Macau – A Lesson in Scarcity, Value and Politics
By Andrew MacDonald and Bill Eadington
Much of the discussion surrounding Macau's gaming opportunities refers to abundance. There is reference to the huge demand from China and more specifically the Pan-Pearl River Delta region. Also noted is the abundance of quality supply of new gaming facilities coming into the market. However, in reality it is SCARCITY that is powering Macau and the gaming companies that have been fortunate enough to secure a position there.
Essentially there are three scarce commodities in Macau: Licenses, Land and Labor. The three L's that drive Macau apart from its location. A fourth important L, which has been historically scarce, is Legitimacy, which will also be discussed below.
The first scarce resource is a License (or "Concession" as it more correctly known in Macau).
In 2001, when the Macau authorities first pursued the opening of the Macau gaming market to new license holders, there were three gaming licenses to be awarded. Twenty-one companies from around the world put their bids forward in a beauty contest held by the Macau Special Administrative Region (MSAR) and overseen by the Chinese Central Government in Beijing. This effectively put an end to the long-standing monopoly over Macau gaming held by Stanley Ho and his company, Sociedade de Turismo e Diversoes de Macau (STDM), which had begun in 1962 and whose monopoly had been extended on several occasions. By all accounts, the Macau authorities had tired of STDM's lack of investment into their gaming facilities and the Sociedade's overt control of the gaming market and general economy of Macau. The STDM's 40-year monopoly had been accompanied by increased associations of Macau with money laundering, prostitution and crime. Somehow Macau had ceded control to Stanley Ho and the STDM in a form of prisoner's dilemma.
When Macau was handed over to China by Portugal in 1999, it seemed to sound the death knell of that period. China quickly sought to clean up the triads that had brought instability in the last few years before the hand-over. China also wanted to prove to the world that its "one country - two systems" model could work and turn a relative "basket case" into a "showcase". Furthermore, success in Macau would enhance China's arguments for perhaps a more challenging and certainly more important success that it wanted with Hong Kong.
To achieve these objectives, both the Macau and Chinese governments understood the need to revitalize Macau's gaming product and bring in visionaries with high ideals, expectations, and track records. At the same time they could not afford to totally disrupt the market and create a war by stripping Stanley Ho's company of his license. As a result, the three winners of the gaming licenses awarded in early 2002 were Galaxy Resorts in partnership with Las Vegas Sands International (LVSI), owned mainly by Sheldon Adelson; Sociedade de Jogos de Macau (SJM), the successor company to SDTM, owned mainly by Stanley Ho; and Wynn Resorts, controlled by Steve Wynn. The two visionaries and one incumbent who were selected for licenses - none of whom at the time had publicly traded companies or corporate boards to answer to - were all known to be decisive, passionate and "market makers."
Interestingly, and little spoken of at present, is the fact that there was a formal list of runnersup or "substitute companies." Those companies that finished fourth, fifth and sixth etc. who could be called upon if the companies that were officially awarded the licenses could not meet their obligations. Among those substitute companies were a joint venture between Park Place Entertainment and Mandalay Resort Group, MGM Mirage, and Genting. By 2006, of the three substitute companies, only one, MGM Mirage, subsequently found a way into the market.
It is interesting to note that the awarding of the three initial licenses was not without controversy, and there were a great many skeptics as to the value of being in the market. One of the licenses had been awarded to a group called Galaxy that included Sheldon Adelson's Las Vegas Sands in partnership with a property construction group from Hong Kong led by the Lui family. According to some accounts, this had been a forced marriage put together by the Macau and Chinese authorities after Adelson's original Taiwanese construction partner was deemed inappropriate. The strained relations became so difficult that the Macau authorities solved the issue they had inadvertently helped create by allowing a split of the Galaxy license concession into two. This created a formal concession (license) and a subconcession (sub-license) based on considerations that were evident under Portuguese law and which the Macau officials were familiar with. However, this led to some inequities among the license holders and, as a consequence, the Macau authorities allowed each of the license holders to issue one sub-license each. The result was the eventual issuance of three licenses and three sub-concessions. The three sub-concessions are presently held by; Las Vegas Sands International (LVSI); MGM Mirage, in a joint venture with Pansy Ho (Stanley's daughter); and PBL/Melco, an Australian publicly traded company partnered with a company whose Managing Director is Lawrence Ho (Stanley Ho's son.)
