Gaming & Entertainment: PE places its bets?

When Permira partially divested its stake in Macanese casino and entertainment group Galaxy Entertainment in September, the headlines said it all: "Permira hits jackpot with Galaxy"; "Permira cashes in Galaxy chips"; "Permira gets double for Galaxy stake."

The story was infectious. The UK-based firm divested approximately 6.5% of its stake in Galaxy for HK$4.8 billion ($614 million) through an institutional placement, more than doubling its money. It was a big win in what is largely seen as a fascinating and often off-limits sector.

"We are bullish on Macau's long-term growth, and that's really the key macro driver of our investment thesis in Galaxy. We thought that way in 2007 and continue to think it," Partner and Co-Head of Permira Asia Henry Chen reflects. "Macau is still at an early stage and largely driven by high rollers. There is a lot of potential yet to be realized."

Permira, which still holds a 12% stake in the company, took a gamble on Asia's gaming sector and has so far come out on top, but the region has essentially seen zero replicas of the deal despite the sector's anticipated growth. Philip Tulk, the Hong Kong-based director and head of Asian conglomerates and gaming research at The Royal Bank of Scotland, says that Macau - still the region's top gaming market - could come out of 2011 seeing 44% year-on-year growth, and Singapore, home to two new casino and resort complexes, could see nearly 20% growth. Markets with established gaming offerings, such as Japan and Korea, as well as up-and-coming gaming spots, such as the Philippines and Vietnam, are slated to grow more modestly.

The figures are enticing, but there are reasons why private equity has largely abstained from the sector, ranging from regulation, to a dearth of quality assets, to the investment remit of funds themselves. But what is more often cited is that private equity players simply can't find a way in.

"Unless there's a chance at ownership, outside investors can really only get in through a straight share purchase," Peter Caveny, Galaxy Entertainment Group's investor relations principal, tells AVCJ. "These days it's highly unlikely that big gaming operators will want to sell a sizable stake in their companies because the profit for them is too great."

Cracking into casinos?

Asia's position as the gaming capital of the world is alluring. For example, Macau, saw a 58% year-on-year rise in casino revenue in 2010, to a record $23.51 billion. Analysts have said this figure was four times higher than takings on the Las Vegas Strip, and the gap is expected to widen to five times in 2011.

Regional analysts add that the gaming sector has solid cash flow. Richard Huang, an analyst at CLSA in Hong Kong, says Asia's casinos in particular see healthy demand and limited industry competition, and anticipates that "cash flow generated by the casino operators will be enormous," juxtaposed to low maintenance capital expenditure.

This has proved true for Galaxy, which saw EBITDA of HK$1.3 billion in the first half of 2011, up 53% year-on-year. Singapore-based Marina Bay Sands, meanwhile, reported net revenue of $792 million in the third quarter of 2011, up 63% y-o-y, and its operating profit of $414 million, up 71% y-o-y.

The model isn't perfect - for example, Genting Singapore announced in August that its second quarter gross earnings fell 34% from the previous quarter, due to competition from rival Marina Bay Sands - but long-term specs are still positive.

"We think gaming and entertainment in Asia is a good long term investment," Huang says. "Growth will be robust and foreseeable, given the limited competition within the sector. Cashflow generated by the casino operators are also enormous, which would imply attractive dividend yields to investors."

Asia's casino space has obvious appeal, but the issue remains of how to get involved. Besides Galaxy, Macau has so far only distributed five casino licenses, which belong to Sociedade de Jogos de Macau, Wynn Resorts, Las Vegas Sands, the partnership of MGM Mirage and Pansy Ho Chiu-king, and the partnership of Melco and PBL. These licenses seem largely earmarked for those with old ties to Macau or for major casino operators in the West.

Singapore has only issued two licenses, to Las Vegas Sands and Malaysia's Genting International, which operates two casinos in Malaysia. There is a rumor that the government is considering issuing a third license - in six years.

Chen admits that Permira got the timing right when it invested in Galaxy in 2007, noting that, of Macau's casino managers, "Galaxy was looking for a partner with international gaming expertise." Given its experience in the sector - it had previously invested in European companies like Sisal, Italy's second-largest gaming operator and the world's sixth-largest lottery company - the private equity firm was seen as a good partner for Galaxy.

"If we look at the overall scale of operators right now, these players are much stronger than they were three and five years ago," Chen says, iterating that many casinos are now self-funding, making it unlikely they would look for outside investment help. "I'm not sure we'll see many more deals quite like this."

Galaxy Entertainment's Caveny agrees. "Casino operators look for investors who understand the business, buy into the strategy of the company and support the management through economic cycles. They look for long-term investors," he says.

