Macau is the only region in China where gambling is legal, and it is also the largest gaming center in the world. In 2019, Macau generated about 37 billion US dollars in gaming revenue, 5 times that of Las Vegas, second in the world. In the more than 20 years since Macau's return, Macau's gaming and related industries have made great strides in taking advantage of outbound travel from mainland tourists.
As mainland China resumes travel vouchers to Macau on September 23, 2020, we believe Macau's gaming industry will slowly break out of the trough caused by the health incident, and travelers will return to the bustle and prosperity of Macau. What are the changes in Macau after the health incident, and where will it go in the future?
We think now is a good time to reintroduce Macau's past and present lives and look forward to the future.
summary
This report on the introduction to the gaming industry in Macau aims to let investors who are new to Macau understand the following aspects:
Macau's gaming industry has various characteristics of an oligopolistic market.A small number of companies (currently 6) rely on exclusive licenses to operate the gaming business and cooperate with each other to avoid price wars and maintain the industry's high profit margins. Geographically, gaming in Macau began in the Macau Peninsula region. After reclamation and land reclamation, large-scale gaming integrated resorts rose in the Cotai region, and the Cotai region gradually became a new gaming center of focus. Furthermore, each of the six Macau gaming operators has shown different development trajectories.
We attribute the development and evolution of Macau to:1) Support for the endorsement policy, especially the mainland's signing policy for Macao; 2) The increasing improvement of infrastructure in and around Macau, especially transportation infrastructure, promotes the increase in the penetration rate of Macau tours in mainland China; 3) The gradual enrichment of local non-gaming elements in Macau, including hotels, restaurants, retail, entertainment, etc. We believe that Macau's passenger capacity (number of gaming tables, number of hotel rooms) is the main bottleneck in Macau's gaming revenue growth, so changes in passenger capacity will be the focus of attention.
Macau gaming is broadly divided into two major categories: VIP business and midmarket business.There is a big difference in business models and profit margins between VIP and midfield. Generally speaking, the EBITDA profit margin for the VIP business is around 10%, while the profit margin for the midfield EBITDA is as high as 30% (or even higher than 30%), mainly because the mid-market business does not require intermediaries to pay rebates. The biggest cash outflow from Macau gaming operators is the gaming tax paid to the Macau government, which is actually equivalent to 39% of gaming revenue. Profit income tax is only payable on non-gaming profits, which is relatively small.
Considering the high capital expenditure of the Macau gaming industry and the visibility of historical data, EV/EBITDA is usually used to value the Macau gaming industry.The average EV/ (adjusted) EBITDA in the Macau gaming sector over the past five years was 14 times, with a range of 10 times to 18 times. As betting grants are about to expire and uncertainty about re-bidding approaches, we are seeing valuations at this stage fall below the range.
risks
Limits on the number of gambling tables; uncertainty of re-bidding after the 2022 gaming license expires; changes in mainland travel promotion policies to Macau; policy changes in the central and Macao governments, particularly capital flow control measures; regional competition caused by the gaming industry in other countries surrounding China against Macau.
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Macau Gaming: From Monopoly to Oligopoly
When it comes to Macau's gaming industry, you should know the following:
► Historical evolution: Portugal legalized the Macau gaming industry in 1847. In 1962, Stanley Ho won the exclusive right to operate the 40-year gaming business (1962-2002). In 2002, the Macau government issued 6 gaming licenses, introduced foreign investment and a mature gaming business model, and the Macau gaming industry began to take off.
►Gambling activities: Most of them are lucky bets, such as betting, horse racing, lottery, etc., but online betting has not yet been legalized.
►Main speakers: Stanley Ho's family, Lu Zhihe's family, Steve Wynn's team, and Sheldon Adelson's team.
► Products and services: Develop integrated resorts to provide one-stop entertainment services such as hotels, entertainment facilities, restaurants, exhibitions and gaming.
Chart: Macau Gaming Operators and Companies
Source: Company Announcements, CICC Research Department
An oligarchic style that cooperates in the midst of competition
We believe that the Macau gaming industry is characterized by an oligopoly industry: 1) the number of market participants is low (6 in total); 2) the entry barriers are high (such as gaming grants, huge investment promises, etc.) interdependence, and any adjustments in prices and marketing by gaming companies will trigger responses from competitors (such as adjusting the minimum or maximum bet amount of gambling tables); and 4) the company can maintain high profitability (the industry's EBITDA profit margin in 2019 was 19%, net profit margin was 14%). The first betting grants will expire in 2022.
Macau is the only legal gaming region in China and the largest gaming center in the world. We think bookmakers will prioritize their efforts to expand market size using their own operating rights to cooperate before entering the stage of competing for market share.
