SJM Holdings Limited (880.HK) Gaming Sector 2 July 2013

Transcription

1 INSTITUTIONAL RESEARCH SJM Holdings Limited (880.HK) Gaming Sector 2 July 2013 Research Idea: War Chest We rate SJM Holdings Ltd. a BUY with target price of HK$23.20/share. SJM is the largest casino operator in Macau by gross gaming revenue with market share of 27%. 3 Reasons to BUY: Deep Local Knowledge - SJM has held its own in delivering a 48% Adjusted EBITDA CAGR over the past 4 years on a 30% revenue CAGR. These numbers stack up well even against its most aggressive competitors. The firm s focus on developing its self-promoted properties, including Casino Grand Lisboa, has resulted in consistent improvement in EBITDA margins since We would attribute a significant part of the firm s success to SJM s long standing history in Macau and deep rooted understanding of its Chinese clients. These intangibles should provide confidence that it can deliver a successful integrated casino resort on the Cotai Strip in 2017 and a project ROIC of at least 18% by High Yield, Sustainable Dividend Lower CapEx requirements versus peers due to its satellite casino model have allowed the firm to amass an industry leading net cash position of HK$26bn, industry low leverage ratio of below 9% and annual operating cash flow generation of over HK$10bn. The firm s strong financials should allow it to maintain its 75% dividend payout ratio even with HK$20-25bn CapEx plans looming. We expect a dividend yield of 5.5% to provide downside support for the stock. Good Momentum - The market has penalized SJM for market share losses and its reliance on satellite casinos. The valuation gap versus its peers is now near 3 year highs. We believe there is opportunity for the gap to narrow to normal levels as the firm begins to deliver better results from initiatives to improve table yield and grow premium mass gaming at its self-promoted casinos over the next couple of quarters. First quarter 2013 results were good after weakness for SJM in the back half of 2012, and we believe momentum is building. Over the next 3 years, we expect the firm to generate 9.7% EBITDA CAGR on 6.8% revenue CAGR. Valuations: In our view, the long term macro factors driving gaming growth in Macau remain solid despite concerns over credit availability and a general deceleration in the Chinese economy. The recent share price pullback provides an attractive risk reward ratio. Our target price of HK$23.20/share is based on SOTP valuation of its existing property and the firm s Cotai project. The implied 2014 EV/EBITDA multiple is 11.0x. Risks: 1) Decline in VIP gaming and slowdown in mass gaming revenue growth in Macau; 2) Greater than expected market share declines due to increased competition; 3) Delays and budget overruns for its Cotai expansion; 4) Significantly reduced table allocation from the DICJ for its Cotai Project. Figure 1: Financial Summary HK$m except per share E 2014E 2015E Revenue 76,092 79,519 87,522 92,444 96,803 Adj. EBITDA 6,928 7,631 8,564 9,466 10,061 Adj. EBITDA Margin - % 9.1% 9.6% 9.8% 10.2% 10.4% Net Profit 5,308 6,745 7,514 8,380 8,938 Revenue Growth - % 32.0% 4.5% 10.1% 5.6% 4.7% EBITDA Growth - % 43.2% 10.1% 12.2% 10.5% 6.3% Dil. EPS (HK$/share) EPS Growth - % 44.1% 26.8% 11.2% 11.5% 6.7% DPS (HK$/share) Sources: The Company and Sun Hung Kai Financial Target Price 12m Rating Price Chart (HK$) Stephen Yang, CFA (852) stephen.yang@shkf.com Reports available at: Bloomberg Code: <shkr> HK$23.20 Buy (26% upside) Bull, HK$27.40 Base, HK$23.2 Bear, HK$16.7 Jun12 Sep12 Dec12 Mar13 Jun13 Sep13 Dec13 Mar14 Jun14 Sources: Bloomberg and Sun Hung Kai Financial Scenario Analysis TP (HK$) Assumptions Bear %y/y FY14 EBITDA 15% ROIC on FY18 Cotai Base %y/y FY14 EBITDA 18% ROIC on FY18 Cotai Bull %y/y FY14 EBITDA 21% ROIC on FY18 Cotai Key Data Price HK$ W high/low HK$ 22.38/13.00 Mkt cap HK$m (US$m) 102,013(13,154) Shares in issue millions 5,550 Free float % M avg. t/o HK$m (US$m) (25.3) Major shareholder STDM 55% Sources: Bloomberg and Sun Hung Kai Financial FY12 revenues: US$79.5bn Satellite Casinos 48% Other 1% Self Promoted 14% Casino Grand Lisboa 37% Sun Hung Kai Financial Institutional Research

2 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 SJM (880.HK): War Chest 2 July 2013 Forecasts SJM will continue to benefit from the macroeconomic and infrastructure improvements that are driving growth in Macau gaming. Top line growth potential continues to favour those with larger and newer properties on the Cotai strip. However, for those operators running near capacity on the Peninsula side there are opportunities to generate decent bottom line growth through margin improvement via investment in existing properties, development of premium mass gaming and reallocating tables across properties to maximize table yields. For SJM, we believe the firm s planned initiatives over the next couple of years should help generate revenue CAGR of 7.2%. We estimate these initiatives will also improve margins by 80bps, driving EBITDA and dividend growth at about 10% CAGR. By 2017, the opening of the firm s Cotai project should supply new growth opportunities and allow a better mix of self-promoted casino revenues that should drive group margins higher. Figure 2: Estimates Summary E 2014E 2015E CAGR Total Revenues 79,519 87,522 92,444 96, % %yoy 4.5% 10.1% 5.6% 4.7% Consensus 86,669 93,225 99, % Adj. EBITDA 7,631 8,564 9,466 10, % %yoy 10.1% 12.2% 10.5% 6.3% Consensus 8,571 9,371 10, % EBITDA Margin 9.6% 9.8% 10.2% 10.4% 80bps Adj. EPS (HK$/sh) % %yoy 26.8% 11.2% 11.5% 6.7% Consensus % DPS (HK$/sh) % %yoy 23.3% 12.0% 11.5% 6.7% Consensus % Sources: The Company, Bloomberg, Sun Hung Kai Financial Valuation Over the past three years, SJM has traded at an average of 10.3X EV/EBITDA. Relative to its peers it has traded at an 18% or 1.9pt valuation discount. A growing discount has stemmed from recent year market share losses as a result of competitor expansion. We expect the market share erosion to subside over the next 2 years as there will be no new casino properties opening until We note that a natural valuation gap will likely persist given SJM s 20% EBITDA reliance on satellite based casino operations. Its satellite model arguably results in reduced transparency into operations and an inherently lower EBITDA margin compared to its peers. Figure 3: Current Year EV/EBITDA 18.0x 16.0x 14.0x 12.0x 10.0x 8.0x 6.0x SJM EV/EBITDA Sector EV/EBITDA Sources: Bloomberg, Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 2

