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Tuesday, July 23, 2013 - 13:00

The Single Best Pure Play On The 'Las Vegas Of China'

Tuesday, July 23, 2013 - 1:00pm

Can you name the gambling capital of the world?

If your answer is "Las Vegas," you're wrong.

Macau is the world's leading destination for betting, having passed Vegas back in 2006 in terms of gambling revenue.

This 11-square-mile special administrative region of China is a self-governed casino destination along China's southern coast. Last year, gambling accounted for 50% of Macau's GDP and 84% of its fiscal revenues.

So what's the best way to play this intriguing and rapidly growing market?

Melco Crown Entertainment (Nasdaq: MPEL) is the absolute best pure play on the Macau gaming market, generating 100% of its revenue from the region.

Other major casino operators have a presence in Macau, including Las Vegas Sands (NYSE: LVS), MGM Resorts (NYSE: MGM) and Wynn Resorts (Nasdaq: WYNN), but their revenues are diluted by their exposure to Las Vegas and other U.S. markets. Vegas Sands gets 52% of EBITDA (earnings before interest, taxes, depreciation and amortization) from Macau, while MGM receives 33% and Wynn earns 74%.

Why Does Macau Matter?
Macau is already generating more than six times as much gambling revenue as Vegas. The Macau GDP growth rate is head and shoulders above the U.S., and its unemployment rate is at multi-year lows. Macau's GDP expanded at an impressive 10.8% during the first quarter, and its unemployment rate fell to a record-low 1.8% in May. Putting these numbers in perspective, U.S. GDP grew 1.8% in the first quarter, and the unemployment rate in May was 7.5%.

People continue to visit Macau in droves. During the first five months of this year, visitor arrivals increased 3% year over year. What's most impressive is that more than 60% of visitors are from mainland China and nearly 25% are from Hong Kong. The long-haul visitors, from the likes of the U.S. and Canada, make up a much smaller portion of Macau's total visitors.

The trend in the U.S. toward legalization of gambling gives Melco another advantage over its U.S.-based competitors. Melco's Asian focus insulates it from the rapidly changing U.S. online gambling market, which could well steal market share from casino operators. Nearly three-quarters of U.S. states currently allow online betting on games that require a minimum degree of "skill," and a bill was introduced in Congress this month that would pave the way for states to legalize online poker.

The other big headwind that U.S.-based casino operators face is the spread of casinos. Twenty years ago, only six states had commercially operated casinos; today, 20 states have commercial casinos.

Macau is already generating more than six times as much gambling revenue as Vegas. During the first five months of this year, visitor arrivals increased 3% year over year.

Melco Crown's Prospects In Asia
For American gamblers, Macau is more of a planned destination trip than a weekend getaway, like a quick trip to Vegas. As a result, any impact from legalized online gambling or the emergence of casinos across the U.S. will affect Melco much less than it would, say, Las Vegas Sands or Wynn.

The majority of Macau's visitors are from mainland China. Enter China's rapidly rising middle class, which is already larger than the entire U.S. population and will likely be the key driver of Macau's growth. Back in 2000, only 4% of China's households were considered middle class. That number had soared to 66% by last year.

Melco is also looking to be the industry leader in Manila, the capital of the Philippines, with plans to build one of the first casinos in the area next year. There will be an all-Asian lineup in Manila , where the four casinos scheduled to be completed next year are the work of China-based companies and Asian billionaires.

Up until now the majority of the casinos in the Philippines have been run by the government. This is about to change, as Melco and other operators look to further tap the fast-growing Asian gambling market. The Filipino market is expected to attract both China's high rollers and Asia's rising middle class.

The Philippines' annual revenues could easily reach $3 billion by the end of 2015, which would be closing in on the Vegas Strip and Singapore markets, which both bring in about $6 billion in gambling revenue a year.

Although Melco's share price has soared 125% during the past 12 months, it is still trading at only 13.5 times operating cash flow, which is in line with Las Vegas Sands and well below Wynn's 23.4 times.

Action to take --> The beautiful thing about casinos is that they operate in a highly insulated and regulated industry. As well, the business is capital-intensive -- Melco's Philippines casino is expected to cost more than $1 billion.

Melco Crown is the best way to invest in the fast-growing Asian gambling industry and rising middle class. While legalized gambling in the U.S. will in all likelihood have a meaningful impact on U.S.-based casino operators, I fail to see how it will have a much of an effect on Melco's overseas casinos.

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Marshall Hargrave does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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