by Will Ashworth | August 29, 2011 6:24 am
Macau casino operators had a very strong first half in 2011 as net profits tripled. Melco Crown Entertainment (NASDAQ:MPEL[1]) reported first-half earnings Aug. 23 that were 273% higher. It sees further good news ahead. Analysts love its stock. Eleven give it at least a “buy” rating and none believes it’s a “sell.”
But Melco Crown stock is off about 21% in the last month, showing the the casino operator might not have a hand full of aces. Besides, when analysts are this bullish, on MPEL stock it’s a sign to get nervous.
Here are three reasons why analysts are wrong and Melco Crown stock is about to crap out.
Macau depends on the mainland for its very existence. Approximately 31% of its casino revenue is from visiting Chinese government officials[2] or senior managers of state-run companies. Recent stock market unrest has sent casino stocks tumbling as concerns about a global economic slowdown have become very real. If China’s economy hits the skids, there’s no way these high rollers are making the trek to the special administrative region and making big bets.
Recently, the mayor of a small town in China lost $12 million at the tables[3], most of it government funds, and scrutiny has been focused on MPEL as a result. The mayor was sentenced to prison for 20 years, and mainland China clearly is concerned about future occurrences during an economic slowdown.
However, perhaps a bigger elephant in the room is China’s financial situation, which many believe is a house of cards on the verge of collapse. If this happens, Melco Crown is going to wish it had a little more diversification and Macau is going to rue the day it became so reliant on gambling.
Macau gets 40% of every gambling dollar generated at the 34 casinos in its jurisdiction. In the first half of 2011, it brought in $6.2 billion ($15.5 billion multiplied by 40%) and looks to rake in another $7.4 billion in the second half of the year. The 2011 estimate for gambling revenue in the region is $34.1 billion, which is five to six times greater than the entire Las Vegas strip.Analysts believe that Singapore, with just two resorts open, albeit large ones, is now in second place ahead of Las Vegas.
While business in Macau looks very promising presently, the tide can turn very quickly. Melco Crown’s three casinos hold a 16% market share, third best in the region behind Galaxy Entertainment Group at 19% and SJM Holdings at 28%. The remaining three players include Wynn Resorts (NASDAQ:WYNN[4]), Las Vegas Sands (NYSE:LVS[5]) and MGM Resorts (NYSE:MGM[6]). It’s an extremely competitive field and Steve Wynn and Sheldon Adelson don’t like to lose.
Melco Crown shareholders might want to ponder the fact it generates 100% of its adjusted property EBITDA from its three Macau casinos, which compares to 77% for Wynn Resorts and 57% for Las Vegas Sands. Adelson’s baby generates revenue from the top three gambling markets in the world providing it with excellent diversification. If Macau falters, Las Vegas Sands gets hurt – but Melco Crown flirts with bankruptcy.
Some of you are probably familiar with the “Graham number,” the quick calculation value icon Ben Graham used to weed out stocks. The simplest version multiplies 22.5 by the trailing 12-month earnings per share and once again by the trailing 12-month book value per share. The square root of that number is the theoretical fair value. It’s not perfect by any means but it gives you a decent idea.
In fairness, I’m not going to use Melco Crown’s trailing 12-month numbers, which aren’t stellar. Instead, I’ll take the analyst’s consensus for December 2012 of 52 cents and a trailing 12-month book value per share that’s inflated by 52% to reflect the increase in earnings. I’m being generous on both fronts because I’m upping the earnings per share figure by 32 cents and the book value per share by 52% when the real increase will be around 10%. Doing so, I get a fair value of $9.33, far below its current price of around $12 currently.
In June, it announced it was buying a 60% interest in the Macau Studio City development, which when completed in 2015, will bring its casino total in Macau to four. To pay for the acquisition, it increased its debt by 33% to $2.4 billion. Too much can and probably will go wrong between now and then. There just isn’t any margin of safety at current prices.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
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