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THE M3: LVS

The Macau Metro Monitor.  November 17th, 2009.

 


LAS VEGAS SANDS TO PAY MACAU wsj.com

A document filed Monday with the SEC revealed that LVS has agreed to make an initial payment to the Macau government of MOP 700 million, or about US$90 million, for the land on which it is developing its new megaresort on the Cotai strip.   Construction on Lots 5&6 was halted last year but, under the terms of the new deal, the company now has 48 months to complete development of the site. 


PNK NOTES FROM LV MEETING

No real changes yet despite Dan Lee’s departure.  The potential is there for a higher ROI focus and possibly a sale of the company, in our opinion.  November a little sluggish.  Here are our notes.

 

 

 

Interim CEO

  • Temporary
  • Already met with the search committee.   
  • They want an operations backbone and cultural fit and there will be some development as well.  They believe that there is some value in the LA licenses given the low tax rate so development background is helpful.  
  • Wade Huntley (former COO) is the #1 name that has popped up - doesn't even know if he's interested.  Want both an operations and development guy (Kentucky/Massachusetts).
  • Interim CEO is doing a lot - making rounds to all gaming commissions.  The interim CEO was fairly involved in operations before.

 

No real changes since Dan Lee left.  The balance sheet is all Steve Capp anyway.  Operations are, of course, overseen by the COO.  Dan was really development focused and River City is in great shape.    

 

Credit extension by December - unclear how the Dan Lee issue affects this.  It was going very smoothly – it’s only 18mm drawn - and if they don't populate Sugarcane Bay gets stalled. 

 

What is the board's view on development?  There was always some push back.  River City should open in March or April. Sugarcane bay is really just piling work right now.  Baton Rouge is paper shuffling.  The new CEO will reevaluate everything that's going on.  Piling work will take them through 2Q2010.  They were targeting 2H2012.  

 

Even if they wanted to, it’s unclear whether LA will allow them to lower the budget on sugarcane. Need approval.

 

At River City slots are already there and some are being tested.

 

November trends have been typically slow and consistent with what they have seen over the last few months.  They are not worried about gas prices.

 

Admiral – the gaming commission told them they could repair the boat.  Trying to figure out how much that would cost. Probably somewhere in the mid-to-high single digit MMs.  Elections are in April - hull expires July 2010.  It’s too risky to wait till April when the guy in office gets kicked out.  Risk is where that boat goes - can't move license with gaming commission approval.  Rumor has it that Gene McNarry has ties to North County which is trying to get a casino.

 

It’s easier to get extensions on the backend.  Something as simple as getting the boat under construction which would cost $30mm and can always be moved. 

 

Will management now be required to actually own stock in the company rather than just options?

He does agree that they are in the dog house regarding this issue.  However no one has exercised any stock at a profit. Restricted stock - ISS dings them for owning restricted stock versus options.  Stupid answer, I think.  Issue of no downside from stock declines, just options.

 

He thinks that the property level management and capital allocation strategy could change.


LVS: OUTLINING THE RISKS OF SANDS CHINA

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.

 

 

KEY RISKS


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.

 


VIP

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.

 


Table Supply

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.


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BYI NOTES FROM G2E

Best product they’ve had in years but still not as flashy as the other guys.  Flooding the market with Wheel games.  Solid long-term prospects.  Here are our notes

 

 

GENERAL PRESENTATION

 

Canada replaces 20% of their games like clockwork every five years.

 

They went to one single platform from seven last year.

 

This year they have 100% more titles then last year.  ProSeries cabinet + Alpha 2.  Sold 140k iviews and now they have a lot of content coming on that: iview wheel, iview wizard.  Biometrics is going live this year.  Today BYI has 8% of the install base in North America of game opportunities and 13% of sold gaming devices.

 

They think that normalized replacement range is 80-110k /year.

