The casino floors on Macau are still crowded – and Galaxy Entertainment Group (Galaxy) can barely meet the demand for hotel rooms from the many visitors flocking to Macau each year to try their luck. In the last few years, the island has gone from being mostly for the serious VIP players to being a place for mass market players who benefit greatlyfrom both the casino operations and the many other services on the island. Galaxy is the only casino operator with a large undeveloped landbank, and the casino operator has plans for expansions for both the VIP and the mass market.

The casino operators at the gambling mecca of Macau are busy. Over the past year, the eager players visiting the island gambled for around 280 billion Hong Kong dollars, which was 14 percent more than the previous year. Gross gaming revenues on Macau are expected to grow by around ten percent each year in the coming years.

Back in 2014 and 2015, the wealthy Chinese reduced their spending, as the Chinese central government launched a comprehensive anti-corruption campaign. This impacted the growth on Macau, which was negative during this period. Since 2016, however, growth has once again picked up, and the island has managed to grow to five times the size of Las Vegas as measured on gaming revenue.

We last visited Macau in September 2018, and though we were not gambling ourselves, we did notice the crowded floors of Galaxy’s casinos. Despite this, Galaxy’s share price experienced great fluctuations last year. These seem to be driven by the fear of a potential trade war between the United States and China in addition to a general concern on how an economic slowdown in China will impact VIP players’ appetite for gambling on the casinos in Macau. This potential slowdown, however, was not noticeable to us when we visited the island as it was buzzing with activity. It has thus not stopped the growth of Macau in 2018, where – as previously mentioned – the gaming revenue grew by around 14 percent.

Galaxy is one of six casino operators on the island, which also include Sands China – another of our companies. With its limited size of around 30 square kilometers, the island of Macau is the only place in China where gambling and casino operations are legal. This makes millions of eager gamblers flock to the island. The number of visitors is on the rise, and in the last few years over 30 million have come here each year. Last year, the number of visitors grew by almost ten percent to more than 35 million. However, this is not unique visitors as the number includes guests making multiple visits.

Focus on non-casino expansions

The number of visitors staying overnight grew at a faster pace than visitors who arrived and left on the same day. The average visit lasted just over two days, which was slightly higher than the year before. We see this as a positive development, as guests staying overnight are estimated to spend more on the island than guests who arrive and leave on the same day.

The high number of visitors does not mean that everyone has visited Macau. There is still a large untapped potential, and only around two-three percent of the estimated addressable Chinese target group have visited the island. In any case, Galaxy’s casinos are virtually fully booked, and in general, the demand for rooms exceeds the supply on the island. New infrastructure improvements and expansions (which we will discuss in greater detail in our description of Sands China) will make it more convenient to get to the island – so this issue of excess demand is not expected to end anytime soon.

The increasing number of visitors benefits Galaxy in particular as the group has the biggest amount of unbuilt land on the island. This land will be used to expand their current capacity and thus make room for even more of the visitors who come here eager to gamble. The new expansions will be more focused on non-casino related services and activities, such as conference facilities, entertainment, shopping, and restaurants. These services are growing fast in Macau and are profitable businesses for the island’s casino operators.

The gamblers coming to Macau can be divided into two main segments: the high-rolling VIP players, and the mass market players who spend relatively “ordinary” amounts on gambling. Galaxy has been strong within the VIP segment, where the group has a market share of almost 30 percent as measured by gaming revenue. As a result, Galaxy has benefitted greatly from the high growth rates previously seen in this segment (even if they were negative from 2014-2016). Even though the growth has since been positive, it is, however, expected to slow down and grow at lower levels than the mass market. The VIP segment can also be linked to some uncertainty, as the willingness to gamble can be impacted by political initiatives such as more crackdowns from the Chinese central government.

Instead, the mass market segment on Macau is really on the move – last year, it grew by 17 percent and it is expected to grow by more than ten percent annually over the next few years. Macau is thus in the midst of a transformation, where the previously dominant VIP market has been surpassed by the mass market, which today represents approximately half of the gaming revenues and just over 80 percent of the gaming income. In our assessment, this change is permanent, and we have thus probably passed the era where the VIP market was dominant. The mass market, however, is, in any case, more stable as well as profitable. The reason being that you can bring more players through at the same time, and there are fewer costs associated with attracting new customers. For example, the casino operators do not need to provide free hotel rooms, food and beverages and other bonuses that VIP players often demand in order to visit a particular casino. They also do not have to hand over parts of the revenue to the organizers of the VIP players’ casino trips – the so-called junkets. Thus, the mass market is assessed as having an operating margin around three to four times higher than the level in the VIP segment.