3 Figure 4: Peer Valuations P/E (x) EV/EBITDA (x) % Ticker Company Mkt Cap (US$mm) YTD %chg Est. Div Yield Macau Casinos 1928 HK Sands China 38, HK Wynn Macau 14, HK Galaxy 20, HK SJM Holdings 13, HK Melco Crown 12, HK MGM China 10, Average Sources: Bloomberg, Sun Hung Kai Financial The company has benefited from macro-economic factors driving growth in Macau gaming and saw its revenues from 2008 climb at 30% CAGR. Meanwhile its EBITDA rose at a 48% CAGR over the same period. This compares with EBITDA CAGRs of 106% for Galaxy, 30% for Sands China Limited and 25% for Wynn Macau. SJM is now trading at 9.5X current year EV/EBITDA, a 25% or 3.1pt discount to its peers. The valuation spread versus its group is near 3 year highs. We believe there is opportunity for the valuation gap to narrow as the company begins to deliver good results from initiatives to improve table yield and grow premium mass gaming at its self-promoted casinos over the next couple of quarters. Additionally, we believe with each passing milestone of its Cotai project, valuations will begin to better reflect its expansion plans. We rate SJM a BUY with a 12m target price of HK$23.20/share. Our valuation is based on sum-of-the-parts methodology and implies a FY2014 EV/EBITDA target multiple of 11.0X. Total return would be 31% including a 5.5% estimated dividend yield. Figure 5: SOTP Valuation SOTP (HK$m) Base Case Bear Bull Existing Properties 2014 EBITDA 9,466 8,992 9,848 growth %y/y 10.5% 5.0% 15.0% Target Multiple 9.0x 6.0x 10.5x Mid-2014 Enterprise Value 85,197 53, ,407 Target HK$/share SJM Cotai HK$25bn CapEx 2018E ROIC 18% 15% 21% 2018E EBITDA 4,500 3,750 5,250 Target Multiple 10.5x 9.5x 11.5x Mid-2018 Enterprise Value 47,250 35,625 60,375 25% ROIC 4yrs 19,354 14,592 24,730 Target HK$/share Total Enterprise Value 104,551 68, ,136 HK$/share Implied 2014 EV/EBITDA 11.0x 7.6x 13.0x Add Net Cash 2013E 25,094 25,094 25,094 Target HK$/share Target Equity Value 129,645 93, ,231 Target HK$/share Upside 26.2% -9.1% 49.1% Est. Dividend Yield 5.5% 5.2% 5.7% Total Return 31.7% -3.9% 54.8% Source: Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 3

4 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 % SJM (880.HK): War Chest 2 July 2013 We value SJM s existing business at an average of 9.0x our FY2014 EBITDA estimate of HK$9.47bn and accounts for 66% of our target valuation. Conservative Valuation on Cotai - Our back of the envelope calculation for SJM Cotai is based on a 10.5X EV/EBITDA multiple on our 2018 EBITDA estimate of HK$4.5bn and then discounted to mid-2014 at a 25% hurdle rate to account for the investment costs. The scope of the project is still being discussed but management estimated the cost could be between HK$20-25bn for a 541K sqm GFA, 2,000 hotel room, proposed 700 gaming tables and 1,000 slot machine integrated casino resort. The opening is slated for late 2016 to early Our assumption is that by 2018 the project will generate HK$4.5bn in EBITDA, i.e. 18% ROIC on a HK$25bn investment in its first full year of stabilized contribution. We believe our ROIC assumption is reasonable in the face of gaming table caps in Macau. For comparison, Casino Grand Lisboa generated EBITDA of HK$32K/table per day (EBITDA Yield) in Applying a modest 4.5% per annum growth on EBITDA yields through 2018, our ROIC assumption would imply that table count for SJM Cotai in 2018 would be roughly 300, or less than half of SJM s total request. We add HK$25bn in estimated net cash at the end of 2013 to arrive at our target price of HK$23.20/share. Downside Dividend Support The risk reward ratio at this point in time is attractive. Even if the company s expectation for FY2014 drops to 5% growth and the market is only willing to pay 7.6X EV/EBITDA for SJM, i.e. close to trough levels, the downside would be less than 10%. This would be offset by the firm s generous dividend payout and estimated yield of 5.5%. Figure 6: Estimated Dividend Yield SJM Est. Div Yield Average +/-1sd Sources: Bloomberg, Sun Hung Kai Financial Optionality We have not priced in two potential sources of additional growth for SJM, including 1) Satellite casino Macau Legend Development s (MLD) announcement that it will redevelop Macau Fisherman s Wharf (MFW). The 110K sqm MFW site currently contains a number of tourist attractions and the Babylon Casino houses 23 mass gaming tables. The expansion could see the property receive 350 additional gaming tables on three new hotel properties over a three year period. SJM receives roughly 4% of every dollar of gross gaming revenue generated by tables at its satellite casinos. In 2012, SJM satellites delivered HK$4.3K in daily EBITDA yield. Based on these metrics the MFW expansion could deliver annual EBITDA contribution of HK$550m or more before applying any yield growth assumptions by The project could add HK$0.50/share or more to our target valuation. 2) An increase in scope of SJM s Cotai project based on a tie-up with Macau Theme Park and Resort Ltd. to build a larger Cotai resort could improve the competitiveness of SJM s Cotai property. Sun Hung Kai Financial Institutional Research 4