 

Upside from new US jurisdictions: 125-150k.  Singapore: 2-3k, Italy: 40-50k, Australia 10-200k opportunity (not in Australia yet but looking for entry as if new regulations pass which would spur replacement cycle), Mexico 30-50, and Brazil 75-ish

 

The new Uspin touch screen game very cool.  They are going to flood the market with wheel games.  

 

New huge jumbo 3 wheel.  It’s a huge version of the legacy games.  They added a wheel version of “Hot Shots”.  Now all the wheels will spin.  30 titles on new V32, more Transmissives.  Cash Spin game looks great.  They have a rear projector that is the competition to MLD.  The Uspin touch screen is very cool and is rolling out March/April.  Loveseat "meet in the middle" with two screens.  There is more interaction between players.  New MLD-like product allows the casino to customize pay tables to different customers.  New game maker with progressive.  New “Hot Shot” gives you second chance to win.  

 

How do they balance more product variety and good product margins?  If volumes increase then they will be able to be able spread fixed costs over a larger base.  Also, they haven't sold a lot of conversions. 300-500 of labor and overhead per unit.  Higher volume allows them to get better pricing on parts.  Think that more volume adds a point and conversion kits is most of it. Doing more legal/accounting from India as well.

 

50% of their game operations is fixed pricing.  Uspin will be 80/20 participation - but not finalized. Integrating systems and games - touch screens/iviews.  Sold 140K iviews with little content before - now coming out with content - would drive the recurring revenue systems line.

 

Australia - regulatory changes? It is a mature gaming market with 200k units. If the proposed gaming legislation passes then all units would need to be replaced by 2016.  They may buy someone to get into that market.

 

Don't see that gaming becomes all software driven. 

 

Strategy in Italy?  Have done a lot - lots of operators have submitted Bally’s tech specs.  Have handshakes on sales.  In Illinois they will have a distributor.  Have to work on the 500 bet limit content. 

 

 

SYSTEMS PRESENTATION

 

Cool new products: Bally’s live, cool sign, iview DM, biometric recognition.

 

Bally integration gateway allows for interoperability between all different products and vendors.

 

SDS 11: the largest slot system manager.  Same code basis globally, backward compatible, internationalized, open, scalable.

 

Business intelligence - captures data from the casino - reports/dashboards - allows you to track all metrics that you care about that are constantly updated.  Visualization/mapping - allows you to visualize the popularity of the floor and the market that people are coming from.

 

In FY09, they did 224 implementations (new installs: 46, add-ons: 88 like iview, BI, bonusing, upgrades: 90)

 

FY 08: did 193 installs - 49 new, 77 add-ons

 

Have 408,000 slots connected to their system.  600 locations.  240 locations are on high speed networks. 

28 of the largest 46 casinos world wide use Bally’s.

 

Competitive replacements:

  • Oneida - replaced IGT
  • Coushatta- ALL
  • South point BI - IGT mariposa
  • Greektown BI - IGT marisposa
  • SJM: ALL

 

ISLE came back to them from the IGT system that they replaced them with 4 years ago

 

BYI makes about 3k per slot device on a systems install - legacy - new are about 4k per device.  Average net competitive systems replacements - 8k slots: 32mm, new casino additions - average 17K units - new casino additions.

 

Canada is coming out with 100s of MMs of RFPs over the next few months.

 

Server based gaming:

  • Targeted marketing at point of play. 1) They will be able to customize second chance to win  2) Slot tournaments 3) customizing marketing content by gender and age 4) community events - however the operator defines them

 

Employee and customer self service:

1) Drinks ordering

2) Kiosk and POS

 

Game management:

1) Game configuration

2) Dynamic bet configuration

3) Peripheral management - for things like software upgrades/new bills/etc

 

Their iviews can talk to any system/any protocol/any manufacturer.  This allows customers to add new technology on old devices.

 

Showcased their server window.  Users can buy lottery tickets, place bets, order drinks (and save each customer's preferences). Can hide the window.

