Today we should be celebrating another strong Macau earnings report from Melco Crown Entertainment Ltd (ADR) (NASDAQ:MPEL). The company reported revenue growth of 9% to $1.1 billion and a very small increase in profit to $108.0 million in the quarter. Adjusted EBITDA was up 7%, a nice increase considering that the company hasn’t added any new resorts this year.
Melco’s resorts echo strong Cotai results from Las Vegas Sands Corp. (NYSE:LVS) and weak Macau Peninsula results from Wynn Resorts, Limited (NASDAQ:WYNN) . But the market isn’t focused on results today, it is focused on a potential crackdown in junket gaming in Macau.
The reports from China
The Times of London reported that in February, Chinese law enforcement would begin cracking down on “Triad-linked ‘junket’ operators” who bring gamblers to Macau. Gambling in Macau through junket operators is a well-known way to launder large amounts of money out of China, and it has driven the high-end gaming growth in Macau. About 70% of gaming in Macau still comes from VIPs, usually with junkets, and a lot of this revenue could dry up if junkets are found to be Triad-linked or are involved with money laundering. The mass market is beginning to grow more quickly in the past year, but these VIP players still account for a large amount of the profits gaming companies earn.
The news has hit everyone in Macau today, but particularly junket Asia Entertainment & Resources Ltd. (NASDAQ:AERL). The company had a 26% reduction in rolling chip turnover in January and there’s now potential that law enforcement will be looking more closely at its junket business. It’s not a good day to be a junket in Macau.
The signs were there
When China’s new leadership was announced, there were rumors that cutting down on corruption would be a top priority. I said in November that this was a major risk for Macau gaming stocks going forward. It’s also another reason I thought gaming stocks were too hot to handle last week after a long run-up. Multiples on gaming companies have exploded after Macau reported 19.6% growth in gaming for December, but I thought this could be a temporary pop given the new leadership.
If reports are true and there will be a crackdown after the upcoming Chinese New Year, then gaming could pull back significantly. At least for now, investors are taking a cautious approach.
Another reason to sell
We don’t yet know if there will be a crackdown on junket play or if gaming revenue will slow down in 2013, but I think there’s reason to believe Macau stocks are too hot. Gaming growth slowed rapidly and now that enterprise value/EBITDA multiples are sky-high and potentially as much as 70% of revenue is under siege, it’s enough to make me cautious at the very least. Unlike Las Vegas, where non-gaming activity drives half of revenue, Macau still relies on gaming for a vast majority of revenue, particularly high rollers.