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Obrigado and goodbye

17 June 2014 By Rob Cox

Spreadsheets with astonishing forecasts can only tell so much about China’s economic miracle. The sole path to believing, or at least comprehending, the scale of the country’s development is to see it. And so it is with any attempt to grasp Macau’s transformation from a Portuguese trading outpost to the Middle Kingdom’s gambling and entertainment hub.

Each year, this territory of about 30 square km a one-hour ferry ride from Hong Kong creates the equivalent of one new Las Vegas in gross gambling revenue. Millions of Chinese mainlanders aspire to visit – not just high-rollers but regular punters and even families. Macau will occupy an important role in China’s cultural and economic future. What’s questionable is whether investors will ever access Macau’s riches to the degree once deemed possible.

How can you be both bullish on Macau and bearish on its investment prospects? Simple: like all things China-related, the primary risk factor is the state, or more aptly China’s Communist Party. And when it comes to gambling, which is illegal in China, it is particularly hard to square Beijing’s goals with a business model where billions of dollars of wealth is transferred into the pockets of a few tycoons in the United States and Hong Kong.

This is not to diminish the scale of ambition and execution taking place on the spit of land first lent to the Portuguese in 1557, which was handed back to China in 1999. While Macau granted the first official gambling monopoly in 1962, it expanded the system to six licensees in 2002, including three American-led groups, Wynn Resorts, Las Vegas Sands and MGM Mirage; and three locals, Melco Crown Entertainment, SJM Holdings (the original monopoly) and Galaxy Entertainment. All have listed their Macau operations on the Hong Kong Stock Exchange.

In the past eight years Macau gambling revenue has surged from less than $10 billion to around $50 billion this year. And there’s more to come. Some $40 billion of capital has been devoted to 14 new developments, largely on the Cotai Strip, a stretch of reclaimed land south of the old colony that is a maelstrom of cranes, construction and Maybachs.

Extraordinary efforts to remove transportation bottlenecks to Macau will ensure the new casinos and hotels are occupied. In 2017, a 50-kilometer bridge will connect Hong Kong’s airport – with its projected 70 million yearly visitors – to Macau and Zhuhai, the city of 1.6 million just over the Chinese border. Pylons of the bridge, which will whisk visitors to Macau in the time it takes to reach the center of Hong Kong from the airport, can be seen poking out of the Pearl River Estuary.

Over the next four years, CLSA projects the authorities will permit the opening of 2,000 new gaming tables in the Cotai casinos, helping push gross gambling revenue above the $66 billion generated in 2013 by all U.S. casinos, to $90 billion in 2018 – and $18 billion of net profit. By that logic, the broker estimates the Macau gambling sector’s market cap can double to nearly $350 billion.

Visiting Macau, it is easy to buy this bull case. The Chinese cultural affinity for gambling is hard to overstate. Underpinning the activity is an extraordinary ambition to become wealthy, which has driven the country’s economic success since Deng Xiaoping expounded on the glories of getting rich. Gaming goes back farther, with archaeological evidence of dice from 600 BC.

The Chinese also hold a strong belief in the powers of good fortune and a fascination with numerology. These come together perfectly on the tables of a casino, specifically in games like baccarat where luck is the sole determinant of success, and turnover is most intense. The game dominates the floors of Macau’s casinos. Indeed, it is harder to find a blackjack or poker table at a Chinese casino than it is to circumvent China’s capital controls.

Which brings us to the risks: Gambling is still a crime in China. Mao Zedong considered it a societal ill and enshrined its prohibition in Article 303 of the Criminal Law of the People’s Republic. China charged nearly 350,000 citizens with gambling violations in 2012 alone, according to OnlineBetting.com.

Squaring this with the idea that Beijing will forever allow casino operators free rein to fleece ordinary Chinese, who will make up the bulk of future visitors to Macau, is hard to fathom. It may not happen for years – the concessions are under review in about five years – but China will eventually exercise greater rights over the winnings at Macau’s houses.

Glimmers of such intervention are already apparent. Chinese visitors are only permitted to take $3,200 a day in cash out of the country. To circumvent this, many purchase expensive watches and gifts from Macau’s pawnshops or jewelers in transactions through Chinese credit-card issuer UnionPay and then convert the goods into cash. A May crackdown on some of these purchases may point to a general change of attitude. Similarly, this week Macau said it will reduce from seven to five the number of days that Chinese visitors with transit visas can stay in the city.

Macau’s supporters argue it offers a “release valve” of sorts, a place where some erosion of capital controls and illicit behavior is tolerated. That made sense when Macau’s visitors were primarily high-rollers, even senior officials, whose trips to Macau could be monitored and catalogued.

It’s harder to accomplish when the new visitor is a family coming in on the high-speed train from Wuhan five hours away. The father may want to gamble $20,000 on sic bo, the Chinese dice game, at the Grand Lisboa while the mother shops at the Galaxy’s boutiques and their daughter wakes up to a “Shrekfast” in her Venetian hotel room. Perhaps they will take in a Canto-pop show as well.

The expansion of this mass market, which is more profitable for casinos because it eliminates middle men known as junket operators, changes the game for Macau and for China. It makes it harder to support a wholesale transfer of wealth to billionaires like Steve Wynn, Pansy Ho or Sheldon Adelson, the Sands mogul who pledged $100 million to Mitt Romney’s U.S. presidential campaign – during which the candidate criticized Barack Obama for not labeling China a currency manipulator.

It won’t happen overnight. And some semblance of the rule of law precludes a Latin American-style expropriation. But a betting man would find favored odds on a long-term erosion of the status quo in Macau for global investors. In the meantime, though, the place will only grow bigger, more garish and more lucrative for some. The trick will be in knowing when to fold.


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