern China players than Macau, and Singapore both showed faster VIP growth rates than Macau last year, and Manila’s Solaire doubled its VIP in the first quarter from the previous three months, to $2.6 billion. That’s equivalent to an average weekend for Wynn Macau, but the trend is telling. Later this year, Solaire will open its upmarket extension, and Melco Crown Entertainment will debut City of Dreams Manila.

Union Gaming analysts in Macau Grant Govertsen and Felicity Chiang attribute VIP softness to China’s anti-corruption campaign. The corruption investigation into China’s former internal security chief Zhou Yongkang, announced Wednesday, adds to the cautious mood among VIP players and promoters. Earlier this year a junket agent absconded with an estimated $1 billion in junket money, and there have been some highly visible money laundering cases, leading to increasing scrutiny of VIPs by casinos. Concerns about VIP play also include mainland China’s slowing economy and reported liquidity squeezes for smaller junket promoters, which Choudhary says would matter most to Melco Crown’s Altira property and least to Galaxy Entertainment Group, which works with larger junkets. But the main factor may be simply that the VIP market has matured – all the big money mainland players that want to come to Macau are already coming as frequently as they can, and increases will be more in line with China’s economic growth rather than double or triple that number in recent years.

Deceleration of VIP revenue hadn’t hurt earning because more profitable mass market play has grown at better than 20% for the past three years and more than 30% the past year. But second quarter mass market play growth slowed to 32% from 39% in the first quarter and spending per visitor has recently declined. Lack of shiny new casinos certainly contributes to decreased enthusiasm, along with mainland travelers’ expanding horizons. The smoking ban on main gaming floors coming in October could also slow mass market revenue growth, pushing some premium mass players, the big spending darlings of casino operators, into the VIP segment, which would cut earnings if operators have to share that revenue with promoters.

Higher labor costs have also hit casinos’ bottom lines. Sands China and Emperor, a peninsula casino that operates under SJM’s license, have experienced labor protests, and all operators are raising salaries and benefits to retain employees in anticipation of the Cotai openings beginning next year. The new and expanded resorts will require up to 32,000 new hires, including thousands of dealers, who must be Macau permanent residents.

Following Wynn Macau’s results, Union Gaming cut its estimates on the company for the rest of this year and 2015. Wells Fargo Securities senior analyst Cameron McKnight, as well as Morgan Stanley’s Choudhary, expect more downward revisions to earnings estimates. That likely means lower share prices, especially if July gaming revenue shows a decline, as most forecasts suggest.