Expiring casino licenses and a smoking ban “threaten” the casino operators

Despite Galaxy’s strong position on the VIP market, the casino operator is ready to embrace the growing mass market through the aforementioned new expansions. The expansions will double the current capacity of Galaxy, both in terms of space and number of rooms. In addition to 4,500 new rooms, the expansions will include conference and meeting facilities, an arena with 16,000 seats, food and beverages, shopping areas as well as casinos.

Galaxy also has a landbank outside of Macau. The neighboring island, Hengqin, is more than three times the size of Macau and is home to approximately 7,000 residents. It is not permitted to operate casinos on the island, but it is a great location for hotels and integrated resorts. It is directly connected to the Cotai part of Macau via a bridge, and in this area Galaxy – and our other casino company Sands China – have several of their casinos.

On Hengqin, Galaxy is also one of the few that has unbuilt land, and as the rules stand today, only Chinese companies are allowed to build on the island. Galaxy is planning to build a major holiday resort area on the island. Among other things, the island will include other holiday resorts and amusement parks, such as a LEGO and a Hello Kitty theme park. In this way, Galaxy can increase the room capacity in an area that is close to Macau. Chinese who come here to gamble can thus visit the casinos on Macau while their families enjoy the holiday resort nearby.

Within one to three years, all the island’s casino licenses will expire. We are aware of the uncertainty related to the new terms in case of renegotiation, such as, whether there will be higher payments or other requirements. However, we are not particularly worried about the licenses failing to be renewed, as the islands’ land contracts with the operators will not expire until many years after the gaming licenses. The current casino operators have built on practically all the available land in Macau. So far, the current non-Chinese concession holders have invested a total of more than 30 billion US dollars in developing the island. In addition, they have demonstrated a superb ability to run the casinos on Macau in an unproblematic and decent manner, living up to the island’s regulatory requirements. For these reasons, among others, it is hard to imagine that the casino licenses will not be renewed.

Another risk is a smoking ban, which came into force in January this year. This means that smoking is no longer allowed at the VIP gambling tables on Macau. Smoking has not been allowed on the regular casino floors since 2014. Some worry that this will negatively impact the VIP players in terms of their eagerness to come and gamble on the island. We recognize that this may have a short-term effect on the gambling activity, as smokers will be forced to leave the tables to smoke. However, in the long run we believe that this is just a matter of getting used to the new reality and that the gamblers who smoke will eventually adjust – and as a side note, some of the newer casinos are already non-smoking areas. Besides this, it is not every gambler who smokes, and it may be that it will have the opposite effect – i.e., the non-smoking gamblers will want to stay longer at the tables.

Bursting coffers finance expansions

Currently, Galaxy owns four properties, and the returns on these investments have been extremely high. Even in crisis-stricken 2015, the returns on Galaxy Macau, which is the star casino in the group, were more than 50 percent. The returns on their first casino, StarWorld, were at almost 100 percent just three years after it opened its doors. Thus, the investment had paid for itself with one year’s earnings. Lower returns than 100 percent are fine with us too, and we are convinced that the large investments that Galaxy will make in the years ahead will pay for themselves many times in the future. The planned infrastructure improvements and expansions are expected to increase the number of visitors to the island further and thus also increase an already high demand for rooms. For this reason, among others, we expect that Galaxy’s expansion of hotels on Macau will be just as profitable and just as fully booked as the current ones.

Historically speaking, Galaxy has made investments in expanding their casinos amounting to approximately ten percent of the company’s revenues, and the investments in the current phases are expected to reach the same levels. Once the expansions are completed, however, it is expected that their maintenance investments will only amount to around three percent of the revenue. This means that there is a potential for growing dividend payments once the expansions are completed. Galaxy has generally lower dividend yields than the other casinos on the island. Yet we see their investments in new properties as more value creating with very attractive returns on investment. The expansions are also self-financed because Galaxy has almost 35 billion Hong Kong dollars in cash – and no debt, unlike other casino operators on the island, and around the world. This is something that we as co-owners appreciate.