Is Melco Crwon Entertainment A Good Stock To Buy?

Any frequent visitor to Las Vegas knows that it just isn’t what it used to be. In the New York fashion scene, green may be the new black but in the world of high stakes gambling, Macau is the new Las Vegas. Steve Wynn opened the eponymous Wynn Hotel in Macau in 2006, perhaps non-coincidentally the same year Macau casinos overtook Vegas’ in terms of revenue from slots and table games. Now we think that we have hit an inflection point as IBES industry projections finally reversed its downward EBITDA trend for Macau casino operators in February. With Sands China’s (HKG: 1928) Cotai Central set to open next month, we think March and April gross gambling revenue (GGR) will probably exceed market expectations. GGR measures amount wagered less winnings returned to gamblers and is often thought as a measure of the economic value of gambling. Also note that casino operators will report first quarter results starting in April, which will help us evaluate if our expectations are warranted. If casino operators show strong earnings, we will see several upgrades in the industry.

So how can you capitalize on the immense growth that Macau is witnessing?

Melco Crown Entertainment Ltd (ADR) (NASDAQ:MPEL)

We identify Melco Crown (NASDAQ: MPEL) as our top pick for a pure-play on Macau given that the upcoming Cotai Central opening should increase earnings potential. Hedge funds Standard Pacific Capital, Bain Capital, Par Capital, and Oaktree Capital are buyers as well. Other Cotai Strip operators are Galaxy Entertainment (HKG:0027) and Sands China. Other Macau operators include MGM China (HKG:2282), Wynn Macau (HKG:1128), and SJM (HKG:0880). Some investors also prefer Las Vegas Sands (NYSE:LVS) to gain exposure to Macau.

MPEL is as close as you get to a pure play on the Macau gambling scene. It owns and operates casino gaming and resort facilities like Mocha Clubs, Altira Macau on Taipa, and the City of Dreams on Cotai. We view Macau Studio City (MSC) as a very positive company-specific catalyst. MSC has not yet received government approval to restart the building process the complex. The CEO of Melco Crown, Lawrence Ho, has indicated that designs for MSC are complete but that the government approval process in Macau is complicated. Estimates are that if the necessary approvals can be obtained and construction can restart this year, MSC could open in 2016.  MPEL is seeking a loan (tentatively $1.25 billion) to finance the project so that it does not need to raise equity in the short term. However, an equity raise has not been ruled out so potential dilution is still a possibility given the large project budget of $1.9 billion. As of year-end 2011, MPEL had $1.5 billion of cash and $2.3 billion of total debt.

MPEL reported a strong fourth quarter. VIP volume declined 3% quarter-over-quarter but management has implemented strict VIP commission rates and cost control to counter the trend. VIP volumes are heavily dependent on the availability of credit, so any government action that will loosen or tighten credit will impact the VIP segment. 77% of MPEL’s total gaming revenue is attributed to VIP gaming with mass market gaming contributing the remaining 23%. We suspect the VIP segment will continue to see declines as competition increases amongst operators. However, management sees real potential in the premium mass-market segment, and we are similarly excited above improvements in that segment.

A concern many investors have is the opening of Sands China’s Cotai Central in April. In fact, management sees this as an opportunity to gain market share. To prepare for the increase in traffic to its Cotai facilities, MPEL will transfer tables from underperforming junkets to better-performing junkets and from Altira to City of Dreams, which should improve table utilization. Since City of Dreams is located next to Cotai Central, we think MPEL has the most potential to gain. At with only 10.8% of the mass market segment compared to Sand China’s 25.3%, we think MPEL has a significant opportunity to increase its market share. Galaxy Macau is not walking distance from Cotai Central.

To give you a sense of trading comps and market share numbers, MPEL trades at 17.1x 2012 earnings and 14.7% overall market share as of 2011. Overall market share includes high-roller, mass-market, and slot machines. Galaxy trades at 11.8x 2012 earnings with 15.6% overall market share. MGM China trades at 12.0x 2012 earnings with 10.7% overall market share. Sands China trades at a premium 23.0x 2012 earnings given the anticipated Cotai Central opening and has 15.8% overall market share. SJM trades at

12.6x 2012 earnings with 29.4% overall market share. And finally Wynn Macau trades at 13.2x 2012 earnings with 13.9% overall market share. The upcoming catalysts offer MPEL opportunities to expand its multiple and market share.

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