 

At City Center, the system isn't really stable.  BYI, ALL, Konami decided that it wasn't in their best interest at opening.  All their games will be there (22% of floor) but will have next generation and not SB. 100 WMS games will have SB windows and the rest will have Next Generation. All their games and ALL and Konami will just have Next Generation. Later on they will move to DM once the environment is stable.  Ask WMS why 450 of their games at city center won't have a SB window.  “Go check out Monte Carlo and see for yourself why".

 

Will have multiple properties committed to full DM view rollout before end of the year.  Also have a language option and ability to have a left hand screen pop out as well.


IGT NOTES FROM G2E

IGT hosted a series of presentations at G2E.  The new products looked very good.  CityCenter roll out of SBG not going well.  “Wheel of Fortune” will face a lot of competition from BYI.  Here are our notes.

 

 

GENERAL PRESENTATION

 

The company has a tendency to be silo focused but they are working very hard to break those silos down.  They are setting “leaner, meaner" organizational goals.

 

The primary goal is to manage their asset base rigorously. Having more interoperability is a very important component of customer service. They are focused on protecting their market share and growing revenues.

  • Focused on improving performance of their games
  • They are preparing for a rebound
  • Higher conversion of R+D to revenue

 

Management is very happy with their share this quarter and hoping they will maintain that going forward.

 

In the long term:

  • Focusing on diversifying their revenue base (beyond Wheel of Fortune too)
  • Outsized revenue growth
  • Stimulating replacement demand (using balance sheet and producing better content)

 

2010 goals:

  • Clients today are focused on enhancing performance today - not 5 years out (think they are referring to failure of SB)
  • Focusing on new markets - Italy, Brazil and China.
  • Focus on their scale and the operating leverage that should come with that.

 

Changes that they have made so far to ensure that they maximize their ROI on R+D:

  • Created smaller studios focused on specific products.
  • No more new platforms for every theme on the game ops side.  Everything will be on the same platform which is reusable.

 

New titles they are excited about:

 

  • “Sex and the City”
  • “American Idol”
  • “Amazing Race”
  • Center stage series - entirely reconfigurable, basically a huge display over five seats.  "Movie theatre style concept". 103" and 70" displays.  Have 4-5 titles in the works.  First one is Wheel of Fortune, American Idol is another.

 

MLD product "dynamix brand" only manufacturer that can have an all in one box that can be a 3,4, reel game or a video poker game. These games are consistently earning above floor average.  IGT is focusing on renewing the content on those devices and introducing new feature. This is the new server based platform - most exciting thing.

 

 

Future product:

  • Improving their time to market - which lets them know if the game will be a hit earlier in the process - rationalizing their platforms - allows them to put their content across more platforms helping them save money

 

Marketing:

  • A lull like this allows you to rethink your strategy
  • On the sales side they have restructured around the customer, now they have one person per client that can talk about all of their products.  Still organized to sell and take orders at the property level but also have corporate level relationship managers.
  • Branding project around "IGT".  

 

Government Relations - US market opportunities:

  • 940,000 legal installed games in new America in ‘09
  • Have not exercised all the legal potential to install games "150k" games in jurisdictions like Kansas, California and Illinois
  • Think that 75k machines can be installed in the near term.
  • 26 states with new budget shortfalls now and 2010 is an election year - so he thinks that it’s easier to vote for gaming than higher taxes.
  • Approved markets with expansion opportunities: MD,  CA, KS, IL, FL
  • Potential markets: OH, TC, AL, NH

 

International opportunities:

  • Casinos: two openings in Singapore, Rosario in South America
  • Longer term: Philippines in 2012/2013 (Manila Bay); Taiwan was close but voted no; Japan may potentially legalize, project starting in Hungary and Spain - early stage

 

2010 opportunities for VLT:

