The risks are numerous and real but so is the reward, long-term and potentially short-term. Here we address the risk side of the equation.
As we all know, the Sands China IPO will begin trading on the Hong Kong stock exchange Wednesday/Thursday - depending on where you are. This is not your father’s IPO. In the blink of an eye, the Macau government has the power to essentially confiscate all of Sands’ Macau assets. Of course, any sub-concession breach prompting such a drastic action would have to be “serious” but the seriousness would be determined by the Macau government. We think this is highly unlikely but it remains one of many unusual risks associated with investing in this high profile IPO.
Lots 5 and 6
This project costs over $4 billion, with 6,000 new hotel rooms and a lot of new table supply (maybe – depending on the government) all opening up at the same time as Galaxy. This probably equates to a low ROI. We’re guessing around 10% for the first few years for the first two phases. Development risk here is big but in reality, LVS has little choice. Beijing and Macau want these sites developed and they will be developed.
Are we in a VIP bubble? VIP has been a roller coaster. The good news is we are still on the upswing. However, business levels are highly dependent on liquidity, Chinese government stimulus, and the Chinese stock market. As we saw earlier in the year, the peak-to-trough declines are severe.
LVS has a huge Mass business and, unfortunately, Mass table supply will be up 25% in the first half of 2010 - two years before Lots 5 and 6 and Galaxy open. As we wrote about in our 10/16/09 note "MACAU: FOCUS SHOULDN’T BE ON VISA RESTRICTIONS", the Street may be underestimating the potential impact. Furthermore, some of the supply increase will come from SJM’s Oceanus, opening in between the Macau Ferry Terminal and Sands Macau. As discussed in “OCEANUS TO SINK SANDS MACAU” (06/28/09), the Street still projects EBITDA growth at Sands Macau in 2010 despite the opening of a direct competitor in a better location.
"The Macau Government can terminate VML’s Subconcession under certain circumstances without compensation to VML, which would have a material adverse effect on our business, financial condition, results of operations and cash flows"
In the event of a determined contract breach, the Macau government has the power to confiscate all of the company’s Macau assets. The sub-concession contract “also allows the Macau Government to request various changes in the plans and specifications of our Macau properties and to make various other decisions and determinations that will be binding on us.” Basically, Sands China is at the mercy of the Macau (and Beijing) government.
Thus far, Sands has played with fire and taken on the government publicly in a few forums. Not smart. The company seems to have learned its lesson but it needs to keep learning. We consider the doomsday scenario highly unlikely but it is a risk. More likely, however, is continued government involvement in Sands’ development and operations.
"We may not be able to monetize some of our non-core real estate assets"
The LVS business model has always included building complementary but non-core assets to the company’s core hotel/casino operations. According to the original plan, LVS would’ve already monetized its two retail malls and the residential assets. Due in part to the company’s issues with the government they have been unable to sell of any of its non-core assets. It is unclear whether the appropriate approvals will be forthcoming from the new Macau government.
"We are required to build and open our developments on Parcel 3 of our Cotai Strip development by April 17, 2013. Unless we meet this deadline or obtain an extension, we may lose our right to the land concession or any properties developed under the land concession for Parcel 3"
LVS doesn’t have the financial capacity right now to build out Parcel 3. On the surface, that is good news given the significant development by LVS and others already on the Cotai Strip. However, LVS could forfeit the development right to Parcel 3, which means cannibalization by someone else.
"We operate a passenger ferry service between Macau (Taipa Temporary Ferry Terminal) and Hong Kong under an agreement with the Macau Government. The loss of our ferry agreement or our ferry operator could have a material adverse effect on our business, financial condition, results of operations and cash flows"
LVS has the right to operate their ferry service from Hong Kong to the Cotai Strip per an agreement with the Macau government. However, a lawsuit was filed challenging the agreement because there was no public bidding process. LVS will only lose about $35 million a year on its Cotai Ferry service so who cares if they lose the operating license, right? Wrong. Venetian Macau (and MPEL’s City of Dreams) is a huge beneficiary of the significant traffic generated by the service and the company’s developments on Lots 5 and 6 will also benefit from the ferry service.
“Our Macau legal advisor is of the opinion that, although uncertain, the outcome of the decision of the Court of Final Appeal is more likely to be unfavorable than favorable”. Translation: LVS will lose the case. However, LVS management claim they’ve been assured they will still operate the ferry and the government will resolve the dispute. Stay tuned.
"Gaming is a highly regulated industry in Macau and adverse changes or developments in gaming laws or regulations could be difficult to comply with or significantly increase our costs"
We included this one because the Macau government is considering a review of the gaming industry that could conclude that there are too many table games right now and not enough regulations. Table limits could impact Venetian Macau and Lots 5 and 6. It’s already going to be a challenge for LVS to generate a decent ROI on Lots 5 and 6 without additional limitations and regulations.
"The Macau Government could grant additional rights to conduct gaming in the future, which could have a material adverse effect on our business, financial condition, results of operations and cash flows"
This has been a risk since the exclusivity of Law 16/2001 granting additional concessions in 2001 expired in April of this year. We haven’t heard any credible talk of new grants but this remains a risk.