5 % Gaming Revenue Contribution Adj.. EBITDA Margin SJM (880.HK): War Chest 2 July 2013 Company Specific Drivers We highlight SJM s initiatives that should help generate a reasonable level of bottom line growth for the company over the next 3 years. Longer term, the company will benefit from the opening of its first Cotai property in early Meanwhile, we expect the company to continue its generous dividends supported by a strong balance sheet and solid free cash flow generation. Growth of Self-Promoted Properties Since the opening of the Grand Lisboa in 2008, the company has driven gaming revenues from HK$34bn to HK$79bn, a CAGR of 30%. With increased revenue mix coming from its flagship casino and self-promoted properties, EBITDA has seen a 48% CAGR. EBITDA margins have increased from 5.7% to 9.7%. By 2015, Grand Lisboa could be 39% of gaming revenues up from 37% in 2012 and 61% of EBITDA up from 59% in Figure 7: 39.0% 37.0% 35.0% 33.0% 31.0% 29.0% 27.0% 25.0% Grand Lisboa Mix Positive on Margins % 9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% Casino Grand Lisboa Mix EBITDA Margin Sources: The Company, Sun Hung Kai Financial We expect revenue from self-promoted properties including Casino Grand Lisboa to grow 8.3% while satellites grow at a 5.9% CAGR to The change in mix will be positive for margins. We expect adjusted EBITDA margins to expand from 9.6% in 2012 to 10.4% by the end of We note that Q margins were up 10bps from Q1 the prior year. Casino Grand Lisboa This year, SJM is expanding gaming capacity at Casino Grand Lisboa by renovating the ground and first floors to make room for high-limit premium mass market gaming tables. First half comparisons will be better due to the inclusion of 40 gaming tables from financially troubled satellite operator Greek Mythology. In the second half, Casino Grand Lisboa is expected to receive another tables from its Jai Alai and Oceanus casinos as those facilities undergo planned renovations over the next 12 months. The reallocation of tables from low yielding properties to the firm s best yielding property is a positive on margins. Casino Lisboa At Casino Lisboa the company is devoting more tables to premium mass market gaming. In May 2013, the casino opened a new area for multi-station electronic games capable of seating 200 players. Casino Jai Alai SJM has begun its facelift project for its Jai Alai building. The estimated cost for the refurbishment is under HK$1bn. SJM plans to include new facilities at Jai Alai Palace including a 100 room hotel, restaurants, department stores to enhance the business of Casino Jai Alai and Casino Oceanus at Jai Alai. Upon completion, the company will lease out retail space at the building starting in Sun Hung Kai Financial Institutional Research 5

6 Cotai Plans for SJM s Cotai project are over 5 years in the making. In May 2013 the company had its land concession of 70.5K sqm published in the gazette in Macau, a major step forward in the development of its Cotai property. SJM has agreed to pay the government HK$2.1bn in total land premiums for a 25 year lease term. The company awaits construction permits and expects to begin construction in the second half of 2013 and completion date of 3 years after ground breaking. Estimated costs are between HK$20-25bn. When completed at the end of 2016 early 2017, the casino hotel resort will include 2,000 rooms, up to 700 gaming tables and 1,000 slot machines. In comparison, planned CapEx is HK$19.6bn for Galaxy Entertainment Group s Galaxy Macau Phase 2 on 450K sq m GFA with 1,350 hotel rooms and up to 500 gaming tables. SJM s planned GFA is 15% larger with 50% more hotel rooms and construction will run in parallel with significant construction activity in Macau from Figure 8: Cotai Plans Sources: The Companies, Sun Hung Kai Financial SJM management has also indicated that they have the opportunity to develop its casino in cooperation with Macau Theme Park and Resort Ltd. (MTPR). MTPR is owned by SJM director and Macau legislator Angela Leong On Kei. MTPR s land plot is 180K sqm and is expected to be used for a theme park, 6,000 hotel rooms and an indoor beach. The cost of MTPR s investment is estimated to be US$1.3bn, half the cost of the casino announced by SJM. Excluding any theme park option with Angela Leong, we expect SJM s Cotai property to generate HK$4.5bn in incremental EBITDA for the firm in 2018 assuming ROIC of 18% on a HK$20-25bn investment. The company owns land bank on the same contiguous block as Melco s Studio City. Management has not made any announcements on what they will do with this land parcel. Sun Hung Kai Financial Institutional Research 6