  • Italy - 56,697 units (14% of existing AWP) converting to VLT as part of earthquake relief effort. Pays (upfront) 800mm euros in new tax revenues in order to get license.  IGT is in discussions with licensed operators to see how they can participate
  • Longer term: Brazil has a bill currently under consideration.  Vote in may 2010 which could legalize gaming

 

Internet gaming (primarily a UK opportunity):

  • Wager works: a content provider in UK and emerging European markets (Spain, France, Italy)
  • Offers internet, digital TV and mobile gaming
  • Longer term Africa/Australia and even the US is possible

 

For 2010 they are focused on controlling costs until the market recovers to get to 30% operating margins.  IGT is focused on reducing production costs, standardization, and content.  Took $50mm out of material and labor costs this year on game production.  Hard to see with depressed volumes.  When volume comes back there will be big margin upside.

 

Next few years they will focus on reducing leverage from 3.5x to under 2x (2.5x by next year). They will continue to do equipment finances for customers.

 

 

Manically focused on what they can control until times get better.

 

Q+A:

  • How is the executive team compensated? 50/50: revenue growth and operating income growth.  Lower down its more ROI focused on things like reduction of working capital, win per unit, margin expansion on for sale
  • R+D: pull money more towards mega jackpot product.  Turn the investment in server based gaming to for sale and jackpot products
  • How do they benchmark conversion of R+D to revenues?  In the past they didn't - only looked at R+D/revenues.  They are focused on how much they spend that never results in a revenue generating product.  Killing bad projects earlier.  Basically what percentage of projects is generating money?  They are doing more market research and analysis now too
  • They are using the balance sheet more to drive sales?  Their balance sheet allows them to do it on a larger scale than competitors.  Have $175mm out to casinos (for development).  Want to be more creative on just lending directly to game ops.  More creative pricing, more leasing, more partnership lending
  • There is not much M+A in the near term/any divestitures.  Expect some cautious investments in tuck in technologies for core business but also video lottery and remote gaming.  Have no sacred cows at IGT - if they have bad business they will either get rid of them or fix them. (A la walker digital)
  • Replacements for next 12 months: bottom end of guidance assumes replacements like ‘09. High end/"best case" think that it’s like last Q.  No indication yet that 2010 will better than 2009
  • Server-based gaming's ability to stimulate demand?  High degrees of interest, clear view on how they would use it.  BUT given the economy, they are now focusing on bridge products (sounds just like BYI)

 

R+D center in Beijing.  Interaction between on and offsite R+D.  In China there are 500k graduating engineers yearly vs 69k in the USA.  The cost of an engineer in China is 45% of the cost of a US engineer.

 

  • There are big opportunities to hire amazing people there.  The China center is embedded across all their platforms.  So they are fully integrated
  • So will they also be manufacturing in China?  IP protection issues?  Portion the code/responsibility so they eliminate a lot of the IP risk.  Purchase a lot of material from Asia (50-55% from low cost suppliers)
  • Subcontracting Australian product to get manufactured in China.  So, they are testing the waters.  They reduced their own manufacturing work force by 38% this year.  Generally trying to move to a more variable cost structure throughout the organization.

 

In Illinois IGT decided to go through a distributor given the nature of that market.  They have an exclusive agreement with the largest distributor in that market.  Now they are getting to know the route operators.  In other markets like Illinois they are usually one of 2-3 suppliers that survive.  Illinois is more of a 2011 relationship.  In addition, they are financing there - which they believe you need to finance to get the business.  That can be a $100mm market for them.

 

In Italy there are already existing shops betting parlors and more casinos-like facilities.  Have a lower priced solution (coming out of UK) and for casino option they have the Reno games.  The games must be centrally determined too.

 

 

PART TWO - Network systems presentation

Advantage: 200 installations and 200,000 EGMs

 

SbX:  8 installations - mostly trials

 

Maripose BI: 32 installations, 48k EGMs

 

Casinolink: international, multi-site accounts.  40 customers.  They acquired this in Jan ‘09, new markets for networked systems. Late ‘09 they will integrate SBG and in mid 2010 they will integrate the mariposa technologies.

