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Coverage Initiation: Melco Crown Entertainment
Gamblers in Asia know that Macau, China is the “it” place to place one’s bets. That market is larger than Las Vegas and still growing quite rapidly. The market is also “it” for investors in Melco Crown Entertainment (MPEL), which has all of its operations there. This can be viewed as a good thing or a big risk.
The company began as a 50/50 joint venture between Melco and PBL Entertainment in December 2004 called, originally enough, Melco PBL Entertainment Limited. It was intended to be the pair’s vehicle to carry on casino, gaming machine and lodging operations in Macau. Crown eventually acquired all of the gaming businesses and investments of PBL, including PBL’s investment in the joint venture and, as a result, changed its name to Melco Crown Entertainment. In December 2006, the company completed an initial public offering on the NASDAQ, whereby each American depository share represents three ordinary shares. It is also listed on the Hong Kong Exchange.
The company’s Melco Crown Gaming subsidiary is one of just a handful of companies licensed, through concession or subconcession, to operate casinos in Macau. This clearly provides the company with a certain amount of market protection. However, this limited exclusivity does not eliminate competition in the fiercely competitive gaming space. Moreover, the concessions are limited in duration and there is no guarantee of renewal. If Melco Crown were not granted an extension, its top and bottom lines would fall swiftly and dramatically.
Melco Crown operates two casino-based operations, City of Dreams and Altira Macau. It also has 10 Mocha Clubs, which offer gambling in non-casino venues. The company’s facilities service a variety of individuals, from the high-end to the low-end of the spectrum. The casinos include hotels and entertainment venues, among other things. It pays for the use of some trademarks, including the Hard Rock Hotel name.
To effectively compete, Melco Crown must maintain the quality of its properties at a high level, as well as provide for upgrades over time. While this can be costly, stale and/or old properties and gaming facilities are not as desirable to patrons, who can easily go to a competitor’s property.
In addition to owning the above gaming operations, the company also has a stake in a site that is currently in development. Building properties from the ground up is a much riskier proposition than simply running existing facilities. There are material front-end costs involved and the company must bear the risks associated with construction. If completed as expected, however, the project, called Studio City, would likely add materially to the company’s top and bottom lines.
Both the construction and the running of casino and related properties are subject to significant regulation. Changes in the regulatory regime would require Melco Crown to adjust its operations accordingly, and may result in additional costs, some of which could be ongoing in nature. For example, a recent law changed the areas in which smoking is allowed in casinos.
It is also worth noting that the company makes use of third parties to attract guests to its properties. Gaming Junkets include both individuals and corporate entities and are officially licensed in Macau. These promoters are responsible for a substantial portion of Melco Crown’s casino revenues. In 2011, 61% of gaming revenues were derived from customers brought in by promoters. Moreover, in 2011, the top five customers were all Junkets and accounted for just-under 24% of the top line. The largest customer accounted for nearly 7% of casino revenues. Clearly, maintaining these relationships is important for the company’s continued success.
Operating casinos and resorts is a highly competitive business across the globe. Melco Crown has the valuable rights to build in the fast-growing Macau market, which is a material positive for the company’s future prospects. Investors interested in a pure play Macau casino operator should consider this company, though they should also note the risks involved in investing here. Interested subscribers should monitor Value Line’s quarterly coverage of the company, while keeping an eye out for Supplementary reports highlighting late-breaking news.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.