Chart: Profit margin comparison (FY19)
Source: Company Announcements, CICC Research Department
The history of gaming development in Macau
Macau Gaming Development History
From 2000 to 2010, Macau's total gaming revenue grew at a compound annual rate of 28%. Among them, VIP gaming revenue and midfield gaming revenue grew at 29% and 27% respectively. However, the performance of VIPs and midfield players has been divided in the last ten years: the compound annual growth rate of total earnings from 2010 to 2019 was 5%, of which the midfield was 14%, but VIP was -2%. The focus of the Macau gaming industry gradually shifted from the VIP gaming business (VIPs accounted for more than 70% of total gaming revenue in 2000-2013) to the midfield gaming business. In 2016, midfield gaming revenue surpassed Vip's revenue for the first time, and 2019 midfield gaming revenue accounted for 59% of total gaming revenue.
Chart: Macau VIP Gaming Revenue from 2000 to 2019
Source: Macau Gaming Supervision and Coordination Authority (DICJ), CICC Research Department
Chart: Macau midfield gaming revenue from 2000 to 2019
Source: DICJ, CICC Research Division
Chart: Macau's total gaming revenue from 2000 to 2019
Source: DICJ, CICC Research Division
Chart: Macau gaming revenue split from 2000 to 2019
Source: DICJ, CICC Research Division
Macau Peninsula vs. Cotai region: development trajectories are varied
Gaming began on the Macau Peninsula and flourished in the Cotai region. There are different development trends in the two places. The Macau gaming industry formed an oligopoly situation after the first gambling auction in 2002. We believe that the first consideration for gaming companies is to jointly promote market expansion and expand the cake, and only then try to win market share.
► Gaming on the Macau Peninsula continued to flourish for half a century until new gaming began to be established in the Cotai region of Macau in the early 21st century. The Macau Travel and Entertainment Company (STDM), a subsidiary of Stanley Ho, obtained the exclusive gaming license of Macau Peninsula Gaming from 1962-2002. Most of these games fell into the Australian Expo (SJM) after the first gambling license auction in 2002. Due to its proximity to the mainland, the Macau Peninsula received the majority of same-day visitors from the mainland through Gongbei Port and Outer Harbour Ferry Terminal (visitors entering from Gongbei Port and Outer Harbour Ferry Terminal in 2019 accounted for 53% and 9% of total visitors, respectively). Gaming on the Macau Peninsula is generally small, close to each other, and there are few non-gaming facilities nearby. As a result, gamblers often move between different bets. After the rise of large-scale gaming in the Cotai region after 2002, the Macau Peninsula's share of gaming revenue in Macau fell from 72% in 2010 to 34% in 2019. The Macau Peninsula currently contributes 20% of Macau's adjusted property EBITDA.
►The emergence of the Cotai region stemmed from land reclamation in the early 21st century. Galaxy Entertainment, Sands China, and Xinhao International took root here by actively acquiring land, and obtained gambling licenses in 2002. The Cotai region has more space to support the development of a large-scale integrated resort model. There are plenty of high-end hotel rooms here that host overnight visitors. Consumers often gamble in hotels where they stay overnight, and are less mobile than on the Macau Peninsula. We will further explain in later chapters that the increase in the number of hotel rooms in the Cotai region has led to an improvement in the tourist structure due to higher consumption levels per overnight visitor. We think bookmakers will continue to invest in the construction of hotels. As of 2019, the share of gaming revenue and adjusted property EBITDA in the Cotai region reached 66% and 80% respectively, indicating that it is superior to the profitability and development trends of the Macau Peninsula.
Chart: Percentage of gaming revenue in Macau Peninsula and Cotai
Source: Macau Gaming Supervision and Coordination Bureau, CICC Research Department
Chart: Gaming revenue growth in Macau Peninsula and Cotai region
Source: DICJ, CICC Research Division
Chart: Gaming revenue in Macau Peninsula and Cotai
Source: DICJ, CICC Research Division
Chart: Adjusted EBITDA for properties in Macau Peninsula and Cotai
Source: DICJ, CICC Research Division
The driving force of Macau's gaming revenue
We believe that the growth and development of the gaming industry in Macau has benefited from the following aspects: 1) the support of endorsement policies (such as individual travel to Hong Kong and Macau, also known as free travel); 2) infrastructure improvements, which have led to an increase in the number of visitors (such as the Hong Kong-Zhuhai-Macao Bridge, the expansion of the high-speed rail network, and the Macau Light Rail); 3) the increase in non-gaming products and service capabilities (such as hotels, catering services, shopping and entertainment).
VIP gaming revenue is closely linked to China's macroeconomy
There is a clear positive correlation between VIP gaming revenue and China's macroeconomy, mainly affected by the following aspects: 1) China's per capita GDP growth; 2) diversification of credit sources and increased capital liquidity; and 3) China's economic vitality. However, after policy and regulatory intervention in 2014-2016, the correlation waned somewhat.