Betting on Southeast Asia

The circumstances may seemingly take Asia's most bustling gambling markets off the table, but countries such as the Philippines, Vietnam, Cambodia and Laos could present new opportunities.

According to RBS' Tulk, smaller, more niche opportunities could turn profitable for a private equity investor in the long run as disposable incomes and market infrastructure become more mature. "Geographically, they're more investable markets than Macau and Singapore," he says. "At this stage of their development, many players in Laos, Vietnam and Cambodia could be interested in taking on a private equity partner that can add substantial value."

Harbinger Capital Partners saw opportunity in this space, and invested in Vietnam casino development MGM Grand Ho Tram, which is also backed by US-based Pinnacle Entertainment. Outside private equity, South Korea's Intercity Group has voiced its interest in developing a casino in Siem Reap, Cambodia, while Adelson and other Western gaming firms have targeted Taiwan, the Philippines and Vietnam.

While investors circle the markets, regulators are said to be slowly liberalizing rules on who can invest in their countries' gaming sectors. The Philippines is a prime example of this: The Philippine Amusement and Gaming Corporation had traditionally been the only legalized casino owner in the country, but this is changing. The country is now in the process of developing a gaming and resort cluster in Manila Bay, with each of four license holders committing to spend a minimum of $1 billion.

Out of Asia

While it may be too nascent to tell how profitable Asia's casino and entertainment sector will be for investors, activity in the West has shown that the segment is still a gamble.

The world's largest casino operator, Las Vegas-based Caesars Entertainment Corp., previously called Harrah's Entertainment, was bought by Apollo Management and TPG for $27.8 billion in 2006 and is sharpest demonstration of how situations can change. Last year, Harrah's had planned an IPO but market conditions led potential investors to devalue the company well below TPG and Apollo's appraisals. This result in the IPO plans being pulled, although recent news suggested that the listing may be back on track, albeit with a revised target of $50 million.

Station Casinos, a prime player in Las Vegas-area gambling venues, also had trouble riding out the economic crisis. Private equity firm Colony Capital and Station's founding family, the Fertittas, delisted the company from the New York Stock Exchange in 2007 for $5.4 billion, only to see the company declare bankruptcy in 2009 under the weight of $6.5 billion in debt against $5.7 billion in assets. The company finally emerged from bankruptcy in June this year.

Neeraj Budhwani, a partner at Clifford Chance based in Hong Kong, says that the lessons learned globally can also apply to Asia in the long run. Embracing growth during the good times creates opportunities, but investors need to be grounded.

"One of the disadvantages is the unknowns," he says. "Given that most of these casino operators are listed entities, share prices will continue to follow the market in times of volatility, and the economy will affect attendance at these venues. Everyone is affected by the state of the world, which is something investors need to consider in their long-term plans."

 

Sidebar: There's more to gaming than casinos

Betting on the house may be a tall order in Asia, but lotteries and sector affiliates are alternative routes to gaming and entertainment profits.

Sigit Prasetya, partner at CVC Asia Pacific and head of its Southeast Asian business, which has invested in Malaysia's largest four-digit lottery operator Magnum Corp., specifically says that the lottery sector appeals because of its "stickiness."

"It has a predictable cash flow and, while I won't say that it's addictive, people are coming back to it - it's very sticky and that's great for business," he says. "The model is sustainable because of its loyal customer base."

CVC first invested $1.5 billion in Magnum in June 2008, then marking Malaysia's largest-ever foreign private equity transaction. Like Permira, CVC forged its way into the Asia's gaming sector by banking on past experience, as it had previously invested in William Hill, the second-largest operator of licensed betting offices in the UK.

CVC notes that Malaysia's lottery market is "essentially a three-way oligopoly," and that Magnum was the first company to be granted a lottery license by the government in 1969. The private equity firm made it a mission to modernize Magnum's operations, and expanded its product line - helping Magnum generate sales of $1.1 billion in 2010. CVC has already made a partial exit, receiving $410 million in cash plus a share allotment worth around $150 million, which Prasetya called "an attractive return" at the time.

Likewise, China-focused GSR Ventures found an inroad into Macau's gaming growth through its investment in Aspect Gaming, which designs and manufactures devices for gaming operators, with an initial focus on Macau.

Kevin Fong, special advisor to GSR Ventures who led the transaction, says that private equity's skillset works well with these companies with regards to financing and market expansion, which is a crucial aspect for growth.

"All the SE Asian markets are growing and there's more to come in Vietnam, the Philippines, Taiwan, Korea and maybe even Hainan Island in China," he says.

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• Topics
• Greater China
• Investments
• Permira Advisers
• China
• Singapore
• Southeast Asia
• CVC Capital Partners
• Sigit Prasetya
• GSR Ventures