Avoid These Pricy Land-Locked Casinos, Look to the Seas

By Bill Edson - October 17, 2012 | Tickers: LVS, MGM, RCL, WYNN | 0 Comments

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After the economic downturn, China was regarded as the place to be for gaming growth. In contrast, Las Vegas and other American gaming areas were considered to be sink holes.

Recent results have challenged these assumptions, as foreign counterparties prove troublesome and China’s growth slows. Investors should not assume that the Chinese gaming growth story will translate into stock returns. Instead, they should focus on valuation.

Macau Has a Cow

Macau's government reported that casino revenue increased 12.3%, lower than analyst expectations of 15% to 17%. This disappointment sent casino stocks lower.

However, Sterne Agee reiterated its buy rating for Las Vegas Sands (NYSE: LVS). Its positive outlook is predicated on location: real estate in the trendy Cotai area of Macau is thought to bode well for growth.

Stern Agee analyst David Bain said, "We think market strength will continue overall in Macau.” He also predicts a faster growth in middle market customers over high-rollers. He said, "Those that lean more to the mass market segment will grow faster than those that cater to VIP."  According to Mr. Bain, Las Vegas Sands will benefit most from middle market customers.

Such a shift would represent real change in Macau gaming, where VIPs currently provide 70% of gambling revenues. A shift toward middle-class gamblers would be reminiscent of changes in the Las Vegas casinos that took place decades ago. Such a change would shift emphasis towards the hotel/resort business and away from high-stakes gambling tables.

There are compelling reasons to believe that the resort and gaming sector is underweight. First, this industry suffers a need for huge initial cash outflows in hopes of customers trickling in later. This capital expenditure should turn off sensible investors. More recently, legal issues have begun to dominate news about many casino & resort firms.

Las Vegas Sands Legal Bout

Many of these casinos are entrenched in legal struggles with former employees and business partners. Recently, Las Vegas Sands was sanctioned by a Nevada judge who says that the company and its Sands China unit deliberately misled her by not producing evidence requested by its Chinese former head of operations in a lawsuit related to his firing.

Judge Elizabeth Gonzalez ordered the companies to pay the legal fees of Steven Jacobs, the fired CEO of Sands China, and to pay $25,000 to the Legal Aid Centre of Southern Nevada.

Jacobs sued in 2010, claiming he was fired because he refused to acquiesce to 'illegal demands' from the majority owner and chairman of Las Vegas Sands, Sheldon Adelson. Jacobs claims that he was asked to secretly investigate government officials from Macau, and then use whatever dirt he could find as 'improper leverage' against them. After the allegations, the U.S. Justice Department and Securities & Exchange Commission began investigating whether Adelson's company violated the Foreign Corrupt Practices Act or not.

Fighting Counterparties: Nobody Wynns

Las Vegas Sands’ conflict is bland compared to Japanese billionaire Kazuo Okada’s legal battle and power struggle with Wynn Resorts (NASDAQ: WYNN) CEO Steve Wynn. This rift could negatively impact shareholders, so investors should demand a discount for all the dirty laundry being aired.

The dispute between Mr. Wynn and Mr. Okada is very public and very personal. Mr. Okada was once Mr. Wynn’s business partner and friend. He was once the largest owner of Wynn stock, and is now fighting in court because the company forced him to sell his shares at a low price. Wynn Resorts utilized a clause which allows the firm to cut ties with business partners which behave unscrupulously. Wynn Resorts used Mr. Okada’s allegedly improper payments to gambling regulators overseas as dirty behavior, which triggered the liquidation clause.

The U.S. Securities and Exchange Commission is investigating a recent $129 million donation to the University of Macau. Wynn Resorts’ board of directors has stated that Okada was unstable as a controlling shareholder and claimed that he made various payments and gifts to officials in the Philippines, where he is currently building a casino resort. The deposition is a result of Okada trying to gain access to corporate files that are related to the company's attempts to obtain a casino license in Macau.

Okada is attempting to place two board members on Wynn Resorts’ board, claiming that the existing board did nothing to stop Mr. Wynn from “questionable actions.” Mr. Okada stated that he would nominate Jonathan Macey, a Yale law processor and Fredric Reynolds, former CBS chief financial officer for Wynn Resorts board. The board's annual meeting is scheduled to be held on Nov. 2. Okada has used his company, Universal Entertainment Corp, to file suit, claiming $140 million in damages, that Wynn's actions caused Universal’s stock to fall, and damages to his reputation. Okada is also trying to use the courts to reinstate his shares so that he can vote in members.

There could be ripples in Wynn’s stock price from this courtroom drama. If you were a lender, a landowner, or a construction company, would you worry about your reputation if you worked with businesspeople who make headlines in a bad way? This reputation risk may make competing casino companies more attractive for counterparties to work with.

MGM Plans Growth in the USA

MGM Resorts International (NYSE: MGM) is also trying to initiate expansion plans in the Eastern United States. MGM intends to build on 10 acres of tornado-damaged land in Springfield, MA, as part of an $800 million casino, hotel, and shopping project.

In a sense, Massachusetts is an emerging market for gaming. Last year Massachusetts legalized gambling and allowed three casinos in three areas of the state.  MGM has turned to Springfield after looking at other locations in MA and has paid a $400,000 fee to put them in the official consideration for a license in western Massachusetts.  Potential competitors for the license in this region include Ameristar Casinos, Penn National Gaming, Mohegan Tribal Gaming Authority, and Seminole Hard Rock Entertainment. 

Valuation Considerations

There is a disconnect between issues facing these firms and their valuations:

Shares of Wynn, Carnival, and Las Vegas Sands are pricy. On the other hand, MGM could be a value trap because debt issues could continue to plague this stock for years.

In contrast, Royal Caribbean Cruises (NYSE: RCL) presents a better investment opportunity. At a value of 0.86, this stock trades at a fraction of the S&P price-to-sales average multiple. Royal Caribbean shares are trading at a fair 13.95 price-to-earnings ratio, in line with the S&P 500 average. The 0.81 price-to-book multiple of this stock is very attractive, much cheaper than the 2.05 S&P 500 average.

Today, investors should consider buying shares of Royal Caribbean. The land-locked casinos considered here are either too pricey or have weak balance sheets and should be ignored at present.

Interested in Additional Analysis?

For many companies, successfully capitalizing on a booming Chinese economy is like winning the jackpot. That's literally the case for gaming company Las Vegas Sands, which made a big bet on Macau gaming about a decade ago that's paid off in spades. The company is now looking to spread its empire further, but will it be able to replicate its prior successes? Learn about all these opportunities, and the risks they pose, in the Fool’s brand new premium report on Las Vegas Sands. We're providing a full year of analyst updates to go with it, so make sure to claim your copy today by clicking here.

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