Chart: Macau VIP Gaming Revenue vs. Mainland China's GDP
Source: CEIC, DICJ, CICC Research Division
Chart: Macau VIP Gaming Revenue — 3mma vs. China Social Finance — 3mma
Source: CEIC, DICJ, CICC Research Division
Chart: Macau VIP Gaming Revenue vs. China Industrial Producer Price Index
Source: CEIC, DICJ, CICC Research Division
Chart: Macau VIP Gaming Revenue — 3mma vs. China m2 — 3mma
Source: CEIC, DICJ, CICC Research Division
Midfield gaming revenue is driven by tourism, particularly the number of outbound visitors from mainland China
The total number of visitors to Macau reached 39.4 million in 2019. Since 2017, visitors from mainland China and Hong Kong have accounted for around 70% and 20% of the total number of visitors to Macau, respectively. According to a rough estimate based on the number of visitors/origin population, Hong Kong trips to Macau are close to saturation (penetration rate reached about 98%), but in 2019, the penetration rate of Macau tourism in mainland China was only 2%.
Since 2003, individual tours to Hong Kong and Macau (also known as free trips to Hong Kong and Macau) have been introduced. Visitors from mainland China can travel to Macau without joining tour groups. The first 4 cities that opened free travel were all located in Guangdong. As of early 2007, 49 cities in mainland China had opened free travel.
As far as Macau is concerned, demand for lucrative midfield gaming will continue to grow, mainly because: 1) the penetration rate of Macau tourism in mainland China continues to increase; 2) the Macau government stipulates that all new gambling tables added after 2015 should be midfield gaming tables; and 3) the opening of new properties in the Cotai region stimulates demand and brings cluster benefits.
Chart: Total number of visitors to Macau
Source: Statistics and Census Bureau (DSEC), CICC Research Department
Chart: Total number of visitors to Macau broken down by region
Source: DSEC, CICC Research Division
Chart: Timeline of 49 free travel cities in mainland China
Source: Hong Kong and Macao Affairs Office of the State Council, CICC Research Department
The penetration rate of tourism to Macau from mainland China other than Guangdong Province is still low, which means there is still potential for long-term growth. Thanks to free travel, the penetration rate of tourism to Macau in Guangdong Province has reached 11%, which is on par with the penetration rate of Las Vegas tourism in the US. The proportion of visitors to the top five mainland provinces visiting Macau fell from 66% in 2011 to 58% in 2019, indicating that tourist sources are more diverse and Macau tourism has further penetrated the mainland.
Chart: Visitors to Macau broken down by province (FY11)
Source: DSEC, CICC Research Division
Chart: Visitors to Macau broken down by province (FY19)
Source: DSEC, CICC Research Division
According to the 2020 Macao Policy Report, the Macao government is considering plans to stimulate tourism development, including: 1) cooperating with the Guangdong government to further relax the endorsements of Guangdong residents to Macau (currently, they can only be renewed once every 2 months through self-service vending machines); 2) requesting the central government to increase the number of cities open for free travel (currently 49).
The spending level of non-tour group visitors is higher than that of tour group visitors
The spending capacity of non-tour group visitors (including independent travelers, business travelers, tourists with transit vouchers, etc.) is higher than that of tour group visitors. We think tour group visitors are relatively more price sensitive, and because of group sightseeing arrangements, tour group visitors contribute significantly less gambling revenue.
The increase in the proportion of independent visitors to Macau has increased the total travel consumption. In 2019, 48% of mainland visitors had free travel vouchers, and midfield gaming revenue over the past 10 years was highly correlated with independent travelers. We believe the increase in the number of freelancers will further drive up midfield gaming revenue.
Chart: Structure of non-tour group visitors
Source: DSEC, CICC Research Division
Chart: Midfield betting revenue vs. mainland freelancers
Source: DSEC, CICC Research Division
Benefiting from national infrastructure upgrades and Greater Bay Area integration
►In 2019, 61% of visitors entered Macau through land ports, including the Gongbei port in the northern part of the Macau Peninsula, the Lianhuaqiao Hengqin port connecting western Cotai, the border crossing of the Zhuhai-Macao Cross-border Industrial Zone, and the Hong Kong-Zhuhai-Macao Bridge. The Hong Kong-Zhuhai-Macao Bridge opened in October 2018, shortening the journey between Hong Kong and Macau from 1 hour to 30 minutes. We found that after the opening of major transportation infrastructure, the number of visitors to Macau often increased significantly.
Chart: The number of visitors to Macau increased significantly after the opening of major transportation infrastructure
Source: DICJ, CEIC, CICC Research Division
►China's high-speed rail construction has led to a long-term increase in the number of visitors from mainland China to Macau. By the end of 2019, more than 350 million people in mainland China were able to reach Macau within 5 hours by train, mainly from North China via the Beijing-Guangzhou High Speed Rail or from East China via the Wuguang High Speed Rail. According to the central government's plan, the total mileage of China's railways will reach about 175,000 kilometers by the end of 2025 (of which the high-speed rail mileage will reach 38,000 kilometers), and by 2035 the total mileage will reach about 200,000 kilometers (of which the high-speed rail mileage will reach 70,000 kilometers).
