Analysts focusing just on a potential FCPA fine are missing the bigger risks.
Let’s face it. Macau is a can of worms. Money laundering, side betting, junket relationships with nefarious triads are just some of the activity that may be going on in Macau. To date, the Nevada Gaming Commission has apparently looked the other way. Will political pressure force them to turn its head eastward? To us, that is one of the biggest risks emerging out of this Department of Justice and SEC investigations announcement. The other is what does this do to LVS's prospects in new markets?
So we had to shake our heads watching two groupthink analysts agreeing with each other that LVS will just face a fine for violating the Foreign Corrupt Practices Act. One analyst estimated a fine between $50 and $200 million. That results in a per share hit of $0.05 to $0.25. Case closed, right? Well, case closed if one wants to stop with a very superficial analysis. The stock market is a little smarter than that which is why we saw almost $3 lopped off the stock price (over 6%). Granted, it was in a down market day but on the flip side, there was a bulge bracket upgrade and the announcement of huge February gaming revenues would’ve normally pushed the stock higher.
We don't pretend to know all the details and veracity of what went down with Jacobs, alleged payments from LVS, alleged “dirt digging” on government officials, etc. And we won't pretend to know how this will all turn out but we can outline the risks. While low probability, a real risk is that the Nevada Gaming Commission decides it cannot stomach its companies operating in Macau. Of course, that would affect WYNN and MGM as well but it has to start with LVS given the alleged behavior. We don’t think this risk can just be summarily dismissed.
In addition to the fine, the 3rd issue for LVS would be a loss of credibility and reputation when it comes to participating in new Asian markets. Japan, Taiwan, India, and Thailand are just some of the markets that may pursue legalized, large scale casinos and LVS and WYNN were probably the top developers for an Asian development. Will politicians want to risks their reputations getting in bed with LVS if these investigations go against LVS? Surely, the LVS multiple has contained a premium for new market growth.
So how do we handicap the risk? Obviously, this is a very imprecise and difficult task. In the following table, we’ve quantified a low and high case for lost value in each of the three areas of risk: FCPA fine, a forced exit from NV and PA, and multiple contraction from lower probability of securing new markets.
Our conclusion is that the Street did a pretty good job of discounting the new risks. Best case for LVS is obviously that DOJ/SEC finds nothing. The bulls (most of the sell side) think that the worst case is a big fine amounting to less than a $1 per share. We think the worst case is LVS is forced to exit the US gaming markets at fire sale prices - 4 multiple points below the implied value in the stock. Also under this scenario, the FCPA fine is actually 5x the largest rumored bribe we’ve heard of $250m. Finally, LVS loses a multiple point of valuation to the lost new market opportunity. Under our worst case scenario, $8 of share price value would be lost.
Of course, there are a range of possibilities in the middle. Nevada could do nothing or it could force a complete separation of the companies which may not result in as much value destruction as a forced sale. It's also unclear what would happen to the brand and management fees paid by Sands China to LVS. For simplicity sake, we've ignored them. We just don't know what will happen. It's all about risk management at this point.
The collective wisdom of the stock market was somewhere in the middle which we think was appropriate. The questions now are the overhang effect, the duration of the investigation, and how do the big long-only funds feel about the huge tail risk. Our guess is that most analysts will come out today with the “overdone” and “risks were well known” commentary. Maybe that helps the stock temporarily but it’s not like the stock is dirt cheap, even after yesterday. And as we pointed out going into the Q4 announcement, estimates are finally reasonable, and not conservative. There is a valuation precedent for a cheaper LVS.