A cunning plan by Sydney casino operator Echo Entertainment Group to have the NSW government give the green light to its billion-dollar casino development as well as a rival casino by James Packer's Crown at nearby Barangaroo could be strategically smart but a value loser, analysts have warned.
Echo, which owns Sydney's only casino at Star City, this week unveiled its defence against losing its gambling monopoly to an encroachment by Mr Packer, dangling before the state government the idea of allowing both casino developments to go ahead rather than choosing one over the other.
However, this "third way" proposal by Echo would still deliver a second casino into the Sydney marketplace - albeit with some restrictions placed on Crown regarding its table games and access to VIPs - further squeezing the sector.
Analysts have also questioned the economics of Echo's main proposal put to a state panel, whereby it would retain its casino exclusivity licence in NSW by investing $1.1 billion to develop a hotel, restaurants and entertainment precinct and public infrastructure. The bid would come with an extra kick of $250 million paid to the state government to extend its monopoly exclusivity for 15 years and block Mr Packer from developing his own casino at Barangaroo.
"An exclusivity payment effectively lowers the valuation upside to the company if their proposal wins by 30¢ per share," said Citi analyst Michael Goltsman.
"While Echo's proposal appears impressive and a competitive alternative to Crown's Barangaroo, returns could be challenged in our view," said Bank of America analyst Mark Bryan.
"While we do believe that the hotel rollout has strategic merit in the under-penetrated Sydney market we see scope for higher returns to be challenged. Our initial analysis indicates that Star would need to more than double its VIP business to keep the project return on invested capital (ROIC) accretive.
"We estimate around 250 per cent growth in 2018-19 VIP revenue is needed to drive a ROIC of 10.3 per cent."
Mr Bryan said Echo's $1.1 billion development would put competitive pressure on Crown's proposal. "However, we continue to question the returns Echo can derive."
Deutsche Bank analyst Mark Wilson said Echo's approach of having both casino projects approved but carrying some provisions was "strategically astute but ultimately low returning".
"The proposal allows the NSW government to approve the projects of both Echo and Crown with a combined budget of $2.3-2.6 billion and it will ensure increased development and connectivity.
"Additional concessions are required to ensure an appropriate return is generated and they could encompass a lower gaming tax and other regulatory changes as there is no cap on the number of table and electronic table games."
Shares in Echo closed up 3¢ at $3.02; Crown ended down 34¢ at $11.50.