►Light Rail is Macau's public transportation. The Taipa Phase 1 route commenced operation in December 2019. The route has 11 stops and connects Cotai, Macau International Airport and Taipa Ferry Terminal. According to the 2020-2040 Macau Urban Development Plan, the next few phases of the light rail will run through the Macau Peninsula and be connected to the Zhuhai High Speed Rail. We think an integrated transportation network will help reduce traveler time wasted on transportation.
Chart: Macau Peninsula Light Rail Plan (as of 2020)
Source: Macau Land Works and Transport Authority, CICC Research Department
Chart: Cotai Light Rail Map (as of 2020)
Source: Macau Land Works and Transport Authority, CICC Research Department
►The five airports in the Greater Bay Area are close to Macau, making it easy for visitors to reach Macau through Hong Kong and Guangdong. The total passenger throughput of the five airports reached about 219 million passengers per year. Macau Airport handled 9.6 million passengers in 2019, 45 percent more than the 6.6 million designed throughput. Macau Airport is being expanded. It is estimated that after the completion of the first phase of expansion, the throughput of Macau Airport will reach 11 million, and the second phase will reach 15 million. In July 2020, the Civil Aviation Administration of China issued a document on supporting the collaborative development of civil aviation in the Greater Bay Area, with the aim of building a world-class airport cluster in the Greater Bay Area by 2025. We believe that the total passenger throughput capacity of the five airports will reach about 338 million (an increase of 52.8%) after completion of the five airport expansion projects.
►The Macao Government is committed to promoting the further integration of Macau and mainland China. We believe Macau will benefit from the implementation of cooperative development projects and favorable policies in the Greater Bay Area.
Chart: Planning a Project
Source: 2020 Macau Policy Report, 2020 Biannual Meeting, CICC Research Department
The spending level of overnight visitors is higher than that of same-day round-trip visitors
In 2019, the average overnight visitor spent MOP 2,681, which is equivalent to 3.9 times the average amount spent by a round-trip visitor on the same day (MOP 680). The number of overnight visitors in 2016 (about 50.7% of the total) surpassed the number of same-day round-trip visitors for the first time. The strong increase in overnight visitors was mainly due to an increase in hotel room supply in 2015. Considering the additional spending of overnight visitors and the positive correlation between overnight visitors and midfield shopping, we believe that an increase in the number of hotel rooms can extend the length of time spent in Australia and further drive a rise in gaming demand. However, growth potential may be limited by Macau's land carrying capacity. We'll talk about that in a later section.
Chart: Percentage of overnight visitors
Source: DSEC, CICC Research Division
Chart: Consumption levels per type of tourist
Source: DSEC, CICC Research Division
Changes in tourist demographics and the frequency of visitors of different age groups visiting Australia
No one is born a gambler. Based on age, we roughly divide betting customers into new gamblers (26-45 years old) and regular players (46 years and over). The chart below shows: 1) 44% of visitors to Australia in 2019 were 26-45 years old; 2) most new gamblers from around 2000 became old gamblers 20 years later, over 46; 3) 74% of visitors over 46 or 63% of young visitors will travel to Macau again within half a year; 4) The number of new gamblers and regular customers has continued to grow over the past few decades. We believe that gaming upgrades and the continuous renewal of other entertainment facilities will help Macau continue to convert and retain young gamblers.
Chart: Percentage of visitors by age group (2003-2019)
Source: Macau Government Tourism Office (MGTO), DSEC, CICC Research Department
Chart: Number of visitors of all ages (2003-2019)
Source: MGTO, DSEC, CICC Research Division
Chart: Visitors returning to Macau within six months (26-45 years old)
Source: DSEC, CICC Research Division
Chart: Visitors returning to Macau within six months (45 years and over)
Source: DSEC, CICC Research Division
Analysis of betting profit models and cash flow
Gaming revenue
Gaming and entertainment tables are divided according to different business segments, namely VIP gaming and midfield gaming. The cash flow situation and profitability of the two businesses are different.
VIP betting is carried out by providing credit services to customers, and customers can use transcoding and cash chips.
Midfield betting is based on a cash entertainment model where customers can only use cash chips.
• VIP Gaming customers can participate in the VIP Transcoding Service Program operated by Gaming itself (Direct VIP Customers) or the VIP Transcoding Service Program of a third party intermediary (brokered VIP customers). Transcoding VIPs are mostly entertained in specially arranged lounges.
• Midfield betting customers are usually entertained in the lobby. Midfield clients can be further divided into regular midfield clients and high-end midfield clients (areas with additional restrictions).
VIP Betting: Brokered VIP Gaming and Direct VIP Gaming
The most notable feature of VIP betting is that customers place bets through transcoding, which allows customers to earn cashback based on the number of transcodes. Gaming operators usually provide credit to gaming intermediaries (intermediary VIP betting) and high-end direct customers (direct VIP betting) on an unsecured basis. The exact amount of credit depends on the amount of their bets and property status.