7 War Chest The casinos offer both significant upside growth and dividend yield. SJM, MGM, Sands and Wynn all pay dividends. Strong free cash flows, friendly dividend policies and improving balance sheets have allowed dividends to grow over time for all operators. The risk to dividends lies in the ability of the operators to fund significant expansion over the next few years through cash flows, debt and their balance sheets. With the six operators expected to spend a combined US$24bn in capital expenditures on new resorts, balance sheets will be tested. Cash Hoard - One of the benefits of SJM s satellite business model is that it allows a bigger portion of the firm s earnings to flow to shareholders or back onto its balance sheet since maintenance CapEx is the responsibility of satellite casino owners. SJM over the past four years has had the lowest ratio of CapEx to revenue, EBITDA and Operating Cash Flow among its peers. Not surprisingly, Sands, Galaxy and Melco have had the highest rates due to their expansion into Cotai in recent years. Figure 9: CapEx % of Revenue, EBITDA, Operating Cash Flows Total Chg in Market Share SJM 0.5% CapEx % of Revenue 7% 4% 1% 1% 0% 2% CapEx % of EBITDA 132% 65% 17% 7% 5% 22% CapEX % of Operating Cash Flow 457% 53% 10% 5% 4% 17% MGM 1.6% CapEx % of Revenue 6% 3% 2% 1% 5% 3% CapEx % of EBITDA 46% 19% 9% 6% 19% 15% CapEX % of Operating Cash Flow -127% 42% 9% 5% 17% 14% Wynn CapEx % of Revenue 11% 17% 4% 3% 5% 7% CapEx % of EBITDA 51% 74% 17% 13% 20% 28% CapEX % of Operating Cash Flow 52% 56% 15% 10% 23% 25% -5.1% Galaxy 8.9% CapEx % of Revenue 15% 19% 25% 11% 4% 11% CapEx % of EBITDA 1356% 261% 265% 98% 24% 91% CapEX % of Operating Cash Flow -216% 145% 216% 77% 22% 80% Melco Crown CapEx % of Revenue 77% 71% 8% 2% 6% 19% CapEx % of EBITDA 427% -763% 50% 12% 25% 114% CapEX % of Operating Cash Flow 941% -500% 50% 13% 24% 126% Sands CapEx % of Revenue 65% 12% 8% 16% 15% 20% CapEx % of EBITDA 345% 51% 29% 51% 55% 76% CapEX % of Operating Cash Flow 2707% 57% 28% 64% 54% 89% Sources: The Companies, Bloomberg, Sun Hung Kai Financial -1.1% -4.8% Can SJM s payout levels continue in light of the capital expenditure requirements? We believe so. Wynn, Sands and MGM have paid out almost all earnings in dividends over the past couple of years, while SJM has been a little more prudent with a 75% payout ratio. The company last year generated HK$10.6bn in operating cash flows. Accounting for its 90 cents/share dividend (HK$5bn in cash), this leaves the company HK$5.5bn a year to spend on capital investments. Thus, if SJM s Cotai project requirement is HK$25bn over the next 4 years, then SJM could essentially pay for % of the property from cash flows after maintaining its current dividend level. This is before any growth assumption. Any remaining requirement could be funded through the company s current net cash position of HK$26bn. Sun Hung Kai Financial Institutional Research 7

8 Net Cash (US$m) SJM (880.HK): War Chest 2 July 2013 Will SJM s dividends grow? We believe dividends will grow along with growth in earnings while the company maintains a payout ratio of 75%. We estimate this to be a 10% CAGR through The risk on the level of growth would then be if: 1) The company has significant expansion cost overruns and/or decides to raise the amount of capital expenditure on the planned property; 2) The company decides to acquire satellite casinos and/or invests a significant amount in the development of the combined project with Macau Theme Part and Resorts. The operative word here is significant as we see a sizeable buffer based on SJM s strong current net cash position. The company has the strongest balance sheet among its peers. Debt to Equity in 2012 improved from 18% to less than 9%. Figure 10: Industry Debt Profile (L) 2012 Net Cash Position (R) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% SJM Galaxy Wynn Macau Sands China MGM China Melco 3,500 3,000 2,500 2,000 1,500 1, ,000-1,500-2,000 SJM Galaxy Wynn Macau Sands China MGM China Melco Sources: The Companies, Bloomberg, Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 8

9 Gross Gaming Revenues (MOP m) SJM (880.HK): War Chest 2 July 2013 Macau, Asia s Gaming Center Macau s gaming market is the world s largest by gross gaming revenues. In 2012 Macau casinos generated US$38bn in GGR, roughly 6X those of Las Vegas. Since the liberalization of Macau s gaming market in 2002, gaming growth in the city has been explosive. GGR has risen at a 30% CAGR since The drivers of Macau gaming remain solid and will continue to facilitate growth going forward for the operators in Macau including SJM. Key factors include: 1) proximity to a large population base; 2) strong economic growth in Asia; 3) growth in mass gaming; 4) supportive government policies and investments in Macau. Figure 11: Macau Gross Gaming Revenues 350, , , ,000 CAGR 30.6% 150, ,000 50, Sources: DICJ and Sun Hung Kai Financial Proximity to Large Population Approximately 3.2 billion people live within a five-hour flight from Macau. The relatively short distance from major population centers in Asia facilitates Macau's development as a popular gaming destination in the region. Macau visitor growth has averaged 10% p.a. since China has been the key driver of visitation growth to Macau, facilitated by the implementation of the Individual Visit Scheme (IVS), which allowed citizens from selected Chinese cities to obtain permits to visit Macau without the need to join a tour. In 2012, 60% of all visitors to Macau were from China. Figure 12: 2012 Macau Visitor Mix Hong Kong 25% Other 11% Taiwan 4% China 60% Sources: DSEC and Sun Hung Kai Financial Growing Chinese Wealth Macau gross gaming revenues have directly benefited from China s expanding economy. Improving incomes have provided a multiplier effect on top of the visitation growth. The correlation Sun Hung Kai Financial Institutional Research 9

