High quality gaming

Casino company Crown turned in a creditable performance in 2010 considering the soft consumer spending environment. The Melbourne and Perth casinos increased turnover and operating profit despite substantial refurbishment activity at both properties. Crown is the best run gaming business in Australia by some distance, but we retain some caution around the Macau properties and its influence on the Crown share price.

“In 2009, the total Macau market generated US$14.9 billion in gross gaming revenue, more than double the US$5.6 billion generated by the Las Vegas strip”

Chief executive Rowen Craigie described the 2010 financial year result for Crown as reasonable, considering the soft consumer spending environment and the disruption due to refurbishment of the premises. We think that is perhaps understating the performance of the local properties.

Normalised revenue growth of 5.9% to almost $2.3 billion led to normalised operating profit growth of 6.1% to $657.2 million. Although the main gaming floor earnings weren’t fantastic, they were at least positive. Both the Melbourne and Perth casinos have been undergoing significant refurbishment work that impacted on visitation and spend per customer. This was expected and as the work continues into 2011-12, there will be a drag on operating earnings as a consequence.

Since touching an intraday low of $7.41 on May 27, Crown has rebounded higher, forming a short term uptrend as evident from the higher lows. The upward move saw a break above both the 50 (green line) and 200 (red line) moving averages, which further confirms the change in trend to the upside.

The RSI is weakening, suggesting some short term weakness, which should be met with support at the 50 period moving average at $8.10. Once this corrective move is complete, we would anticipate a continuation of the upward move. This is further backed by the bullish moving average cross in place since mid August, which suggests that momentum favours the upside.

Crown Melbourne

Crown’s capital expenditure program to upgrade its table games, VIP facilities and non-gaming offerings requires a total of $440 million over the next three years.

The VIP facilities will include four new gaming rooms on level 39 of the Crown Towers hotel, replacing the Presidential Villa. The premium Mahogany Room will expand by 50% with 16 new tables installed. A new 5-star restaurant will also be built. All the villas in Crown Towers are to be refurbished and the spa facilities upgraded. A new Gulf Stream jet will be purchased adding to the fleet of corporate jets on offer to Crown’s international customers. This expansion is to cost around $212 million.

In the 2010 year, VIP gaming revenue increased 10.3% to $363.5 million on turnover of $26.9 billion.

When Crown completes the VIP refurbishment, it will make the business very competitive with the new Asian casinos that have been brought onto the scene over the last few years. Crown knows it must maintain parity or better in terms of its offering to remain viable. For now, it is clearly achieving that aim, but the expenditure will ensure that it continues to do so in future.

The main gaming floor at Crown Melbourne grew revenue by 2.5% to $876.8 million. Crown’s deal with the state government last year allows it to increase the number of table games in return for a progressively higher gaming tax rate. Some of the new tables have been allocated to the VIP expansion but the remainder will find space on the main floor.

Crown’s non-gaming facilities are a very important part of the overall offering to customers. In FY10, non-gaming revenue increased 13.5% to $319.2 million, boosted by the March opening of the new 658-room Crown Metropol hotel at the property. Occupancy and average room rate at the three hotels was exceptional and provides an on-going vital attraction to the entire precinct.

Normalised operating profit at Crown Melbourne increased 5.5% to $474.9 million compared to FY09. Reported EBITDA of $540.7 million was $65.8 million higher, reflecting the higher than theoretical win rate of 1.66%. Overall operating profit margin decreased slightly from 30.7% to 30.4% partly due to the higher level of lower-margin VIP revenue and the disruption to the main gaming floor.

Burswood

Crown struck a deal with the Western Australia government during the year to increase the number of gaming machines at the property and to expand the main gaming floor. Gaming machines will increase by 250 to 2,000 and 50 extra table games will increase the total to 200. In return, the WA government will get a $20 million up-front fee and an increase in gaming tax rate from 22% to 27%.

The deal has enabled Crown to go ahead with a $350 million 3-year expansion program at the property. It will include an upgrade to the Intercontinental hotel and the construction of high-roller facilities on the hotel roof. A new high quality restaurant is also being added.

In the 2010 year, Burswood’s revenue from the main gaming floor declined by 0.4% to $396.2 million but increased by 23.2% in VIP program play to $172.5 million on $12.8 billion of turnover. Total normalised revenue increased by 5.1% to $732.9 million. Non-gaming revenue increased 2.9% to $164.3 million as part of that total.

Normalised operating earnings increased 2.4% to $213.6 million but a below theoretical win rate of 1.08% meant reported EBITDA was 11.8% lower at $183.5 million. The theoretical win rate at both casinos is calculated to be 1.35%.

Melco Crown Entertainment (33.4%)

Crown’s investment in Melco contains its properties in Macau. During the 2010 year, Crown’s share of the reported loss at Melco was $63.8 million. On a normalised basis, the loss was $42.7 million.

At the mass market City of Dreams property, quarterly rolling chip volume increased 24% over the previous quarter. A 9% sequential increase in table game revenue was also an encouraging sign. The Altira Macau property is also improving its VIP profitability and has benefitted from the commission cap on junket play.

The entire Macau market is still growing, despite already being the largest gaming city in the world. In 2009, the total Macau market generated US$14.9 billion in gross gaming revenue, more than double the US$5.6 billion generated by the Las Vegas strip. Total gaming revenue in Macau increased 70.3% in the year to July 2010.

Crown’s investment here, although still producing equity accounted losses, will eventually deliver some very big profits. Crown owns a sub-concession (casino licence) as well as its two properties in this massive gaming city. For now, the share price of the listed Melco is not reflecting much more than the existing profile of the business. As a consequence, most valuations of Crown, which also include Melco at its current price, are understating the future potential of the investment.

Financials

Crown’s operating cash flow in 2010 was $467.5 million. Capital expenditure of $342.5 million (mostly for the Crown Metropol construction) left sufficient cash flow to pay $278 million in dividends and repay $200 million in debt. Crown had $196.4 million in cash as at 30 June 2010.

The future capex program is approximately $788 million but can be comfortably funded from operating cash flow and existing debt facilities.

Valuation

We currently value Crown at $8.90 per share reflecting our value of the Crown Melbourne and Burswood casinos based on forecast FY11 operating earnings. We value Melco Crown Entertainment at market value and attribute a nominal value to the Betfair and Cannery investments. All other investments were written down in value in FY09 but we place no value on these.

At the current share price, there is some upside on this basis and substantially more if the potential of MPEL in particular can be realised over time.

The weekly chart depicts the broader consolidation in place between support at $7.44 and resistance at $9.39. A convincing break above the October 2009 high of $9.39 could potentially mark the beginning of a new leg higher. The positively crossed weekly MACD is suggestive of an upward break over the longer term.

For now, we will not be adding Crown to the Fat Prophets Portfolio but will continue to monitor progress of this high quality gaming company.