► Intermediaries for VIP Gaming: Intermediaries officially authorized by the Macau Gaming Supervisory and Coordination Authority (DICJ) are independent third parties, licensed in the name of an individual or company. Gaming operators provide intermediaries with exclusive or temporary VIP gaming rooms and service personnel, while intermediaries are responsible for attracting customers to entertain themselves and reaching a pre-agreed monthly guaranteed transcoding amount (ranging from HK$200 million to HK$400 million). Intermediaries are responsible for lending and receiving loans to clients.
The commission sharing model offered by betting operators is calculated based on revenue share or monthly transcoding amount. Based on the revenue sharing model (the commission is 1.25% of the transcoding amount, which is equivalent to 42.5-45% of VIP gaming revenue under the theoretical win rate), the intermediary receives the share of the VIP customer's gaming revenue brought by him. According to DICJ Administrative Regulation No. 83/2009, free allowances (such as catering, hotel accommodation, transportation, etc.) must be included in the intermediary rebate limit of 1.25% based on the amount of transcoding.
The existence of gaming intermediaries is essential because: 1) Considering China's strict foreign exchange control (maximum limit of 50,000 US dollars per person per year), there is a need for someone to provide gaming credit services to customers; 2) Since gaming loans are not legally recognized and protected in mainland China, it is very difficult for gaming to recover debts, but since intermediaries have personal connections with customers, intermediaries have channels to recover loans; 3) Promoting gambling in mainland China is also prohibited, but intermediaries can contact customers through their private networks and bring them to cooperating gaming. We estimate that approximately 80% of Macau VIP transcoding amounts are contributed by intermediary VIPs.
The DICJ enacted Law No. 27/2009 to strengthen supervision of betting intermediaries. The gaming brokerage industry has been further consolidated through increased scrutiny and approval of licensees. The number of approved intermediaries dropped from 235 in 2013 to less than 100 in 2020.
Direct VIP customers come from the betting operator's direct marketing, and customers can receive various gambling-related rebates, such as cash, hotel rooms, meals, and other free products or services. Gaming operators give back approximately 0.75— 1.25% of the transcoding amount to direct VIPs. Gaming operators are very careful when providing credit to direct VIPs, usually to customers with a good credit history and assets in jurisdictions that recognize gaming debts. We estimate that around 20% of Macau VIP transcodes come from direct VIP customers.
Chart: The number of gaming intermediary licenses has continued to decline since 2013
Source: DICJ, CICC Research Division
Chart: The number of VIP transcodes decreases with the number of gaming intermediary licenses
Source: DICJ, CICC Research Division
Midfield betting: high-end midfield, regular midfield and slots
Midfield betting does not use transcoding; players play games and win cash or cash chips by putting cash into the betting box. Midfield betting can be divided into three segments: 1) high-end midfield; 2) regular midfield and 3) slots.
►High-end midfielders: Players usually lose around $50,000 to $100,000 a year. Gaming operators actively maintain relationships with these customers and also provide them with free goods and services if they bet more than a certain amount. Most of the rewards are discounts on hotel rooms, dining coupons, or gift chips that can only be used to place bets.
► Regular midfielders: Customers who enter gambling mainly as tourists and do not receive additional rebates and services from the operator. They are responsible for all of their own betting costs, so they are the most profitable customer group when it comes to betting.
► Gaming machines: Mainly including slots, the minimum bet amount is far below the requirements for table betting.
Chart: Simple profit statement for gaming companies (using the new accounting standard IFRS 15 effective in January 2018)
Source: Company Announcements, CICC Research Department
Profit margin structure of VIP betting and midfield betting
Based on the following aspects, we believe that the business quality of midfield betting is higher than that of VIP gaming, based on: 1) it has higher profitability, because it does not require a betting intermediary, so the EBITDA profit margin is close to 30%, which is three times that of VIP gaming; 2) the midfield betting business is supported at the policy level; 3) midfield betting demand is more visible and more resilient, which means less volatility and risk for betting operators.
Chart: Profit Margin Structure and Profitability
Source: Company Announcements, CICC Research Department
Non-gaming business
In addition to the gaming business, Macau's integrated tourist resorts also provide customers with other products and services, such as accommodation, catering, conference and exhibition services (MICE), and other entertainment products. However, compared to gaming revenue, non-gaming revenue is minimal, but the net profit margin may be over 50%. Non-gaming revenue in 2019 accounted for 11% of Macau's gaming companies' total revenue, while the share of non-gaming revenue for Las Vegas gaming companies in the same year was 73%. There is a big difference in revenue structure between Macau and Las Vegas due to differences in regional travel preferences and non-gaming facilities. We'll explain and compare them in more detail in later chapters.
Chart: Macau Gaming Company Revenue Structure
Source: DICJ, CICC Research Division
Chart: Revenue structure of Las Vegas betting companies
Source: UNLV, CICC Research Division
Supplemental analysis of important financial items
We believe the following financial items are critical to understanding EBITDA.