10 Monthly Mass GGR (MOP m) SJM (880.HK): War Chest 2 July 2013 between per capita urban income and monthly mass gaming revenues between 2005 and 2012 is noteworthy. From 2000 to 2012, annual per capita income of China s city dwellers grew from RMB5.8K to RMB23.7K. A rise in Chinese discretionary income has made Macau more affordable to a larger proportion of the nation s population. The urban population in China in 2010 was 666m and approximately 230m were considered middle-income earners. The Chinese Academy of Social Sciences forecast that half the country s urban population will be in the middle-income range by China s central government is targeting per capita income to double over the next 10 years. A growing number of Chinese middle class and higher per capita incomes both in urban and rural areas will provide significant upside to China s consumption habits. We expect Macau casino operators to benefit. Figure 13: Per Capita Urban Income vs. Macau Mass Gaming Revenues 25,000 R² = ,000 15,000 10,000 5, ,500 11,500 16,500 21,500 26,500 Monthly annualized per capita urban income (RMB) Sources: Bloomberg, DICJ, Sun Hung Kai Financial Development of Mass Market Good for Margins The Macau gaming market consists of two primary segments: the cash or mass market segment and the rolling chip or VIP segment. VIP in 2012 was 69% of gaming revenues in Macau. 70% of Macau s tax revenues are from gaming receipts. The high reliance on VIP gaming in the city is a source of sector and tax-revenue volatility and can be a risk to future growth and sustainability of the city. Both the Macau government and the PRC Central government continue to seek ways to diversify the city s revenue base. We expect the government s efforts to promote non-gaming investments such as retail, hotel and other entertainment facilities to benefit mass gaming more than VIP. As the gaming industry in Macau matures, operators are becoming savvier in terms of marketing to their respective clientele. This allows them to extract more value per customer. Loyalty programs, complimentary services and unique property amenities keep players on properties for longer, which drives up game play and results in stronger gaming table yields. More casinos are now offering premium services or special gaming rooms to high-stakes gamblers that are not your average gamer but also not considered ultra-wealthy VIP players. This segment labeled as "premium mass" has gained significant traction in Macau as it provides better table yield rates for the operators. The growth of mass is expected to be the key driver of gaming growth in Macau over the long term. EBITDA margins on mass gaming are assumed to be between 30%-40% while VIP margins are 10%-15%. The difference is mainly from the commissions paid to promoters for VIP gaming. A rise in mass-market gaming is positive for profit margins, but is associated with a higher required capital investment. Sun Hung Kai Financial Institutional Research 10

11 Figure 14: 2012 Macau Gaming Mix Slots 4% Mass 27% VIP 69% Sources: DICJ, Sun Hung Kai Financial Supportive Infrastructure Investments There are six entry points into Macau. 49% of entrants were from mainland China and most enter the city through the Gongbei border gate. According to the National Development and Reform Commission, the PRC government has expressed support for a more modern and integrated transportation system within the Pearl River Delta region as described in its Outline of the Plan for the Reform and Development ( ). Improved transportation to and within Macau is expected to contribute to growth in visitation and mass market gaming. Border Upgrades Expansion of the Gongbei border gate at the end of 2012 should relieve immigration congestion at the border crossing. Additionally, economic development of Hengqin Island with a theme park and other businesses across from the Cotai Strip should increase regional economic wealth and drive visitors to Macau. Transportation The Guangzhou-Zhuhai high-speed train, Hong Kong-Zhuhai-Macau Bridge, Macau Light Rail System, upgrade of the Taipa ferry terminal, and Macau airport should provide additional capacity and convenience for international and mainland travelers into and around Macau. Hotel Capacity At the end of 2012, there were 26K available guest rooms in the city with average occupancy of 83% and likely at capacity on weekends. Supply of new rooms won t change significantly until 2015 when Melco s Studio City and Galaxy Macau s Phase II resorts open. We estimate an additional 15K-18K hotel rooms will be available by the end of 2018 upon completion of the planned resorts by the casino operators. Sun Hung Kai Financial Institutional Research 11

12 Risks VIP Credit Risk The company is exposed to credit risk on credit extended to VIP patrons and gaming promoters. The company has limited control over when the gaming promoters extend credit or their credit procedures, or their collection or enforcement processes. The Group has concentration risk of 81% on advances and receivables due from its five largest gaming promoters. Cotai Expansion Risks SJM s expansion project in Cotai faces execution risk in obtaining the necessary licenses and permits to construct and operate an integrated hotel and casino in Macau. The company awaits a construction permit for its site in Cotai. Additionally with a significant number of casino and infrastructure projects planned in Macau over the next 5 years the company could face labour shortages, delays in construction and/or material cost inflation. Increased Competition The company faces competition in Macau and elsewhere in Asia. Casinos and integrated gaming resorts are becoming increasingly popular in Asia, giving rise to more opportunities for industry participants and increasing regional competition. The company s competitors in Macau and elsewhere in Asia include many of the largest gaming, hospitality, leisure and resort companies in the world. Some of these current and future competitors are larger than the company is and may have more diversified resources and greater access to capital to support their developments and operations in Macau and elsewhere. The company expects competition in Macau to increase as new hotels, casino and entertainment complex projects are completed in Cotai. Regulatory Risks 1) Smoking Ban - Macau s government has mandated that 50% of all gaming floor space must be smoke free from 2013, which could have short-term negative impacts on gaming revenues. 2) The government of Macau has announced that it will limit table supply growth to 3% per annum. This could mean SJM may not receive the entire 700 table request that it has made for its expansion project in Cotai. 4) The PRC government has from time to time tightened its policy on granting visas for its citizens visiting Macau. This could impact the ability of SJM to grow its revenues and attract visitors to its properties. Chinese Economic Risks With 60% of Macau visitors arriving from China, gaming is highly correlated to China s economic health. A slowdown in China s economy could impact growth of the Macau casino operators. Sun Hung Kai Financial Institutional Research 12

