Casino junket stocks much the same as playing slot machines
Junket stocks are profit sharing agreements that don't disclose their trading terms with casinos and clients, raising the risk for investors
Casino junket stocks are steaming hot. After all, Beijing's anti-graft campaign doesn't seem to have scared many high rollers into retreat and the stakes wagered on Macau's gaming tables have continued to multiply.
Before making a bet, however, you must understand there isn't really too much difference between the junket stocks and slot machines.
Without exception, what is listed as a junket stock is not the junkets themselves but a profit-sharing agreement with them.
This is how it is done. The junket signs a piece of paper with a shell company promising to share a certain percentage of its profit from bringing in high rollers and providing them with loans. The shell company is sold to the listed company in return for money or shares and gets a backdoor listing.
This is the only way that a junket business can gain access to the image, bank loans and business opportunities that come with listed status.
Other channels, such as a genuine listing, are a no-no for a junkets for many reasons other than concerns about money laundering.
The first is ownership. Most junkets operate under some sort of informal partnership. For those who have a formal structure, the so-called shareholders are largely "front men". The genuine owners are difficult to identify and verify as being fit for a listing exercise.
Second, there's the business. Company filings describe junket business as "activities undertaken to promote casino games by way of offering transportation, accommodation, food and beverage and entertainment in exchange for a commission".
Imagine detailing "entertainment" under the "our competitive strength" heading in the prospectus. But that may be easier than disclosing their trading terms with casinos and clients, because a third problem is the numbers.
Junkets deal with their customers and casinos mainly on casual terms without documentation. How about asking a mainland mayor who has just lost a small fortune on the baccarat table to sign a loan agreement with a specific interest rate and maturity before giving him more money?
Even if the junket produces a written agreement, how can an auditor possibly verify all that cash in such an opaque business?
That brings us to the fourth challenge; the customers. Does anyone honestly think a mayor would sign a letter sent by an auditor to confirm that he has borrowed millions from a junket operator? But without customer confirmation, how can a junket get an audited financial statement?
All of these issues are conveniently swept under the carpet by the profit-sharing arrangement because the listed firm only has to explain the business and financials of the shell company that is holding the agreement and which it is investing in.
In most of the profit-sharing agreements, investors are only told about the tally and growth of bets placed and the number of gambling tables. Important basics such as who runs the junket and on what terms are missing.
What kind of risk and rewards assessment can one possibly make from this flimsy information?
Some may say why bother as long as the money keeps flowing in. Hasn't tycoon Cheng Yu-tong's International Entertainment recently signed a preliminary agreement to give a junket HK$7.35 billion in return for a 70 per cent interest?
They should not forget the cautionary tale of Amax International.
Amax loaned HK$1.9 billion to a junket in return for a so-called profit-sharing arrangement in 2008. The newly opened junket recorded an impressive tally of HK$56 billion in bets in its first 45 days of operation and Amax's share price rose sixfold.
Yet, within a year, the investment turned sour. The junket's collaborators circumvented the original co-operation model to deal directly with the gaming operator and have also refused to repay the loan.
To be fair, most of the latest profit-sharing agreements come with a profit guarantee, which in the case of First Natural Food lasts until 2029.
The guarantee makes the bets look safe, but in fact they are not.
The guarantee is largely on the profit, not the accounts receivable. Yet, a major issue for junkets is collecting debt from gamblers. In 2010, Sino Credit sold a profit-sharing deal with a junket because of the latter's rising unpaid debt. It lost HK$140 million in the deal.
Besides, the penalty for failing a guarantee can be quite meaningless in some cases. First Natural Food issued HK$400 million worth of convertible notes - to be converted into a 99 per cent stake - in return for the junket profit sharing. If it failed, the seller would forfeit the notes and therefore the stake. The problem is the seller is the sister of First Natural Food's major shareholder. Forfeited or not, the control is still in the family.
Now, where are you going to put your money? A junket stock or a slot machine?