►Gaming Tax: 39% of total gaming revenue is payable to the Macau Government as gaming tax, including:
• A special gaming tax that accounts for 35% of total gaming revenue, applies to gaming revenue earned in all gaming regions, regardless of business type;
• 1.6% of total gaming revenue shall be given to the Macao Government for a public foundation whose purpose is to promote, develop or study cultural, social, economic, educational, scientific, academic and charitable activities;
• 2.4% of total gaming revenue will be given to the Macao Government for urban development, tourism promotion and social security;
• A fixed annuity of MOP 30 million per year for each gaming license;
• An annual pension of MOP 300,000 per VIP table;
• An annuity of MOP 150,000 per year for each mid-game table;
• An annuity of MOP 1,000 per year for each e-betting machine or slot machine.
►Profit Tax: Macau companies are subject to a maximum of 12% profit income tax; however, most gaming operators have been granted a tax exemption period for gaming profits approved by DICJ:
• Wynn Macau to December 31, 2020 (Order of the Chief Executive of the Macao Special Administrative Region No. 324/2015)
• City of Dreams Entertainment until December 31, 2021 (Order of the Chief Executive of the Macao Special Administrative Region No. 330/2016)
• Galaxy Entertainment until June 26, 2022 (Order of the Chief Executive of the Macao Special Administrative Region No. 193/2018)
• Sands China until June 26, 2022 (Order of the Chief Executive of the Macao Special Administrative Region No. 194/2018)
• The Macau Expo until March 31, 2020 (Order of the Chief Executive of the Macao SAR No. 194/2018), until June 26, 2022 due to the postponement of gambling cards
• MGM China until March 31, 2020 (Macau SAR Chief Executive Order No. 324/2015) until June 26, 2022 due to the extension of gambling cards
Chart: Gaming Tax and Profit Income Tax in Major Gaming Regions (as of June 2020)
Source: Company Announcements, CICC Research Department
► Operating expenses: Fixed employee costs account for 60— 70% of total operating expenses. Other major operating expenses include: 1) advertising and marketing (in proportion to the CPC's harvest); 2) repair and maintenance of fixed assets; and 3) energy and raw materials (such as water, electricity, and food consumed by gaming and hotels). Since project development requires large capital expenses, bookmakers may record high depreciation and amortization expenses. Under normal operating conditions, EBITDA growth may be higher or lower than revenue growth due to operating leverage.
Growing under the limit of passenger capacity
Using Las Vegas as a reference to study Macau, we believe that the growth of the Macau gaming industry will be limited by non-gaming factors (such as the number of hotel rooms, leisure and entertainment facilities, etc.), so it is important to expand the number of guest rooms.
The total number of hotel rooms and suites in Macau increased from 19,500 in 2010 to 37,700 in 2019, with a compound annual growth rate of 7%. As of June 2020, gaming companies have delayed the opening schedule of new projects due to health incidents. We estimate that by 2021, around 4,500 new hotel rooms and suites (11% increase from existing rooms) will be open to visitors, including Galaxy Macau Phase III, Sands Londoners, and the Macau Expo.
► Operators can drive gambling demand through compelling lodging products. The expansion and opening of guest rooms in 2015/16 contributed to a rapid rebound in overnight visitors from the bottom of 2014 and brought back traffic to midfield betting, further driving midfield betting back from the trough.
►The average length of stay of visitors to Macau is limited by insufficient room availability. The total number of visitors to Macau in 2019 was 39.4 million, and only 37,700 hotel rooms were available, with an average of about 0.38 rooms per visitor per day. However, the 147,000 guest rooms in Las Vegas can provide each visitor with about 1.3 rooms per day. The average length of stay for visitors to Las Vegas is about 4.4 days, while Macau is only 1.2 days. We believe the difference in the number of rooms is one reason. Overnight travelers usually spend about 4 times as much as those traveling back and forth on the same day, so increasing room availability is critical.
Chart: Macau hotel rooms have an average compound annual growth rate of 7%, and the occupancy rate remains 90%
Source: DSEC, CICC Research Division
Chart: Number of guest rooms per tourist, Macau vs. Las Vegas
Source: UNLV, DSEC, CICC Research Division
► As far as the development of non-gaming businesses is concerned, can Macau become the next Las Vegas?
We pointed out in the previous section that Macau's non-gaming revenue is minimal compared to Las Vegas. As of 2019, the number of visitors to Macau followed Las Vegas (39.4 million in Macau and 42.5 million in Las Vegas). However, non-gaming spending per Macau visitor is about 71% lower than Las Vegas ($263 in Macau and $920 in Las Vegas). Shopping is the main expense of visitors to Macau, while visitors to Las Vegas spend more on dining, sightseeing, and other leisure and entertainment activities.
The Macau Government has been encouraging the development of the non-gaming industry through policy support and financial aid. Bookmakers are encouraged to increase investment in hotel expansion and non-gaming facilities. We estimate that the supply of better accommodation products and the increase in recreational facilities can further meet the needs of multi-day leisure travelers.
