Crown: Adding up the chips
Recommendation
Valuations of companies are just as much an art as a science, depending as they do on the assumptions used. Moreover, the further ahead we look, the greater the inherent uncertainty in any calculations.
When we first upgraded Crown to Buy in Betting on Crown – part 1 on 20 Apr 15 (Buy — $13.15), we took an asset-based approach. This was because Crown was – and still is – investing heavily in various projects around the world and so we needed to look many years ahead, to 2022, when Crown Sydney should (hopefully) be completed and Macau should (hopefully) have recovered from its current cyclical downturn. (See Betting on Crown – part 2 for the details).
The trouble is, of course, that it's hard enough to accurately predict a company's earnings and asset values one year ahead, let alone seven – but if you don't try these things then you don't have a basis for a valuation. You just have to do your best, consider a range of scenarios and allow a fat margin of safety. You also have to be careful not to get fixated on a particular valuation and be ready to make adjustments as things change.
So, with Crown recently making a return to our Buy list after members of its staff were arrested in China (and after adding it to our Equity Income Portfolio and increasing our holding in our Growth Portfolio), it's time for another detailed look at the numbers.
Key Points
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Crown is a complex business
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Assumptions made to simplify calculation
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Wide range of outcomes possible
Complex business
Like any valuation, we've made a number of assumptions in each of our three cases (see Table 1). However, the complexity of Crown and its many moving parts means some of our assumptions are intended to reduce the complexity while also maximising our margin of safety.
First and foremost, while we think the proposed demerger of most of Crown's international investments and the IPO of four of its hotels will provide incremental value, we've deliberately assumed none will arise in each of our three cases. We've also assumed no value for Crown's fast-growing Wagering & Online business.
2016 EBITDA: Bear / Base / Bull ($m) |
Multiples: Bear / Base / Bull |
Bear case ($m) |
Base case ($m) |
Bull case ($m) |
|
---|---|---|---|---|---|
Crown Melbourne | 572 / 619 / 673 | 7/9/11 | 4,004 | 5,571 | 7,403 |
Crown Perth | 221 / 239 / 260 | 7/9/11 | 1,547 | 2,153 | 2,860 |
Crown Sydney | n/a | n/a | 226 | 226 | 1,119 |
Crown Aspinalls | 26 / 26 / 26 | 7/9/11 | 182 | 234 | 286 |
Alon Las Vegas | n/a | n/a | 372 | 372 | 372 |
Wagering & Online | (5) | n/a | - | - | - |
Other * | n/a | n/a | 283 | 283 | 283 |
Corporate | (98) | 10/10/10 | (980) | (980) | (980) |
Total | 5,634 | 7,859 | 11,344 | ||
Less: net debt | (1,812) | (1,812) | (1,812) | ||
Total equity value | 3,823 | 6,048 | 9,532 | ||
Shares (m) | 728.4 | 728.4 | 728.4 | ||
Value per share ($) | 5.25 | 8.30 | 13.09 | ||
Melco Crown value per share (per SOTP analysis in Table 2) ($) | 2.43 | 3.37 | 6.29 | ||
Melco Crown value per share (based on current share price) ($) | 4.59 | 4.59 | 4.59 | ||
Total value (using Melco Crown SOTP value) ($) | 7.68 | 11.68 | 19.37 | ||
Total value (using Melco Crown share price) ($) | 9.83 | 12.89 | 17.67 | ||
* Nobu, Ellerston, Aspers & Queensbridge hotel JV |
Crown's 27% investment in Melco Crown Entertainment, which owns casinos in Macau and The Philippines and whose majority-owned Studio City Macau and City of Dreams Manila are still ramping up, only adds to the complexity. Moreover, a fifth tower is being added to City of Dreams Macau, which will add 780 rooms to the existing 1,400 rooms.
There are a couple of options with this – and we've presented both in Table 1. The first is simply to take the market value of Crown's stake in Melco Crown Entertainment since it's listed on the Nasdaq. The second is to give it its own sum-of-the-parts valuation, and the details for this are presented in Table 2.
Melco Crown's earnings are likely to grow faster than those of Crown's Australian casinos due to Macau likely being at or near the bottom of the cycle and Studio City and City of Dreams Manila still ramping up. As such, we've used higher multiples of earnings before interest, tax, depreciation and amortisation (or EBITDA) than for Crown's Australian casinos.
Moreover, with the bulk of Melco Crown's capital expenditure behind it, free cash flow should rise at a decent clip, thus also justifying higher multiples.
With that said, let's start with our base case.
Base case
After the recent arrest of its employees in China, Crown said that around 12% of its revenues come from mainland Chinese VIPs. Further, because margins on VIP betting are lower than for ordinary punters (due to the freebies and commissions used to attract them), VIPs from mainland China represent ‘substantially less than 12%' of Crown's profits.
