Gaming Changer

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If nothing else, arrests in China will dent Crown Resorts VIP revenue but has the stock, and sector, been oversold?

– Arrests not unprecedented
– VIP turnover to be impacted
– Crown share price plunge too extensive
– Star, SkyCity also oversold
 

By Greg Peel

It is illegal to promote gambling in mainland China but it is not illegal to promote tourism to a destination where gambling is promoted. Given eighteen employees of Crown Resorts ((CWN)) have been arrested in China for “gambling crimes” related to marketing, one might presume Crown may have strayed a little too far into this rather grey area.

The arrests are not without precedent. In June 2015, employees of South Korean casinos were arrested under similar circumstances.

Credit Suisse makes the point that the Crown employees arrested are only “suspected” of gambling crimes. This is important, the broker believes, in regard to how Australian regulators might react were a crime actually committed. Australian casinos promote “junkets” to the Chinese.

South Korean casinos no longer do.  After the 2015 arrests, South Korean casinos pulled all their marketing staff out of China. Star Entertainment Group ((SGR)) has temporarily pulled out the few staff it has in China in the wake of the Crown arrests.

In the quarter after the 2015 arrests, the VIP revenues from China for South Korea’s Paradise Casino fell 33%, Morgan Stanley notes. However in the quarter before, they fell 25%, so Morgan Stanley is calling only an incremental net 8% fall. Yet the Paradise share price fell 24% in the month after the arrests. VIP accounted for 87% of revenue.

But actual junkets – marketed in China – represented only 10% of all revenues, with the other 90% being direct business. So it’s all a bit messy in terms of what the true impact might be.

Credit Suisse believes Crown will at least suffer a reputational backlash in the near term as players and junkets avoid the group’s casinos temporarily, ahead of a multi-year recovery. Crown will probably have to adjust its operations in China, offering up liquidity risk. The broker now sees the group’s leverage ratio peaking at 3.0x, above the 2.5x required to maintain an investment grade credit rating.

The broker forecasts a 15% in VIP revenue and lowers its target on Crown to $12.30 from $13.00, retaining a Neutral rating.

Citi views the arrest as disruptive to Crown’s VIP business over the next 12-18 months. The broker has lifted its forecast decline in VIP revenue in FY17 to 8% from a previous 3.5%. This leads to a target price drop to $15.10 from $15.35 and a retained Buy rating. The 14% plunge in Crown’s share price yesterday affectively wipes out all expected VIP revenue, Citi notes.

Deutsche Bank has cut its target to $13.75 from $14.35 but on the share price reaction, upgraded its Crown recommendation to Buy from Hold. The broker believes Crown’s VIP turnover will reduce by 20% in FY17 as Chinese turnover falls 30%. Yet the share price reaction equates to a 70% loss of VIP revenue and a 100% loss from China, the broker calculates.

Deutsche notes that aforementioned South Korean casinos suffered a 17% net decline in VIP turnover and a 31.5% reduction in Chinese VIP turnover in the twelve months following the arrests.

Deutsche believes Star Entertainment will suffer a 25% decline in VIP revenue in FY17 with a 30% decline from China. The broker estimates VIP represents 14% of group earnings and China accounts for 80% of VIP turnover. Junket operators and players will be less inclined to travel to Australia, Deutsche suggests, while investigations are ongoing.

The broker has cut its target for Star to $6.25 from $6.50 and retains Buy.

Credit Suisse also had a $6.50 target for Star and has not made any adjustment. The broker retains Outperform.

Morgan Stanley suggests yesterday’s 5% in Star’s share price and 4% for New Zealand’s SkyCity Entertainment Group ((SKC)) mean a worst case scenario has already been priced in.

Morgan Stanley, too, has a $6.50 target on Star, and an Overweight rating. Indeed, Star is one of a handful of stocks in the FNArena database that presently has a full suite of Buy or equivalent ratings from each covering broker, albeit not all database brokers have updated their view post the Crown arrests.

The same applies for Crown itself. Following the Deutsche upgrade, Crown currently attracts three Buy and three Hold ratings. We will await further analysis and potential changes from brokers yet to report.

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