Chart: Total number of visitors to Macau
Source: UNLV, LVCVA, DSEC, CICC Research Division
Chart: Average non-gaming expenses of tourists
Source: UNLV, LVCVA, DSEC, CICC Research Division
Industry risks
We believe that the Macau gaming industry mainly faces the following risks: 1) bottlenecks in the number of gaming tables and hotel rooms; 2) uncertainty about the expiration and re-bidding of gaming grants in 2022; 3) changes in mainland travel endorsement policies; 4) the regulatory influence of the mainland and Macau governments, including tightening capital exit controls; 5) regional competition in other gaming centers around China.
The number of new gambling tables added each year is limited
Gambling tables are the main instrument of profit. Since 2013, Macau has imposed restrictions on the number of gambling tables, requiring that the compound annual growth rate of the number of gambling tables put into use in Macau should not exceed 3% during the 10-year period up to December 2022. The restriction aims to guide the orderly growth of gaming demand in Macau and improve the quality of profits. Since 2015, Macau has not allowed the addition of new VIP gambling tables. This regulation has not been incorporated into legal provisions or regulations, but it has always been strictly enforced. The only exceptions are that Galaxy Macau II and Studio City of Dreams opened in the fourth quarter of 2015, when 400 new mid-game gambling tables were approved (the theoretical limit of 175 was added). This sharp increase in the number of gambling tables was digested by a later reduction in grants. Digestion has been completed by 2019.
Assuming a 10-year CAGR of 3%, we expect to have around 7,371 gambling tables by the end of 2022. We found that changes in total gaming revenue over the past ten years were largely consistent with fluctuations in table operating efficiency (calculated from the daily revenue of a single gaming table) in the VIP business and the midmarket business. Therefore, assuming that gambling table restrictions will continue to be enforced until 2022 and that individual gaming revenue is stable, and that new tables will only be granted to midfield players, then the total revenue and share of midfield betting will increase steadily, while total revenue from VIP gaming will continue to be low.
Chart: Actual number of gambling tables vs. theoretical number
Source: DICJ, CICC Research Division
Chart: Number of VIP tables vs. number of midfield tables
Source: Macau Gaming Supervision and Coordination Bureau, Company Announcements, CICC Research Department
Chart: Macau VIP blog
Source: DICJ, CICC Research Division
Chart: Macau's midfield victory (including slots)
Source: DICJ, CICC Research Division
The gaming operating license will expire in 2022 and the tender will be re-tendered
The gaming grants or sublicenses of the six gaming operators in Macau will expire on June 26, 2022. We believe the following factors may have a significant impact on the bid: 1) the timing of the betting grant to be re-tendered; 2) the number of gaming licenses granted; 3) the gaming tax plan; 4) the large gaming grant fees that may be payable; 5) the commitment of further investment in Macau or the Greater Bay Area; 6) the validity period of the new gaming grant.
The Macau Government's re-tender schedule for gaming grants includes: 1) public consultation in the second half of 2020; 2) legislative amendments in 2021 (if any); 3) communication with gaming operators to prepare for re-bidding. We look forward to receiving updates from the Macau Government in Q4 2020.
Chart: Macau Gaming Approval Situation
Source: Company Announcements, CICC Research Department
Travel Endorsement Policy
In 2008, for the first time, the Macau government shortened the length of stay for passengers transiting through the country with Chinese passports from 14 days to 7 days. In July 2014, Macau's transit agreement policy was tightened, the permitted period of stay was shortened from 7 days to 5 days, and the entry ban period was extended (re-entry prohibited for 60 days, previously 30 days). The move is aimed at cracking down on underground illegal signing agencies in Zhuhai. In July 2015, this policy was relaxed to the previous 7 days. Due to the tightening of the endorsement policy, Macau gaming sector stocks fell about 28% in the third quarter of 2014, and Macau's total gaming revenue fell 16% year-on-year in the second half of 2014. Macau's gaming industry rebounded 12% between June and August 2015 after the endorsement policy was relaxed.
During the health incident, tour group endorsements and individual travel visas were suspended starting January 24, 2020 and January 28, 2020, respectively. Zhuhai began reinstating travel vouchers to Macau on August 12, 2020, Guangdong Province resumed on August 26, 2020, and other provinces and cities resumed on September 23, 2020. Tourism policy adjustments have complied with health incident prevention and control requirements and the pace of economic recovery. We believe the uncertainty of travel endorsement policies may be the main risk facing the gaming industry. The Macao Government and the Central Government have maintained close communication on the endorsement policy. We expect that the overall changes in the signing policy should be consistent with the development process of the Guangdong-Hong Kong-Macao Greater Bay Area for some time to come.
