Macau – Confidence or Crisis.
by William R Eadington and Andrew MacDonald

Macau – Confidence or Crisis.

By Andrew MacDonald and William R Eadington.

The world has been amazed by the performance of Macau’s gaming industry since the new law was passed in 2001. In 2001, gross gaming revenues for Macau under the monopoly concession STDM were US$2.3 billion. For the first quarter of 2008, they were US$3.7 billion. If the current pace continues for the rest of 2008, Macau will end up with gaming revenues for the year of around US$15 billion, compared to US$10.3 billion in 2007. Not only has Macau officially surpassed all of Las Vegas in gaming win; Macau’s gaming revenues in 2008 will likely exceed those of the entire State of Nevada, or alternatively the combined gaming win of America’s two largest gaming cities: Las Vegas and Atlantic City.

Such growth would normally bring into question the title of this article: “Macau – Confidence or Crisis”. Crisis – what crisis? How bad can things be with average annual revenue growth rates exceeding 20% per annum? Yet many investors, analysts and observers are indeed concerned about what might be happening—and what might soon happen—in Macau.

Most of the concerns of the skeptics stem from what we can call the “C8”: Competition, Costs, Constraints (labor and infrastructure), Commission rates, Consumer profiles, Capital crunch, Credit availability, and China. The relative importance of each element in the “C8” may differ from observer to observer. However, there is little doubt that these factors are significantly contributing to a cautionary sentiment among a growing number of observers regarding Macau’s future.

Consider the related issues of competition, commission rates, credit availability and costs. The Macau gaming market can be divided into Mass Market Play, which consists of about 30% of the total, and Premium Play, which makes up 70% of revenues. The Premium Play or VIP market has been dramatically shaken in recent months by the efforts of certain companies to consolidate and aggregate the business of smaller junket agents under the umbrella of a larger more powerful entity – with the smaller junket agents becoming sub-contractors to the consolidators. The consolidators, as a result, gain considerably greater bargaining power relative to the concessionaires in delivering their players through their network of junket operators.

The formation of AMA International, a junket aggregation business owned by the publicly traded company A-MAX Holdings Ltd in December 2007, was just such a vehicle. AMA International established a “partnership” with one of the concession holders, PBL Melco and the Crown Macau Casino, and has reportedly been able to extract commission rates of up to 1.35% of monthly rolling chip turnover volumes. As a percentage of gaming revenues, this commission rate should result in about 50% of the Premium Play win being paid to the junket aggregator who then distributes payments to the sub-junkets. (Not all of the contractual arrangements between concessionaires and consolidators, or consolidators and junket operators, are presently reviewable by Macau's regulators, and none are released for public scrutiny.) Because the government taxes gaming revenues at about 40% of actual win, the residual margins on such premium play are disconcertingly thin.

This commission rate is significantly higher than arrangements which have existed for some time in the past in Macau, where major junket operators received commissions equivalent of about 40% of revenues; these were called 40/40/20 deals (or 60/40 deals for simplicity here). Under the 60/40 deal, the casino would retain only 20% of theoretical win after taxes and commissions. With the new rates (assuming no other adjustments), margins would drop to only 10%, not to mention the fact that the casino has to absorb the volatility risk of fluctuations in wins and losses, which at high-end baccarat can be dramatic. Casinos—as with other businesses—can make up for thin margins if volumes are large enough to generate adequate revenues and overcome volatility, and if the contractual agreements with consolidators are sensibly structured to ensure that fixed operating overheads are covered before other obligations are met. Nonetheless, in comparison to the pre-2004 monopoly STDM and SJM days, margins have significantly eroded and competition has dramatically increased.

Reaction to this junket aggregation model in the Premium Play sector has been swift. Market shares among the concessionaires swung dramatically in the last few months of 2007 and early 2008 and, as would be expected, emulation and pricing pressures to match these trends have emerged elsewhere in the industry. Some concessionaires, such as Wynn and Venetian, seem to be engaging in the price war on commissions, while still suggesting that they do not have to pay premium prices for commissions due to their size, brand power and quality of facilities. Nonetheless, the traditional 60/40 structure is increasingly evolving to a 55/45 structure – perhaps not yet meeting the market price between AMA and PBL Melco, but still reacting to these competitive changes and attempting to win back market share or prevent further player or junket operator desertion. Other companies, such as MGM, have decided so far to concentrate on the Mass Market, and avoid the headaches and risks of this cutthroat competition. Competition is therefore increasingly evident among all participants in the Macau market – at the junket agent level and among casino concessionaires as they vie for new players and fight to retain existing ones.

Supplier power is significant in Macau and the major junket agents have emerged as strong and powerful suppliers of VIP customers. While the concessionaires have sought disintermediation strategies, they have had significant difficulties in dealing with customers directly – not wanting to take on the substantial credit risks as well as having to deal with complex funds transfer arrangements in China. (They may also lack the personal connections and cultural understandings that junket operators exercise.) Furthermore, high value customers are notoriously disloyal and will move from one casino to another to try their luck elsewhere if they have been on a losing run or can get a better offer. An advantage for the junket operators is that they can offer their services across a number of the various concessionaires’ properties (unless, of course, they have signed an exclusive deal, as with PBL Melco and AMA.)

Commission rates in Macau have therefore risen in recent times - eroding margins and putting pressure on competitive responses. Pricing is often considered a “low level strategy” due to the ease of replication. This apparently is the case in Macau where supplier power in the hands of the junkets has made them a very strong force with which to contend. As they become even more powerful, the Macau SAR government and regulators may be forced to consider ways of gaining control over them.

Commission rates cannot go much higher. At the extreme, the maximum that the commission rate could be extended on the non-negotiable chip program would be somewhere between 1.42% and 1.62%. Any commission rate above that range creates a situation where players as a group, betting on any combination of Player and Banker (but not Ties), would not generate enough losses to cover the commission rates and the tax obligations. For commission rates above this range, the casino concession holder would be losing money on every Banker or Player wager.

On a revenue sharing basis, recent Macau street talk suggests that SJM may be offering a 45/55 structure to certain junket operators who then agree to cover all operating costs, leaving SJM with only about 5% of gross revenues after paying taxes and levies. In such an instance, SJM would bear no direct costs and would act as an intermediary only (effectively acting as a landlord for their VIP

Date Posted: 01-Jun-2008

Andrew MacDonald is founder of urbino.net and is also Executive Vice President of Gaming and Business Development with Genting Berhad in Malaysia covering that group's global activities. He can be reached at andrew@urbino.net

Bill Eadington is a professor of economics and director of the Institute for the Study of Gambling and Commercial Gaming at the University of Nevada, Reno. He is an internationally recognized authority on the legalization and regulation of commercial gambling, and has written extensively on issues relating to the economic and social impacts of commercial gaming. Eadington can be reached at eading@unr.nevada.edu.

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