Echo calls Crown's bluff in a casino end-game

Echo Entertainment has come up with a clever, albeit somewhat transparent, tactic in its attempt to prevent James Packer from building his proposed $1 billion VIP gaming facility at Barangaroo in Sydney.

The Echo counter-proposal unveiled at the weekend has two options in it. The preferred option is that Echo pays the NSW government $250 million to extend its exclusivity from 2019 to 2034 and then invests $1.1 billion to build two new hotels and more non-gaming infrastructure, including public infrastructure, within and around The Star casino’s precinct.

The alternative option is that the NSW government doesn’t get the $250 million and Packer’s Crown group gets to build its six-star hotel and VIP facility at Barangaroo – but only if it is a table-only facility and that it is confined to international and interstate VIP gamblers only.

As a tactic that attempt to restrict the market for the Crown facility is designed to buttress Echo’s claim that despite Crown saying that its facility would be effectively a private club for VIP gamblers and a drawcard for the seriously rich Asian tourists it is effectively a smokescreen for Crown to build a large second casino in direct competition with Echo.

Echo knows that Crown would need NSW VIP gamblers (and to cannibalise Echo’s high-roller turnover) as well as those from overseas and interstate to make economic sense of its $1 billion plans. By presenting the possibility of two facilities and a combined $2 billion of capital expenditure it is hoping to entice the NSW government into exposing what it believes is Crown’s true Sydney agenda.

Crown, of course, would say that while it needs access to NSW VIPs, as well as those from offshore and interstate, to make its proposed complex viable its gaming facility will be very exclusive and narrowly targeted. It is most unlikely to accept or support the Echo option – or build its six-star facility – unless it can access the domestic NSW VIP market, which is why Echo put that option forward.

The interesting aspect of the Echo core proposal is that while it would spend $1.35 billion, only a fraction of the $1.1 billion of infrastructure investment – about 7 per cent, or $77 million – would be on gaming facilities.

In the past spending by Crown and Echo on non-gaming facilities – mainly hotels and restaurants – has been tied to increased gaming capacity. Without increased gaming revenues it is difficult to generate acceptable returns from the non-gaming assets.

Echo believes that its arrangements with the NSW government allow it the discretion to add tables to its casino if the demand warrants it but the commitment to the $1.1 billion of spending, and the $250 million payment to the government, appear to be more about securing and extending its existing monopoly and the cash flows it will generate rather than investment that will generate appropriate returns on capital on a standalone basis.

While defensible in terms of what Echo might stand to lose if the Packer proposal gets up, it’s a bold plan for a group that has been struggling to get acceptable returns on the near-$1 billion it has only recently invested to renovate and upgrade The Star.

It is also going to be a stretch to fund the commitments without a major capital raising, although the Echo team did make the point at the weekend that construction, if the proposal was accepted by the NSW government, wouldn’t start until 2015 at the earliest and would probably take until about 2019 to be completed. It has time, and the cash flows it generates in the meantime, to determine how much equity it might have to raise, not just for The Star’s expansion, but to fund its plans for a major overhaul of its Queensland casinos.

While Echo’s John Redmond did refer to an undrawn $475 million debt facility when discussing the group’s capacity to fund its proposal it is inevitable that Echo, with a market capitalisation of about $2.5 billion and existing borrowings of about $700 million, would eventually need to raise a big chunk of equity to fund new commitments that just about equal its market value.

Casinos with significant VIP gaming components can’t carry significant leverage because of the extent of the volatility associated with high-roller gambling – Echo was forced to raise $450 million of equity last year for precisely that reason.

Despite that overhang of an eventual large equity raising, the market appears untroubled by that prospect.

That could be because the issue would only arise if Echo’s proposal is preferred by the panel evaluating the competing proposals (headed by former Commonwealth bank chief executive David Murray) and even then would be some years off.

With the panel expected to make its recommendation to the NSW government within a week, the protracted and at times destabilising stalking of Echo that has occurred as Crown has pursued its ambition of affixing its brand to a high-spec and exclusive NSW casino, with or without Echo’s co-operation, is finally nearing its end.