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Crown – Spending big when it matters

The NSW Government is yet to decide which casino proposal it will back, but Crown’s posturing is either a brave bluff or a supremely confident hand.

We think Crown is worth $16.00 per share based on robust earnings growth in Australia and conservatively attributing the market value of its Macau investment.

We have been recommending Crown to our clients since September 2011 when the share price was $7.85 based on the same rationale.

Crown’s proposed Barangaroo development at 250m in height is already above the allowable 170m limit, but the bravado with which the company has approached the concept should be admired rather than admonished.

Crown’s original entrée into gaming in 1999 was under its former guise as PBL when James Packer agitated to acquire the Crown Casino in Melbourne for $1.9 billion representing a 9.3x multiple of operating earnings (EBITDA) at the time.

Shortly after in April 1999, Tabcorp (the forerunner to Echo Entertainment Group) bought Sydney’s Star Casino (now The Star) for $1.66 billion representing a 10.7x multiple of operating earnings.

In the intervening 14 years, Crown has consistently spent money on its properties to maintain and improve an offer that has appealed to its customer base, both locally and internationally. In the last 7 years, Crown has spent more than $2 billion in Melbourne and Perth and has detailed the next $1 billion out to 2015.

Casino properties are capital intensive businesses incorporating hotels, carparks, restaurants and other non-gaming facilities to complement the gaming business. Just as important is the timing of such expenditure and it is in this regard that Crown has comprehensively outmanoeuvred its Sydney-based opponent since 1999.

Tabcorp belatedly recognised the need to update its Sydney casino, possibly due to the distraction of its wagering and gaming machine businesses in Victoria. The $1 billion ‘Project Star’ plan was initially underdone but subsequently topped up (by former CEO Larry Mullin) to create a much improved property.

Echo Entertainment has also muddled about with its capital spending plans at its Queensland casinos.

The net effect of this difference is that Crown has built a more substantial domestic business and a dominant high-roller (also called VIP) business in Australia.

 

 Crown, through its investment in Macau and its greater focus on high-roller business, has accumulated a higher quality list of clientele over the years. Last year, Echo suffered the embarrassment of having to write-off almost $30 million due to the liquidation of a junket operator that owed the company money.

If Crown can convince the NSW Government that its proposal will add significantly more pizzazz to the Sydney skyline as well as the financial and economic benefits, then the outcome will be good for Crown (obviously) and bad for Echo.

Not only would Crown be able to leverage its existing high-roller clientele across three Australian properties, it would probably take market share from Echo as well.

Echo Entertainment’s refurbished Sydney property is virtually complete but it is unclear what the company is now proposing to supplement what has been an arduous process to achieve the new Star casino.

Management scandals aside (now history) and with a new chairman and chief executive, Echo is barely out of one major refurbishment before it is being bullied into another. The company has hardly had a chance to produce the expected earnings from Project Star but may now undergo a further period of disruption if it wins favour from the state government.

Either way, Crown has made a crafty move to exit its stake in Echo (even at a loss) yet still has the regulatory approval to acquire up to 23% of Echo.

Cash Macau

To rub salt in Echo’s wounds, Crown is beginning to harvest the fruit of its Macau investments as the gross gaming revenue in the Chinese enclave consistently climbs at a double-digit clip.

Macau has well and truly surpassed Las Vegas as the largest gaming region in the world and yet has barely tapped the full potential of China’s burgeoning middle class with greater freedom to travel and gamble.

Macau’s gaming industry is beginning to transition towards more mass gaming after initially relying heavily (as it still does) on VIP gaming. Crown’s 33.67% stake in Melco Crown Entertainment (MCE) has exposure to both groups of players.

The share price of MCE has risen strongly this year in line with the whole sector in Macau. If it is included simply at market value in Crown’s valuation, it contributes approximately $6.00 per Crown share.

MCE’s Studio City is now under construction and when completed will give MCE its third casino property in Macau along with the Mocha gaming machine business plus a valuable sub-concession (casino license).

Crown is already looking beyond Macau for its next Asian investments and has established a partnership to build a gaming property in the Philippines. When it opens next year, The Belle Grand will be one of four properties in Manila that could generate up to US$10 billion of revenue each year and attract up to 10 million tourists annually. This formula has been successfully tested in Singapore.

Understandably, Crown’s share price currently reflects no value for this or subsequent investments in Asia but must surely do so eventually, given the track record in Macau.

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