The impact of regulation on gaming operations
China's anti-corruption campaign began in 2014
China's anti-corruption campaign was one of the main reasons for the downturn in Macau's gaming industry from 2014 to 2016. VIP and high-end midmarket businesses were affected. From 2014 to 2016, total gaming revenue fell 36%, and VIP betting revenue fell 55%. The daily revenue of VIP gaming leader Galaxy Entertainment's single-card VIP table declined 55% ($54,867 in the first quarter of 2014 and $24,487 in the second quarter of 2016). The midmarket business has also been affected by the stagnation in tourism development. Midfield gaming revenue fell 19% in 2015 due to the lack of high-net-worth clients in the high-end midfield business. In 2017, as the impact of anti-corruption weakened and gaming revenue rebounded from a low level, the growth rate of total gaming revenue rebounded to 19% in 2017.
Chart: Daily revenue of a single VIP casino
Source: DICJ, CICC Research Division
Chart: Daily revenue for single-card midfield gambling tables
Source: DICJ, CICC Research Division
Smoking is prohibited throughout the midfield gaming area and VIP lounge
The first gambling ban was implemented in the mid-field gaming area from January 2013. The impact of the ban is limited because customers are still allowed to smoke in nearly 50% of gaming areas, and bookmakers can adjust the gaming layout to make full use of smoking areas. The impact of the midfield total smoking ban implemented in October 2014 was even more significant. Mid-market earnings fell 8% year-on-year in 2014/10 (14% year-on-year increase in 2014/9), the first time since 2010 that there was a negative monthly increase in earnings. In order to reduce losses caused by the smoking ban in the midfield area, gaming companies began to increase their investment in high-end midfield businesses in the fourth quarter of 2014. City of Dreams Boya and Galaxy Entertainment maintained leading positions in the high-end mid-market market.
The VIP lounge smoking ban came into effect in January 2019. Monthly VIP earnings recorded negative growth in the same month (January 2019 was down 17% year over year), and 2019 fell 19% on an annual basis. The daily revenue of Galaxy Entertainment and Wynn Macau's single-card VIP table declined 22% and 32%, respectively, in 2019. We don't think the Macau government will lift these bans after the health incident to revive Macau's economy.
Chart: The number of VIP transcodes dropped the most from 2014 to 2016, and has been affected by the smoking ban since 2019
Source: DICJ, CICC Research Division
Chart: The increase in VIP revenue is in line with the number of VIP transcodes; midfield revenue is also affected by the smoking ban, but it is more resilient
Source: DICJ, CICC Research Division
Chart: Performance of Macau's gaming sector
Source: Company Announcements, CICC Research Department
Gaming companies' competitive strategies and advantages
Macau gaming operators benefit from the cluster effect, and the risk of a potential price war could weaken the oligopoly's advantage. The main costs of Macau gaming operators include commissions and rebates paid to VIP intermediaries (accounting for about 42.5% to 45% of VIP gaming revenue, regulated by DICJ) and rebate allowances given to high-end midfield customers (accounting for about 22% to 27% of high-end midfield gaming revenue according to industry practice). In order to win in the fierce competition, bookmakers can choose to give intermediaries and customers higher commissions and rebates, which narrows the overall profit margin of the industry. As a supervisory authority, DICJ regularly monitors intermediaries' commissions and rebate rates.
Aware of the negative impact of the price war, bookmakers are competing in other fields, including: 1) placing local advertisements to attract customers and brand marketing; 2) expanding the guest capacity of gaming facilities (such as the number of tables and slots), and improving the customer capacity and service quality of non-gaming facilities (such as the number of hotel rooms, non-gaming and entertainment programs, etc.). Every company has unique advantages.
Chart: Macau's total gaming revenue market share
Source: Company Announcements, DICJ, CICC Research Department
Chart: VIP betting revenue market share
Source: Company Announcements, DICJ, CICC Research Department
Gambling industry valuation methods
EV/EBITDA is an appropriate valuation indicator
Considering the high capital expenditure of the Macau gaming industry and the visibility of historical data, the EV/EBITDA valuation method is usually used to value the Macau gaming industry.
►Why EV/EBITDA instead of P/E? We believe EBITDA can better reflect the company's free cash flow situation. 1) Debts related to new gaming property projects often incur large interest expenses, but with later deleveraging, interest expenses will gradually decrease; 2) Most companies have low profits or losses in the early stages of large capital expenditure projects, and depreciation expenses tend to increase rapidly after the opening of new gaming projects.
►Why is the bookmaker announcing adjusted EBITDA instead of EBITDA? Adjusted EBITDA (or adjusted property EBITDA) is EBITDA attributable to shareholders excluding stock incentive expenses, business expenses, pre-opening expenses, and other expenses unrelated to the management of a particular gaming property. It is commonly thought that adjusted EBITDA is a supplementary financial indicator for measuring the operating performance of individual gaming properties, which is more useful for comparing the operating performance of various properties. The average adjusted EBITDA is generally higher than EBITDA, but the specific adjustment items vary from bookmaker to bookmaker.
The average EV/ (adjusted) EBITDA in the betting sector in recent years is 14 times, and the range is 10 to 18 times. As betting grants are about to expire and uncertainty about re-bidding approaches, we are seeing valuations at this stage fall below the range.
Chart: Industry forecast EV/EBITDA (as of December 31, 2019)
