Crown returns to its roots

Having sold out of its Macau investment, what now for Crown?

After 13 years, Crown has cashed in its chips and sold out of Nasdaq-listed Melco Resorts, the owner of casinos in Macau and The Philippines.

Crown has taken advantage of Melco Resorts' share price nearly doubling over the past year on the back of a recovery in gross gaming revenue (GGR) in Macau: GGR rose a cool 24% in May 2017 compared to the previous May. While the Dragon Boat Festival holiday fell in May rather than June this year, this was the tenth straight month of GGR rises.

An eventual recovery in Macau after the dramatic cyclical downturn caused by the Chinese government’s corruption crackdown was one of the reasons we upgraded Crown two years ago – and we’d have preferred the company not to sell out completely as we think the recovery is still in its early stages.

Given it has, though, let’s take a look at the slimmed-down Crown and update our sum-of-the-parts valuation.

Key Points

  • Slower-growing, more focused on Australia

  • Wagering business has good potential

  • Japan a possibility

Australian focus

As well as removing the most obvious source of growth for Crown, the sale of its Melco Resorts stake makes the company much more focused on Australia. It’s also hoping to cash in its $380m investment in its cancelled Alon Las Vegas project.

All this means Crown is likely to be slower growing, while also being more dependent on the Australian economy.

Competitor The Star Entertainment Group last month noted a ‘softer gaming market and macro-economic conditions’, and signs ranging from lower retail sales and monthly pokie turnover figures suggest consumers are currently tightening their belts.

This could potentially affect Crown in the near term as consumers’ discretionary income is squeezed by a combination of slower wage growth and higher interest rates. Any material downturn in the residential property market could also reduce the amount punters are willing to spend at Crown's casinos.

New chief executive John Alexander, however, is quickly finding ways to cut costs, starting with salaries: the scuttlebutt is that many employees have been asked to justify their continued employment, often unsuccessfully.

Along with relatively easy savings as a result of the decline in VIP revenue after its employees were arrested in China, we think there is a fair degree of fat to cut. According to a recent report from UBS, operating costs at Crown Melbourne represent around 41% of sales compared to 36% at The Star, Sydney. We also note that, starting in April 2012, Star Entertainment was able to cut around 7% of costs over a two-year period.

Well-placed long term

While there will no doubt be hiccups, over the medium to longer term Crown Melbourne and Crown Perth should retain the benefits that their monopoly status brings. This should lead to reasonable returns: main gaming floor (ie non-VIP) revenue at Crown Melbourne has grown at an average of 6% a year since it opened in 1995, with only a single year of decline. We expect slower growth in future, though, and a recession would likely lead to another temporary decline.

Star Entertainment also noted recently that VIP business volumes were ‘showing signs of stabilisation’. Once the furore over the arrests of Crown’s employees in China dies down, we’d expect North Asian VIPs to start returning to Australia.

Crown’s Australian casinos are also well-placed to benefit from increasing Asian immigration and rising tourism – particularly from China – as most Asian countries continue to develop quickly. 1.2m Chinese nationals visited Australia in 2016 (up 16% on 2015) and they are projected to rise to 2m by 2025, helped by increasing family and business contacts in Australia.

For these reasons, we think ‘VIP-only’ Crown Sydney – currently due for completion in 2021 – will still be a profitable investment for Crown.

Wagering & online

Apart from its casinos, Crown’s other major business is its Wagering & online division. This division comprises three businesses but the biggest and fastest growing is CrownBet, its 62%-owned online wagering business.

The online wagering industry is intensely competitive – with rivals including the likes of TattsTabcorp and corporate bookmakers such as William Hill and Sportsbet – and most punters have multiple online accounts.

Along with the substantial marketing and customer acquisition costs, this is a business where scale matters, so why would Crown choose to enter such a competitive market?

Crown has one big advantage over its competitors: its existing databases of VIP players and Crown Rewards members. Crown can also sign up new CrownBet users by targeting visitors to its casinos – as your analyst can attest after conducting some fieldwork at Crown Melbourne.

We’d expect customer acquisition costs to moderate eventually and, helped by potential consolidation within the industry and a ‘point of consumption’ tax which would create a more even competitive playing field, CrownBet could be a profitable investment for Crown. However, with it barely profitable at this stage, we’ve assumed zero value for CrownBet in our valuation (see below).

Big in Japan

Elsewhere, the Melco Resorts selldown also gives Crown more flexibility now that Japan has legalised casino gambling.

Table 1: Gross gaming revenue
Macau US$28bn
Japan (est) US$7–20bn
Las Vegas strip US$6.3bn
Singapore US$4.2bn
All figures (other than Japan) for 2016
Source: UBS

The specifics are still to be determined but early indications are that three or four licences will be issued initially – in Yokohama, Osaka (or perhaps Tokyo) and one or two regional locations. Moreover, foreign operators such as Crown will likely have to be content with 30–40% equity stakes as part of consortia that include Japanese companies.

The limited number of licences and potential size of the Japanese market (see Table 1) means these licences are highly coveted.

Giant US casino owner Las Vegas Sands spent US$6.5bn to build its highly profitable Marina Bay Sands casino in Singapore (which opened in 2010 and recorded earnings before interest, tax, depreciation and amortisation (EBITDA) of US$1.4bn in 2016). So initial estimates are that an integrated resort – the casino, hotel(s), associated retail and convention facilities, etc – could cost anywhere from US$7bn to US$10bn.

Assuming 30–40% equity funding with the rest funded using project finance and a 40% equity stake, this could mean equity contributions by Crown of anywhere from US$840m to US$1.6bn or around A$1.1bn to A$2.1bn.

Based on a similar timetable to the legalisation of casinos in Singapore, it could be five to seven years before the first casinos open in Japan. And, depending on how construction of Crown Sydney progresses, Crown's capital expenditure should peak in 2019-2020. This means it now has the option of pursuing one of the Japanese licences.

However, on top of Crown’s already substantial capital investment obligations and commitment to pay a minimum of 60 cents in annual dividends, a potential Japanese investment is one of the major risks that Crown shareholders need to consider should its results deteriorate, perhaps due to an Australian recession.

At this stage, though, Crown hasn't revealed its intentions regarding Japan so it’s still too early to determine what impact any Japanese adventures will have on the company.

Updated sum-of-the-parts

Pulling it all together, we’ve updated our sum-of-the-parts valuation in Table 2:

Table 2: Crown sum of the parts
  2017E 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 381 381 381
Wagering & Online (5) n/a - - -
Other * n/a n/a 286 286 286
Corporate (60) 10/10/10 (600) (600) (600)
Total     6,026 8,251 11,735
Add: net cash     204 204 204
Total equity value     6,230 8,455 11,939
Shares (m)     717.8 717.8 717.8
Value per share ($)     8.68 11.78 16.63
* Nobu, Ellerston, Aspers & Queensbridge hotel JV

Apart from the sale of Melco Resorts, we’ve adjusted Corporate costs based on the company’s latest guidance. We’ve also updated the net debt line for the Melco selldown, its $600m ($0.83 cent per share) special dividend paid in March and the ongoing ordinary share and Crown Subordinated Notes buybacks.

There's more detail in Crown: Adding up the chips 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.

As with any company, there are risks but we continue to recommend you HOLD.

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 and also has a (dormant) CrownBet account.