To be conservative, in our Base case we assume Crown loses all mainland Chinese VIP business or around 8% of its 2016 EBITDA for its Australian casinos.
Our estimate of Crown Sydney's value is the capital expenditure invested in it to date while our estimate of Alon Las Vegas's value is the total equity investment made by Crown to date.
For Melco Crown, we've simply annualised its casinos' results for the first nine months of the 2016 calendar year. With two new casinos recently opening in Cotai and more to follow, and infrastructure improvements such as the Hong Kong to Macau bridge and light rail being delayed, we're being conservative and using current earnings. That is, we're not adjusting for Studio City and City of Dreams Manila still ramping up, nor for any cyclical upturn in Macau.
Bear case
Here we've assumed that EBITDA for Crown's Australian casinos declines by 15%, whether due to the loss of mainland Chinese VIP revenue, a downturn in revenue from ordinary punters or a bit of both.
2016E EBITDA Bear / Base / Bull (US$m) |
Multiples: Bear / Base / Bull |
Bear case (US$m) |
Base case (US$m) |
Bull case (US$m) |
|
---|---|---|---|---|---|
City of Dreams Macau | 738 / 738 / 800 | 8/10/12 | 5,904 | 7,380 | 9,600 |
Altira | 2 / 2 / 30 | 8/10/12 | 16 | 20 | 360 |
Mocha | 24 / 24 / 30 | 8/10/12 | 192 | 240 | 360 |
Studio City (60%) | 79 / 79 / 240 | 8/10/12 | 632 | 790 | 2,880 |
City of Dreams Manila (69%) | 107 / 107 / 182 | 8/10/12 | 856 | 1,070 | 2,184 |
Corporate | (110) | 10/10/10 | (1,100) | (1,100) | (1,100) |
Total | 6,500 | 8,400 | 14,284 | ||
Less: net debt * | (1,582) | (1,582) | (1,582) | ||
Total equity value | 4,918 | 6,818 | 12,702 | ||
Crown's share (US$m) | 1,333 | 1,848 | 3,442 | ||
AUD/USD | 1.33 | 1.33 | 1.33 | ||
Crown's share (AU$m) | 1,773 | 2,457 | 4,578 | ||
Shares (m) | 728.4 | 728.4 | 728.4 | ||
Value per share (AU$) | 2.43 | 3.37 | 6.29 | ||
* Melco Crown's proportionate share of cash and non-recourse debt held by its majority-owned subsidiaries |
We've also used a lower EBITDA multiple of seven. For reference, both Crown and The Star Entertainment Group have traded on an average EBITDA multiple of 11 since they listed on the ASX in 2008 and 2011, respectively.
During the GFC, Crown's EBITDA multiple reached six, but this was an extreme situation and remember that we've already discounted EBITDA itself by 15%.
For Melco Crown, the only adjustment to our Base case is to use a lower EBITDA multiple of eight. This is higher than our multiple for the Australian casinos because Macau is likely near a cyclical low and Studio City and City of Dreams Manila are still ramping up.
Bull case
Here we assume that Crown Melbourne and Crown Perth maintain their 2016 EBITDA, perhaps through minimal losses to VIP revenue being offset by increases in other income from mass market punters and non-gaming. This could be helped by a doubling in hotel rooms at Crown Perth when Crown Towers Perth opens in December.
In this case, our estimate of Crown Sydney's value is its expected $1.5bn cost discounted to today.
We've also estimated normalised earnings for Melco Crown, assuming Studio City and City of Dreams Manila are fully ramped up and Macau has risen from around cyclical lows. It's possible that Studio City won't meet its financial covenants in calendar 2017, which could lead to its debtholders taking ownership and rendering the equity worthless to Melco Crown. However, as Melco Crown's proportionate share of Studio City's net debt (the debt is non-recourse) is around $1bn, this would actually increase the value in our Bear and Base cases but reduce our Bull case valuation by around $1.
Wide range
Putting all this together leads to a wide range of outcomes, as you would expect – from a bear case of just below $8 to a bull case of above $19. With the share price currently much closer to the bottom of that range, we think the upside is more than adequate to compensate for the downside.
No doubt it's possible for the valuation to end up outside this range, but we think we've been conservative for all three scenarios. We also think the Base and Bull scenarios are more likely over the medium to long term, which adds further reassurance.
Even so, for such a complex business with a wide range of outcomes we recommend treading carefully – so bear in mind our risk ratings of high and our 4% recommended maximum portfolio weighting. For most people it will make sense to start a bit below this level, to allow room to buy more if a better opportunity emerges. Our Growth and Equity Income portfolios, for example, currently have weightings of 3%. BUY.
Note: The Intelligent Investor Growth and Equity Income portfolios own shares in Crown Resorts. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.
Disclosure: the author owns shares in Crown Resorts.