13 Industry Overview Macau is a Special Administrative Region (MSAR) of the People s Republic of China. It is located on the southern border of Guangdong province. The city consists of the Macau peninsula and the islands of Taipa and Coloane and is home to China s only legal casino gaming industry. The gaming history of Macau stretches across three centuries starting when the government in 1847 legalized gaming in response to slowing trade in the region. Liberalization of Gaming Prior to 2002, STDM, SJM s parent company, held the monopoly rights to operate games of fortune in Macau. Following its decision to open up Macau's gaming industry, the local government conducted a public tender process for gaming concessions. As a result of the public tender, the Government awarded three gaming concessions, to SJM, Galaxy Entertainment Group and Wynn Macau. The Macau Government subsequently authorized three subconcessions permitting each of SJM, Galaxy and Wynn Macau to enter into subconcession contracts with their respective subconcessionaires to operate games of fortune in Macau. The subconcession holders are MGM, Venetian and Melco Crown. Post the granting of concessions; Sands Venetian was the first foreign operated casino to open in May The number of casinos in operation increased from 17 in 2005 to 35 today. The number of gaming tables also increased from 1,226 to 5,497, while gross gaming revenues rose from MOP47bn (US$6bn) in 2005 to MOP305bn (US$38bn) in Visitor arrivals to the enclave have risen from 18.7m per year in 2005 to 28m in Over the past 10 years, casino operators have invested a significant amount in building the city into a gaming and entertainment Mecca. Macau is considered the world s largest and fastest growing gaming market in terms of gross gaming revenues. In 2012, Macau gaming revenues were approximately 6X the revenue generated in Las Vegas. Gaming revenues are estimated to account for more than 70% of Macau s fiscal revenues and over 50% of its GDP. While gaming growth rates have moderated due to supply constraints and a deceleration in China s economy, the longer-term potential for the region remains significant. Competition & Supply There are six legal licensed operators in Macau. There are 35 casinos of which 19 are satellite casinos that operate under service agreements with one of the concession holders. By gross gaming revenue market share SJM remains the leader, collecting nearly 27% of gaming revenues in Figure 15: SJM 27% MGM 10% Wynn 12% 2012 Estimated GGR Market Share (L); Third party casinos (R) Galaxy 19% Sands 19% Melco 13% No. Property name Concessionaire/ Subconcessionaire VIP tables Mass-market tables Total Percentage of Total 1 Casino L'Arc Macau SJM Holdings % 2 Casino VIP Legend/Pharaoh SJM Holdings % 3 Casino Ponte 16 SJM Holdings % 4 Casino Golden Dragon SJM Holdings % 5 Casino Lan Kwai Fong SJM Holdings % 6 Casino Greek Mythology SJM Holdings % 7 Casino Emperor Palace SJM Holdings % 8 Rio Casino Galaxy Entertainment Group % 9 Casino Fortuna SJM Holdings % 10 Casino Jimei SJM Holdings % 11 Casino Casa Real SJM Holdings % 12 Grand Waldo Casino Galaxy Entertainment Group % 13 Waldo Casino Galaxy Entertainment Group % 14 Casino Diamond SJM Holdings % 15 Taipa Square Casino Melco Crown Entertainment % 16 Casino Kam Pek Paradise SJM Holdings % 17 Casino Grandview/MJC SJM Holdings % 18 Casino Babylon SJM Holdings % 19 President Casino Galaxy Entertainment Group % , % Sources: The Companies, DICJ and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 13

14 Figure 16: Macau Gaming Snapshot Sands China Wynn Galaxy SJM Melco MGM 1928.HK 1128.HK 27.HK 880.HK 6883.HK 2282.HK 2012 (US$m) Net Revenues 6,511 3,671 7,322 10,261 4,078 2,809 Adj. EBITDA 1, , Adj. EBITDA Margins 30.4% 27.2% 17.4% 9.6% 24.4% 24.4% Cash 1,953 1,352 2,103 3,023 2, Debt 3, , , Shareholder's Equity 5,586 1,355 2,820 2,565 3, Net Debt 1, , D/E % 58% 52% 52% 9% 94% 67% Gaming Mix 2012 VIP 58% 76% 79% 68% n/a 64% Mass 35% 19% 18% 31% n/a 27% Slots 7% 5% 3% 2% n/a 10% Casinos Penisula Cotai Key Casinos Sands Macao Wynn Macau Galaxy Macau Grand Lisboa Altira MGM Macau Venetian StarWorld Lisboa City of Dreams Sands Central Cotai Grand Waldo Oceanus & Jai Alai Mocha Clubs Plaza Macao City Clubs (3) Satellite (14) Hotel Rooms 7,229 1,008 2, , Tables 1, *842 *1750 * Slots & Gaming Machines 5, ,454 3,776 3,393 1,272 Sources: The Company and Sun Hung Kai Financial Looking ahead, a significant supply of casinos is set to come online in Macau starting in The number of new hotel rooms will top 15K while capex spending will approach US$24bn. Current table requests currently exceed the number of tables the DICJ is expected to allocate over the next 10 years based on its announcement of a table cap. Figure 17: Future Projects Cotai Projects GFA (000 sqm) Land Cost (US$m) Capex (US$bn) Hotel Rooms Table Request Slot Machines Expected Opening Galaxy Phase II , ,000 Mid 2015 Melco Studio City , , Wynn Cotai , , MGM Cotai n/a , , SJM Cotai , , Sands Parisian , ,500 n/a Galaxy Phase III & IV n/a n/a 7.0 4, , Totals ,550 3,750 11,500 Sources: The Companies and Sun Hung Kai Financial Figure 18: Current and future Cotai properties Sources: The Companies, Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 14

