Melco International wins on deals but faces hurdles

PUBLISHED : Monday, 07 April, 2008, 12:00am
UPDATED : Monday, 07 April, 2008, 12:00am

Just a few years ago, Melco International Development was losing money and its principal asset was Stanley Ho Hung-sun's 30-year-old Jumbo Kingdom floating restaurant anchored in Aberdeen.

Today the company is controlled by Mr Ho's 31-year-old son, Lawrence Ho Yau-lung, and boasts a market value in excess of HK$13 billion, bolstered by a deal-making bonanza last year that added to its portfolio of businesses ranging from ski slopes on the mainland to slot machines in Southeast Asia. This is, of course, in addition to its most prized asset - a 37.85 per cent stake in Nasdaq-listed Melco PBL Entertainment, a gaming joint venture with Australian billionaire James Packer.

Despite the traditional conglomerate model characterised by sprawling but disjointed investments having lost some of its lustre among investors in recent years, Melco International recently started to bill itself as a 'new generation Asian conglomerate'.

Whatever that means, it appears to appeal to investors. Of the 11 analysts that cover the stock, 10 rate it a 'buy' and one a 'hold'. On average they target a share price of HK$14.48, implying a bullish 29 per cent upside from Melco International's closing price of HK$11.24 last week.

Melco International now trades at 38 times projected earnings - a slight discount to Macau gaming rivals Las Vegas Sands Corp and Wynn Resorts, but a premium to Galaxy Entertainment and MGM Mirage.

A closer look at Melco International's results, however, suggests it has a lot of work to do before most of its recent acquisitions become positive contributors to core earnings.

Net profit last year slipped 5 per cent to HK$2.69 billion, down from HK$2.72 billion a year before, but the figure was more than double the company's total combined net income for the decade to 2005.

The numbers look less impressive when you consider that exceptional gains amounted to HK$3.19 billion last year and HK$3.01 billion in 2006.

Citigroup analyst Anil Daswani estimated the company's core loss widened to HK$507.47 million last year from HK$182.93 million in 2006.

In short, Melco International's shopping spree in the past two years has seen it flip mostly money-losing businesses on to other listed firms, usually in exchange for equity, turning the targets into associates and jointly-controlled entities and booking sizeable one-off gains at the holding company level in the process.

While an unsustainable way to generate profit, this flurry of deal making has helped the company to build a small empire in a hurry. Now that the dust appears to be settling, investors would do well to re-examine post-restructuring prospects for Melco International.

At the moment the biggest bets are being placed on the success of Melco PBL and the turnaround of its debut casino hotel, the US$583.6 million Crown Macau.

Opened in May of last year, the Crown had the roughest start to date among recently opened resorts in Macau. During its first full quarter of operations, the property actually reported a loss before interest, tax, depreciation and amortisation - something unseen at the Sands, Wynn, Galaxy Starworld or Venetian.

A run of bad luck was partly to blame: from May to December high rollers at the Crown won more bets than the company expected they would (the casino won back 2.3-2.4 per cent of VIP gambling chip sales each quarter, compared to an expected 2.7 per cent). But the larger problem was that the property failed to drum up business.

That issue has been resolved, and the Crown has made a dramatic turnaround in the first quarter of this year following a December deal with locally listed A-Max Holdings to drive more VIP players to the property in exchange for paying a higher commission to A-Max's junket promoter.

The Crown claimed an 18 per cent share of Macau's casino revenues during the first quarter, up from around 6 per cent in November, according to analysts.

At the same time the casino's luck finally turned and it won a better than expected 3 to 3.2 per cent of VIP chip sales during the first two months of the year, according to Deutsche Bank analyst Karen Tang.

What that translates into for Melco PBL is a projected US$70 million in first quarter ebitda, according to Ms Tang's top-of-the-range estimate - still trailing larger rivals Las Vegas Sands and Wynn Resorts in absolute terms, but a huge improvement from last year's losses.

But with the Macau gaming firm now on track, the holding company has new hurdles to clear as it attempts to turn around a slew of new ventures that have recently been added to its stable.

In addition to its acquisitions, Melco International sold down an additional 4.49 per cent stake in Melco PBL via a January greenshoe option and a November placement that amounted to a gain of HK$1.54 billion for the holding company, but decreased its stake in the casino unit to 37.85 per cent. Its stake in brokerage Value Convergence was likewise reduced to 43.5 per cent, down from 63.39 per cent, following two share placements in July and September that raised a combined HK$367.6 million in gross proceeds.

All this apparently was just a warm up, and this year is set to bring 'a quantum leap forward', according to BNP Paribas analyst Chris Zee. Investors had best hang on to their hats.