 

SbX floor manager (downloading to avp) + SbX media manager - drives the service window.  All ready now

 

SbX is all about managing their existing real estate.  In order for it to work they need Ethernet, G2S compatible EGMs, game library and floor manager, service window and player services.  IGT's tier 1 solution is meant to be a solution (6-10/day) to conversion kits - allows you to swap out the game as soon as performance becomes poor.

 

Server window: allows them to customize content to each client.  Having the media manager eliminates 2k of product hardware cost - some of which they can pass down to clients.  Mid-2010 deployment.

 

Trial data?  It’s unclear because they didn't have a lot of content that was deployable on the box.  They won't really comment on the results/ROI - even though it’s been at Monte Carlo for almost 5 months.  The SB window is very cool and we really like their ability to also use the top LCD to real estate as well.  Can work side-by-side with next generation.

 

The 103 game is more about the puzzle and a community gaming. Expect to see on floors in March.  Not for sale till January 2010.  Top dollar - new high and mid denomination game.  “Alice in Wonderland” - new progressive game.  Doesn't reset each time.  “Quest for Lost City” - another fantasy progressive  - remembers where you left off.  Lots of very cool MLD games.  Introduced a transmissive element to it.  Also have 3D video slots (“Little House of Horrors” looks cool).  Multi-play - basically multi-video slots at the same time.  4 sets of 3 reels.  Average wager is 2/spin vs 50 cent average.

 

Reel edge: first skill-based spinning reel game.  The player can stop reels when he/she wants.  For Generation X/Y.  Seek to capture 21-35 years of age emerging customer base.  These are evolving traditionalists that have moved on to newer types of devices.

 

New Illinois product:  game king/poker Illinois didn't limit payouts in the state.  Can have different types of games.  Game kings, super star poker, hall of fame video games all on one box.


Chart of The Week: Benny's Gold Price

Ben Bernanke is turning into the most politicized Chief that the US Federal Reserve has ever had. Given the history of the US central bank, that’s saying a lot.

 

As I type this note, Bernanke is speaking at the Economics Club of New York. It seems to be a lovely affair of world class group-thinking. In his prepared remarks, Bernanke explained away a -16% crash in the price of the US Currency the same way that his political friends in Washington have asked him to.

 

Summers/Geithner political playbook: First, establish that the US Dollar was the “safe haven” of choice during last year’s stock market crash. Then, suggest that all we are seeing is a controlled unwind of that “safe haven” global asset allocation.

 

There are 3 glaring problems with this view:

  1. This political party line is inaccurate
  2. The Chinese and Japanese disagree  
  3. It implies that the only way to strengthen the dollar is to crash the stock market

From a trust building perspective for a currency, this lacks credibility to the core. As a result, the Buck continues to Burn. And everything priced in bucks continues to REFLATE.

 

In the chart below, Matt Hedrick and I show the visual representation of our view versus that of Mr. Bernanke. This chart of GLD (the gold ETF) is marked-to-market. Bernanke’s political stardom is marked by compromise and constrain.

 

I am selling half of the 7% position in Gold (GLD) that we have in the Asset Allocation Model today. While it may be cozy for Bernanke to buddy up with his banker friends who are in bonus season in NYC, his boss will be in not so friendly Chinese confines tonight. President Obama, be prepared to be laughed at if you dismiss the Burning Buck like Bernanke just did.

 

The long term fears associated with a US Dollar Credibility Crisis are very well placed. For the immediate term TRADE, they may be peaking right here, right now. The US Dollar is hitting new YTD lows.

 

I can’t think of a Fed Chairman more equipped to have delivered the message of a pandering politician. Thanks for the Gold price, Benny.

 

Cheers,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Chart of The Week: Benny's Gold Price - GLD

 


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