15 Macau gaming operators also compete with casinos in countries such as Malaysia, South Korea, the Philippines, Vietnam, Cambodia, Australia, New Zealand and Singapore. Taiwan and Japan are also in the process of legalizing casinos for their markets. Despite growing gaming competition in Asia, gaming operators in Macau continue to benefit from economic growth in the region. 2) Hotel and Retail Market In the past, facilities in Macau focused on gaming. Properties developed over the past 10 years have increasingly offered a variety of non-gaming services, including high-end hotels, retail, concert halls and banquet spaces. The introduction of non-gaming facilities has encouraged longer stays as well as spending in Macau. In 2012, there were 26K hotel rooms in the city with the average length of stay at 1.4 nights and overall occupancy rate of 83.1%. Figure 19: Macau hotel rooms Year Ended 31 December Total Available Rooms 17,490 19,259 20,091 22,356 26,069 Total Hotel Guests (in millions) Average Length of Stay (Nights) Occupancy (%) ADR (US$) Sources: DSEC and Sun Hung Kai Financial Total retail space has expanded significantly in Macau. Spending has also increased as the average urban income of mainland Chinese citizens expanded. According to the DSEC, total retail spending in 2012 was HK$24.9bn, up 60% from HK$15.6bn in Government & Regulation The DICJ is the primary regulator and government agency that oversees that gaming operators abide by the laws and regulations set forth by the Macau government under the Gaming Laws. Promoters Gaming promotion are activities used to promote casino games by offering transportation, accommodation or any other entertainment services in exchange for commissions paid by a casino operator. These activities are regulated by Macau s Gaming Promoters Regulation and gaming promoters must be annually licensed by the DICJ. There are about 219 operators licensed with the top five operators, controlling 50% of all rolling chip turnover in Macau. In 2009, the government capped gaming promoters commission at 1.25% of rolling chip volume. Labor Quotas All companies operating in the city must receive approval from the Macau Human Resources Office for labor quotas when importing non-resident unskilled workers. Employment of non-resident skilled workers is also regulated. The current unemployment rate in Macau is less than 2% and the government is expecting labor shortages over the next few years due to heavy construction planned in the city. The government has signaled that it will provide accommodative policies to ensure an adequate supply of workers in Macau. Controls These include: Figure 20: Smoking Ban Table Caps IVS Restrictions Government controls Starting in 2013, 50% of the public casino areas must be designated non-smoking. In March 2010, the Macau Government announced that the number of gaming tables operating in Macau would not exceed 5,500 until the end of the first quarter of 2013, and in September 2011, the Macau Government announced that for the 10 years after 2013, the total number of gaming tables to be authorized in Macau will be limited to an annual increase of 3.0%. In addition, governmental approval is required before a casino commences operations. As at 31 December 2012, SJM operated 20 (including slot machine halls) of the 35 casinos in Macau. Of the remaining casinos in Macau, Galaxy operated six casinos, Melco Crown Gaming operated three casinos, VML operated four casinos, and each of Wynn Macau and MGM Grand Paradise operated one casino. The current sets of concessions are set to expire between 2020 and 2022 but no timetable for renewal discussions has yet been set by the Macau government. China s central government has also exerted control over Macau in the past. In 2008, the government tightened travel visas granted to Chinese citizens to visit Macau resulting in a significant fall-off in visitations in Since then the government has somewhat relaxed its Individual Visit Scheme (IVS) and growth has picked up. Sources: DICJ, DSEC and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 15

16 The Company Background SJM Holdings Ltd. (880.HK) is the holding company of Sociedade de Jogos de Macau, S.A. (SJM). SJM is one of six authorized companies to operate casino games in Macau. The company was incorporated in 2006 and listed on the HKEx in 2008, raising about US$500m by floating 25% of the company. Sociedade de Turismo e Diversões de Macau (STDM) is the largest shareholder of the company with a 55% stake. STDM s major shareholder is casino magnate Stanley Ho. Prior to 2002, STDM held monopoly rights for Macau gaming from 1962 to SJM s casino operating concession was granted by the government of Macau in 2002 and runs to March SJM s gaming operations are regulated by the DICJ and are outlined in its gaming concession agreements. The concession agreements set out minimum capital-expenditure requirements for operators as well as taxes, fees and levies that must be paid to the Macau government. SJM is obligated to report monthly gaming revenues and comply with Macau s gaming laws. SJM s license to operate casinos in Macau officially ends in 2020, but the Macau government can in 2017 exercise its right to end SJM s concession by providing written notice a year in advance. No timetable has been set to renew the concessions for SJM. Figure 21: SJM s concession details Common Across Concession Holders Special Gaming Tax 35% of gross gaming revenues Annual Gaming Premium MOP30.0m (US$3.8m) MOP300K (US$37.5K) per VIP Table MOP150K (US$18.7K) per mass market table MOP1K (US$125) per electronic gaming machine or slot machine Other Major Conditions to SJM Committed Investment MOP4.7bn (US$0.6bn) Term 18 years (1 April 2002 to 31 March 2020) Special Levies 1.6% of GGR to foundation in Macau designated by Macau Gov't 1.4% of GGR to Macau government urban construction fund Sources: DICJ and Sun Hung Kai Financial Today, SJM employs 21,000 full time employees across 17 casinos, 2 slot machine halls and 2 hotels in Macau. As of the end of 2012 the company had 587 VIP tables, 1,184 mass market tables and 3,532 slot machines in operation. The company divides its casinos into Self-Promoted and Third Party-Promoted casinos (satellites). Self Promoted Casinos are casinos for which promotional and marketing efforts are handled directly by SJM s marketing department while satellite casinos are promoted by third parties but operated by SJM as required by its concession contract. The contracts with third-party service providers run through the life of SJM s concession to Sun Hung Kai Financial Institutional Research 16

