Many segments of China’s vast economy can rightly be described as shady, but few are as opaque as Macau’s casino junkets.
Junkets have evolved partly in response to specialization – middlemen who evaluate the credit-worthiness of rich gamblers – as well as to get around Chinese capital controls. The outfits recruit rich mainland “VIP” gamblers, funnel them to the country’s casino haven, lend them credit to play and later collect the debts. They are variously – some say unfairly – alleged to engage in illegal currency conversion, money laundering and visa malpractice.
Junkets also take a generous cut of VIP revenue that in other markets goes to casinos. This is encouraging Macau casinos to reorient their business toward the mainland’s mass market audience.
The mass market segment is expanding. But since VIP business is growing nearly as fast, casinos have so far failed to rebalance their businesses. For all the talk of mass market expansion, Macau’s casinos will realistically remain hooked on high-rollers for the foreseeable future.
Meanwhile, their battle with junkets shows no sign of letting up. “We’re always concerned about the relative strength of junkets versus casinos, and we have seen strength passed to junkets over the last six to 12 months,” said Philip Tulk, head of gaming research at Royal Bank of Scotland. “It’s really the biggest challenge.”
History fails to turn
Once a backwater Portuguese colony overshadowed by neighboring Hong Kong, Macau overtook Las Vegas as the world’s biggest gambling destination in 2006. It is now five times as large as Las Vegas. Revenues leapt 42% last year on top of 58% growth in 2010.
But the makeup of Macau’s income is lopsided. Gambling accounts for a staggeringly 95% of the territory’s casino revenues, and about 73% of that figure is generated by rich VIP gamblers (visitors who gamble with at least US$125,000, per trip). By contrast, most of Las Vegas’ casino income comes from conventions, entertainment, hotels and restaurants; gambling is less than half the total.
Macau’s business was not supposed to be this way. The government ended the casino monopoly held by tycoon Stanley Ho in 2002 and has since awarded gambling licenses to six other operators: Sands China, Wynn Macau, MGM China, Melco Crown and Galaxy.
Many analysts predicted a surge in the mass-market segment when Sands Macao opened in 2004, said Michael Grimes, editor of magazine “Inside Asian Gaming.” The market did grow – gross gaming revenue more than quintupled between 2004 and the end of 2011 – but the VIP segment remained dominant as rich mainlanders piled into the territory.
Macau’s high percentage of VIP clientele vis-a-vis Las Vegas may reflect China’s proportionately smaller middle class. Culture could also play a role: casino operators say wealthy Chinese clients often approach gambling more as an investment than recreation. Some mainlanders “invest” in a trip to Macau to gauge their luck before embarking on a new business venture back home.
Rich but unprofitable
Macau’s larger junkets, such as Asia Entertainment and Resources, Neptune Group and Dore Holdings, are publicly listed and reasonably transparent. But overall the industry’s reputation is shady. Smaller junkets are frequently accused of gaming visa rules, laundering money for crime syndicates and smuggling funds out of the mainland for the wealthy.
The extent of malfeasance is hard to gauge, because evidence is anecdotal. “This is something Western people tend to obsess about and link to Western-style organized crime,” said Grimes. But in China, hiding wealth from the authorities and skirting capital controls “is a part of everyday living” that extends far beyond Macau’s gaming industry, he said.
For companies and investors, the more pressing concern is the sizeable volume of VIP revenue junkets siphon off – usually 40% of gross VIP revenue. VIP margins for casinos therefore hover around a mere 10%. “It’s a high-volume, low-margin business,” said Tulk of RBS.
In response, casinos are busily constructing new mass market gaming halls, exhibition centers and fancy restaurants on Macau’s Cotai Strip. Mass market business lines require higher marketing costs, but are about four to five times more profitable than VIP gambling, noted Tulk. The Venetian Macao, City of Dreams and Galaxy Macau casinos have all recently opened, and the Sands Cotai Central is scheduled to launch in April.
These new properties have led to rapid growth in the mass market segment – by around 37% last year, up from 33% in 2010 and just 13% in 2009. Accelerating growth and the anticipated Sands Cotai Central opening have led some analysts to predict that 2012 could mark a “tipping point” for the mass market.
Others say such talk is premature. Mass-market growth did outpace the VIP segment in the fourth quarter of last year for the first time since 2009, so the picture is changing, said Teng Yee Tan, a casino gaming analyst at Hong Kong’s CIMB Securities. But because the VIP segment is also growing fast – almost 45% last year – the shift will remain gradual.
The reality is that casinos will need to focus on VIP clients for the foreseeable future. “What matters is not percentage margin, but dollars in the bank,” said Tulk of RBS. “If the VIP [segment] is doing more volume, even at a lower percentage the casino makes more money.”
Yet concentration in the VIP segment brings risks. The segment is more sensitive to fluctuations in China’s economic growth. “If you plot the chart between [mainland China’s] M2 [money supply] growth and gross gaming revenue growth, it’s pretty clear that for the past two and a half years or so the boom in Macau has been largely driven by liquidity in China,” said Teng of CIMB Securities.
Reliance on VIP clients also means casinos must continue battling junkets for gambling spoils. Casinos have so far presented a united front to avoid junket rate hikes. But junkets are consolidating: Around 80% of revenues now go to the top 40 firms. A de facto cartel of four or five large players are in position to dictate better terms, said Tulk of RBS.
The fear is that one casino operator could become “a little less rational” when negotiating rates with the junket cartel, said Tulk. “If they got a new property and they really want to knock the ball out of the park, they might pay up to get junket volume. That would lead to all sorts of potential balance sheet issues.” Industry watchers are keeping an eye on smaller companies such as MGM China. So far casinos have held the line on rate negotiations, but the temptation will remain constant in a VIP-dependent industry.
The best Macau casinos can do is to keep courting the mass market to slowly ease the vice-like grip of the junkets. Until then, the middlemen will remain as opaque as ever – and just as necessary.