Echo vs the high-rollers

A golden stream of luck among Echo Entertainment's richest clients explains why the company is proceeding with a capital raising as it faces off against predators.

There’s a number within Echo Entertainment’s presentation for its $454 million equity raising today that explains why, with potential predators breathing down its neck – indeed because it has potential predators on its register – it decided to push ahead with the issue.

The number is $45 million and that is the breadth of the range of potential earnings before interest, tax, depreciation and amortisation Echo believes might be generated this month. The month has only two weeks left in it and the gaming group could, within that fortnight, experience a $45 million swing in its fortunes, with its EBITDA guidance for 2011-12 ranging from $348 million to $393 million as a result of that uncertainty.

There is a simple reason for the caution Echo is expressing about what might happen over the next two weeks.

Echo has been driving aggressively into the international high-roller gambling market and is generating substantial volume growth in that segment. It says "front" money from its VIP gamblers was up 60.6 per cent in the 11 months to May. Actual gross revenue from that business, however, was only 2.9 per cent.

Echo’s problem was that in the last few months the high-rollers have been running a golden stream of luck.

Echo’s theoretical win rate – the "house edge" – established over the past five years is 1.62 per cent, but in recent months the house has actually been losing to the high-rollers and for the full year the win rate is likely to be down 0.45 per cent.

It might not sound like much but given the volumes of dollars going through that business – the front money in what Echo calls the international rebate business will be close to $1.5 billion this year – it can, as that range of potential outcomes for June demonstrates – translate to very material bottom line effects.

As a relative newcomer to the high-roller segment of the market Echo has had to learn from experience just how volatile and destabilising it can be.

Over time, especially if it builds even bigger volumes, the law of large numbers will start to work for it to dampen that volatility and produce outcomes closer to the theoretical but with significant debt and $78 million of significant items (losses and write-downs) this financial year it would be risky to bet the house on theoretical outcomes.

The capital raising is all about creating a balance sheet that can support the volatility of the high-roller business.

The fact that James Packer owns 10 per cent of Echo and has been aggressively and very publicly expressing his desire to have influence within its boardroom and over its Sydney casino licence (so that he can develop a new dedicated high-roller facility at Barangaroo), and that Singapore casino giant Genting has recently joined him on the register, might conventionally have deterred Echo from announcing an equity raising.

Given that it has no control over the performance of its VIP business in the short term, however, buttressing its balance sheet means that financial necessity won’t drive it into Packer’s arms. Packer, incidentally, supports the issue and Crown Ltd will take up its entitlement.

The encouraging aspect of Echo’s guidance today was that after a torrid few months – because of the high-rollers’ run of luck and the impact of the sacking of the former managing director of The Star casino and ensuing independent inquiry, which impacted The Star’s performance during a period of consumer caution – its underlying activity picked up in May and early June.

With some pick-up in underlying activity, an improvement in its VIP win rate and much less debt, it is possible that Echo has passed the nadir of its fortunes, which would suggest that Packer timed his initial assault on Echo and the accumulation of his 10 per cent stake near-perfectly.

Genting hasn’t indicated its attitude towards the raising but might see an opportunity to increase its existing shareholding of just under 5 per cent cheaply if there is large-scale renouncing of the rights to the issue. It isn’t clear at this point what its motivation for buying into Echo might be or whether it is a potential ally or competitor to Packer in any contest for control.

What is clear is that the raising puts Echo in a far less vulnerable position in any negotiations that might develop with either or both of its strategic shareholders.

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