17 Figure 22: SJM Property Map Sources: The Company, DICJ and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 17

18 Properties Grand Lisboa Hotel & Casino SJM s flagship property is the Grand Lisboa Hotel and casino on the Macau Peninsula. The Grand Lisboa Casino opened in 2007 and the hotel opened at the end of The Grand Lisboa at 58 floors is the tallest in Macau and its lotus flower architectural facade makes it a well recognized landmark in the city. The property houses 412 rooms, over 400 gaming tables (175 VIP and 240 mass) and 731 slot machines. It is also connected to the firm s Casino Lisboa via an overhead bridge. In 2012 the Grand Lisboa generated HK$29.2bn in gaming revenues, HK$4.5bn EBITDA and HK$4.2bn in net profits. The hotel ran at a 95% occupancy rate for the full year at an average room rate of HK$2,129. Figure 23: Casino Grand Lisboa Casino Grand Lisboa Gaming Revenues (HK$m) 15,579 22,798 29,233 VIP Mix 72.5% 74.1% 77.7% Mass & Slot Mix 27.5% 25.9% 22.3% #Tables #Slots Rev/table/day (HK$ 000s) Adj. EBITDA (HK$m) 2,557 3,756 4,481 EBITDA Margin 16.4% 16.5% 15.3% EBITDA/table/day (HK$ 000s) Sources: The Company and Sun Hung Kai Financial Other Self-Promoted Casinos - The other casinos that are promoted directly by SJM include Casino Lisboa, Oceanus and Jai Alai. They also promote 2 slot halls: Treasure Hunt and Yat Yuen Canidrome Slot lounge. In 2012, revenues generated from other self-promoted casinos were HK$11.1bn and contributed HK$1.2bn in EBITDA and HK$1.0bn in profits. EBITDA margin under HK GAAP was 10.7%. Figure 24: Self-Promoted Casinos Self-Promoted Casinos Gaming Revenues (HK$m) 11,434 12,012 11,084 VIP Mix 67.0% 62.0% 55.2% Mass & Slot Mix 33.0% 38.0% 44.8% #Tables #Slots 1,294 1,271 1,226 Rev/table/day (HK$ 000s) Adj. EBITDA (HK$m) 891 1,228 1,189 EBITDA Margin 7.8% 10.2% 10.7% EBITDA/table/day (HK$ 000s) Sources: The Company and Sun Hung Kai Financial Satellites SJM operates 14 satellite casinos. Twelve of its satellites are on the Macau Peninsula while 2 are located on the Island of Taipa, comprising 625 mass market gaming tables, 363 VIP gaming tables and 1,718 slot machines. SJM remains liable for all taxes, levies, contributions and premiums of its satellites as stated by its concession contract. Furthermore, SJM is responsible for security and internal audit of its satellites while its third-party partner provides general services including maintenance of the property, installation of gaming equipment, provision of food and beverage and promotion of the casino. As consideration for their services, third party service providers are paid a percentage of gross gaming income generated by the table games and slot machines. All third party providers have exclusive agreements with SJM. On a net basis SJM receives about 3% for revenues on VIP and 5% on mass gaming revenues. Sun Hung Kai Financial Institutional Research 18

19 HK$ m MOP m SJM (880.HK): War Chest 2 July 2013 Figure 25: Satellite Casinos Satellite Casinos Gaming Revenues (HK$m) 30,182 40,706 38,567 VIP Mix 66.0% 69.9% 63.4% Mass & Slot Mix 34.0% 30.1% 36.6% #Tables 1,004 1,009 1,016 #Slots 2,552 1,911 1,807 Rev/table/day (HK$ 000s) Adj. EBITDA (HK$m) 1,164 1,661 1,590 EBITDA Margin 3.9% 4.1% 4.1% EBITDA/table/day (HK$ 000s) Sources: The Company and Sun Hung Kai Financial Sofitel The Sofitel at Ponte 16 is a 408 room hotel that overlooks the inner harbor of Macau. The hotel opened in late SJM has a 51% stake in the property. In 2012 the hotel generated HK$184m with an occupancy rate of 81% and average room rate of HK$1,210. The hotel is located next to the Ponte 16 satellite casino, which houses 109 gaming tables. Financial Analysis Revenues The Company reported HK$79.5bn, up 4.5%y/y with nearly all of this from gaming revenues. Hotel and related services revenues were HK$635m. SJM holds the leading position among the six licensed operators with revenue market share of about 27% in Since the opening of the Grand Lisboa in 2008, the company has grown its revenues at a 29% CAGR, in line with the growth in Macau s gross gaming revenues. Figure 26: SJM Revenue (L) and Macau GGR (R) 90, ,000 80,000 70,000 60,000 CAGR 29.6% 300, ,000 CAGR 29.1% 50, ,000 40, ,000 30,000 20,000 10, ,000 50, Sources: The Company, DICJ and Sun Hung Kai Financial 2012 revenues from VIP accounted for 67% of the total. VIP rolling chip sales declined 4%y/y while VIP revenues improved 1%y/y to HK$53.3bn. The increase in revenues was due to a better win rate of 3.03% compared to 2.88% in Mass gaming revenues were HK$24.1bn, up 13.3%y/y. Average table yields improved 12.7%. At year end the company was operating 1,184 mass market gaming tables. Slots generated HK$1.5bn in revenues in 2012, up 3%y/y. The number of slots in operations at year end was 3,532. Hotel and related revenues were HK$635m, up 10%y/y. Sun Hung Kai Financial Institutional Research 19

20 Figure 27: 2012 Revenue Mix (L) EBITDA Mix (R) Other 1% Other 5% Satellite Casinos 48% Self Promoted 14% Casino Grand Lisboa 37% Satellite Casinos 48% Self Promoted 15% Casino Grand Lisboa 59% Sources: Company, Sun Hung Kai Financial Operating Costs In 2012, operating expenses were HK$72.8bn, up 3.1%y/y. Gaming taxes and marketing represent 90% of operating expenses. Hotel and administrative expenses account for 10%. Profits 2012 EBITDA was HK$7.6bn, up 10%y/y. The EBITDA CAGR since 2008 is 48%. EBITDA growth has exceeded revenue growth as margins have expanded from 5.7% to 9.6% owing to higher contributions from mass gaming mix and self-promoted casinos. Net profits grew 27%y/y to HK$6.8bn in Cash Flows and Balance Sheet Last year the firm generated HK$10.6bn in operating cash flows and incurred HK$800m in committed capital expenditures for roughly HK$9.8bn in free cash flow. The company also announced HK 90 cents/share in dividends including HK 30 cents/share in special dividends. Excluding the special dividend, the payout was 50% of net profits, in line with the company s dividend payout policy. Yearend cash was HK$23.4bn while total outstanding debt was HK$1.7bn ROA was 19% while ROE was 36%. Figure 28: D/E (L) and ROE (R) 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% E 2014E 2015E 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% E 2014E 2015E Sources: The Company, Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 20