Melco’s Cyprus Foray Interests Us, But Still Too Risky (NASDAQ:MLCO)

Published on the Value Lab 20/6/22

The value of Melco (NASDAQ:MLCO) is underpinned by its long-established international operations in a cash-generative gambling industry. MLCO benefits from an ownership of a portfolio of international resorts, the majority of which are open, others which are planned to open in the next 12 months. Given the share price, which is currently close to its lowest level, a reversion to the mean in COVID-19 cases and in price could be a catalyst for the company as it expands its portfolio. The challenge or threat is in the unpredictable COVID situation in China and Macau, which could continue to deteriorate, and the very strict zero-tolerance Government measures. Given the most recent surge in COVID cases in Macau, the share price may still slide lower in the next few days. With a watchful eye on Chinese lockdowns, we might be nearing an inflection point that could be attractive for investors with a risk appetite.

Macau

Macau is the most important exposure for Melco accounting for over 80% of their overall revenue. Naturally, the lockdowns in mainland China are a concern for the company, as if infections continue to spread to Macau, the zero-COVID policy will mean a hammer will fall on the island. MLCO stock has fallen substantially on the news, and it continues to near all-time lows. While lockdowns will trigger the obvious adverse effect of reduced foot traffic to key locations, there is a silver lining which is the dependence on the region’s government on the gambling income. Current taxes lie at 40%, but these could fall as a concession for operators to continue to engage viably in operations there and support a long-term diversification strategy for Macau to branch out into other forms of tourism. Indeed, the importance of gambling for the region as of now is why casinos remain open, even though plenty of other non-essential establishments are being mandated to shut down. A cut in gambling tax could mean as much as a 15-20% increase to the EBITDA from whatever its run-rate level is.

However, as with any investment that involves China, there is the flip side of the Macau gambling dependence, which is that it is a drain of capital out from the PRC and into the coffers of American companies. There are untold even if improbable risks relating to how China might play the mercantilist game on US enterprises operating there, especially with China-based operators capable of picking up the slack.

Cyprus

The City of Dreams franchise is extending past Macau and Manila now to Cyprus. Cyprus, currently only 3% of revenue, constitutes a rather interesting opportunity. Being a nexus for Islamic and Orthodox influence, the strategy behind a fully developed location there constitutes an opportunity for Muslims who reside in countries that prohibit gambling to easily transit into a geography where it is permitted. The political stability of the region is a contributing factor to this development of tourism in Cyprus. This is seen against the backdrop of Cyprus as a stable EU country whose standing has been recently increased by the fact that it is going to be a significant energy producer given its proven reserves of natural gas and oil, and their significance for the EU. As such, Cyprus is an opportunity to capitalise on the large Muslim population in the Middle East in a profitable industry that will be supported by a government whose economic strategy depends heavily on tourism. This is an emerging story, as development issues with the location mean that revenue from the City of Dreams in the Mediterranean is still nascent. The location is going to have about 20% of the gaming tables and 40% of the slot machines as a location such as the Marina Bay Sands which generates around $1 billion in sales every year. While Singapore is a more profitable geography in all likelihood, the opportunity of Cyprus could boost MLCO revenues by about 10-15%. This could start ramping from the end of the year.

Conclusions

MLCO’s prices are at all-time lows, but due to the unprofitable situation over the last couple of years, historical price analysis isn’t very effective. On a relative basis, the case does not particularly impress compared to Las Vegas Sands (LVS). Both had similar 75% EBITDA declines from 2019 levels, but also trade at the same forward multiple. MLCO’s Macau exposures are more substantial at 80% instead of 60% and this is the most beleaguered region right now that detracts from an investment case and from revenue recovery forecasts. On these forward EBITDA figures, the companies are evaluated at the same multiple. We believe Macau is a more threatened region due to political factors, and a greater exposure to them probably deserves some kind of discount. However, accounting for the major opportunity in Cyprus, where LVS’s foray into Japan remains unrealised, the discount can be reversed since the company can concretely exceed by 30% its 2019 normalised levels of EBITDA. With LVS being a little more static, essentially a 30% discount for the 20% extra Macau exposure is being implied. Overall, it plays just as well as a reopening play as LVS, and perhaps with a more under-the-radar Cyprus exposure giving it the edge on a gaming reversal, where its discount might be a little overdone. While a risky investor would be alright with such an exposure, the reliance on more broad-based tourism at the resorts, depending on economic prosperity, worries us at the moment given the rate hikes as opposed to online gaming or regional casinos in the US like Gaming and Leisure Properties (GLPI). As such, we pass, but remain followers of the story.