Apart from the Galaxy license split, the other sub-concessions were awarded on the basis of a commercial sale of the right to operate casino gaming in Macau. The MGM/Pansy Ho subconcession was sold by SJM (Stanley Ho) at a reported cost of US$200 million, while Wynn Resorts sold the PBL/Melco sub-concession at a cost of US$900 million. The Macau authorities did not originally consider the concept of sub-concessions and it is interesting that only one of the original "substitute companies" was able to enter the market in this manner. (It should be noted that two of the other three were absorbed into larger gaming companies in 2004: Harrah's acquired Park Place Entertainment (Caesars) that year, and MGM Mirage acquired Mandalay Bay Group.) It is also interesting that the beneficiary of the sale of the sub-concessions were the original license holders rather than the government, with the license holders being able to "deal" with any company that they felt were appropriate (subject to approval by the Macau authorities).
Arguably the Macau government could have run a more traditional bid process rather than a beauty contest for the original licenses and subsequent sale of sub-concessions, but this does not recognize the history of Macau and the manner in which "problems" have been solved. It has been suggested that the right to sell off the sub-concession compensates the license holders in some way for the additional competition entering the market.
The Macau authorities have the right to open up the license process again in 2009 when further licenses could be legally awarded, but it is not yet known whether or not they will do so. Many analysts do not believe there is compelling logic for the government to issue new licenses, given the abundance of projects already underway in Cotai and elsewhere in Macau. Nevertheless, it is possible that the MSAR government may decide to further open the market to bring in additional leading casino entertainment companies. The sale of sub-concessions has demonstrated the strength of interest and expectations regarding the Macau market, and the government could seek to capture rents for additional infrastructure needs to continue the casino and tourism boom. However, in light of the high tax rates on Gross Gaming Revenues (at 39%), and the possibility that increased competition might put downward pressure on those rates, it is unclear whether the MSAR government's interests would be best served by issuance of new licenses.
In sum, licenses to conduct casino gaming are a scarce resource controlled by the government, which can become incredibly valuable in the hands of recipients. The share prices of all the publicly traded gaming companies that have secured positions in Macau have reflected that value. As an example of this, one only has to look at the current share price and market capitalization of Sheldon Adelson's company LVSI. LVSI had a market capitalization of approximately US$25 billion in mid-2006, and about 60% to 75% of the market capitalization could be attributed to their Macau endeavors, with the as yet unopened Cotai Strip developments accounting for much of this.
The second scarce resource that must be considered is Land.
The license is the piece of paper that grants the right to operate casino gaming in Macau, but it is land that is needed to enable the development of the properties to cater to the market. Macau is a small peninsular in Eastern Asia measuring only 28 square kilometers, approximately one-sixth the size of Washington DC, around one-tenth the size of the city of Las Vegas, and only twice as large as Los Angeles International Airport (LAX). The location of Macau in the Pan-Pearl River Delta region provides it access to around 400 million people within two or three hours travel time. The immense population that Macau can cater to is therefore somewhat limited by the land available within Macau for development.
Over the years the MSAR's own need for additional land has led to much reclamation. Interestingly, the area known as Cotai is land reclaimed between the islands of Coloane and Taipa (Co-Tai). The land for casino development is strictly controlled by the government and released following the approval of a number of government bodies and the payment of a land premium. Having a license is important but perhaps even more important is the granting of land. Sheldon Adelson and LVSI along with Galaxy (under the award of the original license) were granted much of the land on the Cotai strip, as Stanley Ho and SJM were seen to control the main peninsular area, and much of the central business area was already developed.
Adelson is reported to have stated that he initially felt like a banished foreigner when first shown the Cotai area. "At first, I thought it was political exile," Adelson recalled. "I thought (rival Chinese casino developer) Stanley Ho had some influence that he got me off the peninsular because that's where he believes the center of everything is. All I was hoping was that I could get a location in which I could really do something."
