Take a punt on Macau’s casinos

This week I have a rather speculative funds idea that plays on the broader theme of emerging markets, and China in particular. Over the medium term, I'm as wary as any of the China bears about the country's massive increase in credit and lending. But for now, the country seems to be in half-decent shape.

I make no comment about the current leadership and its partisan attempt to clamp down on corruption and political rivals. However, one concrete effect of this crackdown is that there's been a huge state push to curb the VIP gambling that was once the mainstay of China's version of Las Vegas Macau. The net effect is that Macau has been knocked for six its GDP in the first quarter of this year shrunk 11% from the previous quarter. That's a big number for a small place.

The former colony now needs to base its economy on a new mass-market casino business model. The good news is that there are six new casinos that have already opened, or are in the process of opening, for business. Mass-market gaming now accounts for 46% of total gaming revenues, compared with 26% five years ago. Sands China, one of the largest firms, revealed that its VIP segment now generates a relatively low 10% to 12% operating margin compared with 40% or more from its mass-market segment. These big new all-inclusive casinos need lots of staff collectively 40,000, according to one report and consequently new residential property will be required to house them.

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This is where my speculative idea comes in London-listed investment trust Macau Property Opportunities (LSE: MPO). MPO has been on the market for quite a few years now, promising a pot of gold for those investors patient enough to wait for the coming bonanza in new residential property. Unfortunately, the corruption clampdown dampened spirits and London-based investors abandoned any fund or stock that seemed hard-wired into China's vast debt-based property system. MPO's shares have dived, and even though they are up 38% in the last three months helped by a plunging pound they are trading at a discount of 28% to net asset value (NAV).

The fund's managers have recognised that they can't just keep promising future profits and have switched to realisation mode selling down key assets and returning money to shareholders. The fund started off with seven properties and is now down to four. We should expect most of those remaining assets to be sold over the next few years.

If the new mass-market casinos build up steam and I think there's a good chance of that happening property prices might increase. But we probably won't get much sense of the turnaround for at least six to 12 months, so investors should keep a close eye on the share price of Macanese casinos, which have mostly recovered the last 12 months' losses.

The good news is that even if property prices don't budge, this fund has a buffer in that 28% discount to NAV. We might see that gap narrow over time, depending on how much MPO can actually get on the open market for its last four assets. My hunch is that even in a scenario where prices don't move, we probably wouldn't see much more than a 5% hit to NAV if the managers took a lower offer.

The downside risks are not inordinately huge, though they are not insignificant, given how volatile Chinese stockmarkets can be. Still, I think the chance of a 25% to 35% uplift from here in the next two years is a possibility, which isn't a bad possible return, given how expensive developed-world markets are at the moment.