Gambling On Casino Stocks: Where Should Investors Place Their Bets?

Casino stocks lost big last month as weak earnings and new gambling restrictions in Macao drove investors away from the highly cyclical sector. But the future may not be as bleak as many investors fear, which means casinos could be building towards a big payout.

Shares of both Wynn Resorts Ltd. (WYNN) and MGM Mirage (MGM) are down more than 20% this month, while Las Vegas Sands Corp. (LVS) stock has tumbled 15%.

“Casino stocks were so badly beaten during the crisis last year, they were probably only second to banking stocks,” Lawrence Ho, who owns Macao’s City of Dreams casino, told MarketWatch. “They were so beaten that even after the run they’ve had this year they’re nowhere near the valuations they were at in 2007 or early 2008.”

Lawrence Ho is the son of the 87-year old Stanley Ho, who controlled Macau’s gambling business for 40 years before China took it over in 1999 and deregulated gambling in 2002. And Macao - a former Portuguese colony that is now a special administrative region under Chinese rule - is the new center of the gambling universe.

Macao’s Cotai Strip generated $13.5 billion in gross gaming revenue last year, up 31% from 2007. The Las Vegas Strip raked in less than half that, with $6 billion in 2008 gaming revenue.

However, Macau is the only city in China where gambling is legal, and as such, it is subjected to tight government regulation. That means investor profits are often subject to the whim of Beijing’s central government, but it also means the region will be protected from problems such as overexpansion, which has become a problem for Las Vegas.

And in some cases, government restrictions provide buying opportunities by driving more timid investors out of the market. That has been the case this month.

Bright Lights, Big City… Cash Cow

About 65% of the Macau’s casino visitors come from Mainland China, particularly the neighboring Guangdong province. Hoping to keep more money on the Mainland to bolster its economic recovery, China tightened travel restrictions on Guangdong residents, limiting them to just two trips into the region each year. The result was a 12.5% drop in gaming revenue over the first half of the year.

However, authorities began easing visa restrictions in July, making it possible for Chinese residents to visit Macau once a month. The effects were noticeable immediately.

Macau casino revenue surged 22.3% in the July-September quarter to a record $3.81 billion. September revenue doubled from a year ago but analysts expect October will be the best month on record.

But now that money is rushing back into Macau at an unprecedented pace, Beijing is pondering restrictions to rein in the region’s growth. For instance, the travel restrictions that were eased in July have again been tightened. Residents may now only make one trip to the city every two months. Officials are also considering limiting the number of table games a casino can offer, and raising the gambling age to 21 from 18.

The news that such restrictions were on table sent casino stocks diving in October. But what investors didn’t realize was that such restrictions would actually benefit the six major casino companies already operating in Macao - Wynn Resorts, Las Vegas Sands, MGM Mirage, Galaxy Entertainment Group Ltd. (GXYEY.PK), SJM Holdings Ltd., and Melco Crown Entertainment Ltd. (MPEL) - by keeping new competition out of the region.

“It’s more psychological,” Francis Lun, a general manager at Fulbright Securities, told Reuters, referring to the plunge in casino stock valuations following the decision. “The problem of Macao now is oversupply, so if the government restricts the supply, it is good for the existing players.”

Macau’s casino operators agree.

“We’re very much in favor of [the restrictions],” Wynn, whose company operates a luxury casino hotel in Macau and will open a second next April, said in an interview with Reuters. “The government wants to keep people calm while they provide jobs and industrialize the country.”

Wynn pointed out that Macau’s jobs sector is of particular concern to Beijing.

“If you allow people to spread games without any control then what happens is they get overzealous - as you’ve seen here in Las Vegas -… they hire people and fire them,” he said.

Macau officials have asked casino operators to return workers to a 48-hour workweek, up from the 40-hour week four of the city’s major casino operators have implemented, according to Wynn.

“The six operators understand that paying higher commissions and opening more gaming tables than others might win them short-term market share, but is not a sustainable competitive strategy,” a Citigroup Inc. (C) report said. “They realize that they have to foster a less hostile environment so that the industry as a whole can be more profitable.”

Betting On Macau

Of the six gaming companies operating in Macau, Wynn Resorts may be investors’ best bet.

“If we were going to pick one stock among the gaming sector, we would prefer Wynn,” Belle Yang, Core Pacific-Yamaichi’s Hong Kong-based head of research, told MarketWatch. “The profitability is higher, and they have some more international background and management experience.”

Third-quarter net income at Wynn Resorts fell 33% to $34.2 million, or 28 cents a share, from $51.2 billion, or 49 cents a share a year earlier. Revenue rose to $773.1 million from $769.2 million.

“In the summer, things started to change,” Wynn said on a conference call to investors. “I’m spilling over into October a little bit, but to give you a general impression, if things continue the way they are, we are going to equal or beat 2008 in Las Vegas and we are going to equal or beat last year in Macau.”

Wynn Resorts also priced an initial public offering (IPO) of 1.25 billion shares on the Hong Kong market at $1.30 per share. The shares - which represent a 25% stake in the company’s Macau operations - raised $1.63 billion and jumped 7% Oct. 9, the first day they were traded.

Wynn’s operating income in Macau was $83.2 million for the third quarter, compared with $59.6 million a year earlier. Revenue from operations in Macau surged to about $4 billion - almost ten times the $410 million in the casino earned in the second quarter. Wynn Resorts is Macau’s No. 4 operator, with about 14% of the local gambling market.

Las Vegas Sands on Friday won approval from the Hong Kong stock exchange for more than $6 billion in combined initial public offerings. The company hopes to piggyback on strong investor sentiment the way Wynn did. Analysts expect the company will raise $2 billion or more.

However, the world’s most valuable casino operator is struggling with debt and needs the money to complete its two suspended projects in Macau

Las Vegas Sands third-quarter revenue climbed 3.2% to $1.14 billion. However, the company reported a net loss of $76.5 million, or 19 cents a share, compared to a loss of $32.2 million, or 9 cents a share the year prior.

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