Adelson took up the challenge and was granted much of the land in Cotai for casino developments that he believed could ultimately rival the famed Las Vegas Strip. The 250 acres that make up the Cotai strip have subsequently been parceled and split by the government among many of the license and sub-concession holders. However, LVSI and Galaxy control the two largest parcels.
The "Cotai Strip" is now considered the place to be once critical mass is achieved, and hence all the license holders are keen to have some presence there. LVSI, Galaxy, Wynn Resorts, and PBL/Melco are all "known" to have secured land from the government, although formal title will not be granted until virtually all development on each parcel is complete. Therefore, there is still jockeying for position with the government ultimately in control of who gets what. It is also understood that while the government is seeking to reclaim a further 983 acres of land over the next twenty years, much of this will not be allocated for casino use (although as with everything else in Macau, things can change). Thus land in premium locations is an exceptionally valuable and scarce resource that is ultimately controlled by government and politics.
To gain some understanding of the value of land in Macau, the PBL/Melco joint venture recently purchased a 1.6 acre site on the Macau peninsular for approximately US$190 million, or US$120 million per acre. Of course, plot ratios are important to take into consideration and it should be noted that the PBL/Melco price allows the development of a significant high-rise building. Nonetheless, this example clearly shows the value placed on prime land in Macau.
The remaining scarce resource in Macau that needs to be considered is Labor.
The population of Macau is around 450,000 with unemployment running around four percent from an estimated workforce base of 250,000. Labor practices are strictly controlled, with the Macau authorities ensuring "full employment" for its citizens. Even under the "one country - two systems" approach, the employment market in Macau is not open to other Chinese nationals, whether from Hong Kong or the Mainland. With the rapid development in the casino sector, there has been immense strain placed on the local work force. The demands that will be evident when the Cotai Strip projects become operational will be immense; with around 50,000 new jobs required, that would represent an increase of 20% on the employment base. The ripple effects through the local economy are already being seen with difficulties attracting employees in casinos and other businesses, resulting in wage increases and inflationary pressure.
The Macau government will be under pressure to solve this situation but without creating an influx of lowly paid Chinese workers from across the border that would threaten lower wages and working standards for Macau residents. While labor in general is clearly a scarce resource, experienced and well-trained mid-level and senior-level management for Macau's casinos will be even scarcer. The Cotai Strip and other casino projects increase the number of gaming tables in Macau from around 1,650 currently to over 4,000 by 2008 (compared to 2,300 tables on the Las Vegas Strip). In this environment, the demand for experienced casino management will become exceptional in the very near future. Companies often state that their employees are their most valuable resource, but in the case of Macau over the next few years nothing will be truer. At the present time, tables are left closed in many Macau casinos, not because demand is not evident or that tables are not on the floor, but rather that there are not enough staff to open or manage them.
Many operators are also finding it difficult to attract quality management from abroad. In general, Macau is not seen as a family friendly environment to relocate to for experienced foreign gaming managers. That perspective is slowly changing as a number of seasoned Americans, Australian and European managers have already taken residence in Macau. However, this remains a real challenge. The sophistication of management will clearly be a competitive advantage in such an intense market place and human resource assets are going to be crucial to long-term success.
The final resource whose current scarcity is debatable is Legitimacy.
Until the hand-over from Portugal to China in 1999, there was considerable speculation as to whether Macau's casino industry would even be allowed to continue by the authorities in Beijing. Gambling had long been condemned as a vice by the Chinese authorities - certainly since 1949 - and the "triad wars" that were fought out in the streets and even on the casino floors of Macau in the late 1990s did not present a pretty picture to the outside world. Gaming jurisdictions throughout the world expressed skepticism that this particular Chinese tiger could indeed change its stripes. If it had taken Nevada gaming officials and regulators decades to move that industry from an "outlaw" culture to a corporate culture, could Macau achieve the same outcome in less than a decade?
By 2006, many observers were pleasantly surprised by how much progress the MSAR had made in moving Macau's legal and regulatory structures toward acceptable "international standards." The willingness of publicly traded companies from the United States and Australia to invest billions of U.S. dollars into Macau - and the financial community's positive response to the economic potential of such capital outlays - was a strong indicator that Macau had made significant strides from where it had been only seven years before.
However, there still remain some critical challenges ahead for Macau's gaming operators and regulators. Take, for example, the issue of VIP Rooms. In 2005, about 70% of Macau's US$6 billion in gaming revenues came from VIP Room operations. Since the early 1980s, independent contractors and junket operators have effectively rented space within the SDTM (and now Galaxy) casinos in order to offer their games. The primary financial relationship between the contractors and the license holders takes place with so-called "dead chips:" nonnegotiable chips that are purchased at discount by the contractors from the licensee, who then in turn sell them at face value to their players. The contractors and junket operators bring the players to Macau, extend them credit, and provide them with complimentaries and other services. In the past, they were not subject to regulatory oversight, and it is likely that some of the practices that take place between them and their players would not be acceptable to regulators in other jurisdictions.
Thus, a prevailing reality is that many such contractors and junket operators would have difficulty meeting licensing standards that other jurisdictions would impose. However, because they currently play a critical role in bringing customers to the gaming tables in Macau, it is going to be very challenging for the international companies to integrate VIP Room play into their operations without addressing the concerns raised by international regulatory bodies. Avoiding the VIP Room market may not be an alternative, as the non-VIP market may not be large enough to support all of the new Cotai Strip and Peninsular casinos. Thus, Legitimacy may end up being even more complex and challenging than the other scarce resources of Licenses, Land, and Labor. If Macau's Legitimacy reverts to its previously scarce status, it would be bad news for Macau and its licensees, but for reasons that may be hard to fathom at this time.
In the end, Macau will be about scarcity and abundance: the scarcity of licenses, land and labor against the abundance of a huge market sitting right on its doorstep. Managing the challenges of scarcity - while staying within the proper rules dictated by law, regulation and international standards - will require substantial effort and vision by both private sector and government entities. The Macau and Chinese governments have demonstrated a willingness to allow Macau to evolve quickly into a showcase for the "one country - two systems" approach. There is a willingness by these governments to address any issues that are needed to ensure success. Macau's future may very well depend on how well these challenges are addressed, controlled, with the Macau authorities ensuring "full employment" for its citizens. Even under the "one country - two systems" approach, the employment market in Macau is not open to other Chinese nationals, whether from Hong Kong or the mainland. With the rapid development in the casino sector, there has been immense strain placed on the local work force. The demands that will be evident when the Cotai Strip projects become operational will be immense; with around 50,000 new jobs required, that would represent an increase of 20% on the employment base. The ripple effects through the local economy are already being seen with difficulties attracting employees in casinos and other businesses, resulting in wage increases and inflationary pressure.
The Macau government will be under pressure to solve this situation but without creating an influx of lowly-paid Chinese workers from across the border that would threaten lower wages and working standards for Macau residents. While labor in general is clearly a scarce resource, experienced and well-trained mid-level and senior-level management for Macau's casinos will be even scarcer. The Cotai Strip and other casino projects increase the number of gaming tables in Macau from around 1,650 currently to over 4,000 by 2008 (compared to 2,300 tables on the Las Vegas Strip). In this environment, the demand for experienced casino management will become exceptional in the very near future. Companies often state that their employees are their most valuable resource, but in the case of Macau over the next few years nothing will be truer. At the present time, tables are left closed in many Macau casinos, not because demand is not evident or that tables are not on the floor, but rather that there are not enough staff to open or manage them.
Many operators are also finding it difficult to attract quality management from abroad. In general, Macau is not seen as a family friendly environment to relocate to for experienced foreign gaming managers. That perspective is slowly changing as a number of seasoned Americans, Australian and European managers have already taken residence in Macau. However, this remains a real challenge. The sophistication of management will clearly be a competitive advantage in such an intense market place and human resource assets are going to be crucial to long-term success.
