Two years ago, Crown Resorts (ASX: CWN) announced that 18 of its staff working in China had been arrested for breaches of China’s gambling laws. Crown’s stock plummeted, ultimately falling 5% to end the day at $10.42.
VIP visitation to its casinos in Melbourne and Perth also subsequently plummeted, as visitors from mainland China, Hong Kong and Macau steered clear to avoid attracting undue attention from the Chinese authorities.
With a highly indebted balance sheet and substantial capital expenditure planned – including spending $2.2bn on “VIP-only” Crown Sydney (albeit offset by a hoped-for $800m in proceeds from apartment sales) – Crown was forced into drastic action.
Unfortunately, this included the sale of its then 27.4% stake in Melco Entertainment (NASDAQ: MLCO), which owns casinos in Macau and The Philippines.
Although Crown got a decent price for its Melco shares – its stake was sold in stages at between US$16 and US$21.12 per share – the sale was made when Macau was still recovering from a strong cyclical downturn in gambling revenue resulting from the Chinese government’s corruption crackdown.
Moreover, Melco’s 60%-owned Studio City casino in Macau was still cranking up after recently opening, and the same went for its 73%-owned City of Dreams Manila.
So I felt the price at which Crown sold might appear low in hindsight.
And so it has proven.
Melco shares rose to nearly US$33 before pulling back to around US$23 today due to concerns over the falling value of the Chinese Yuan and the ongoing trade dispute between the United States and China.
And after selling its stake in Melco and cancelling its proposed Alon Las Vegas casino, Crown essentially retreated to Australia to concentrated on improving the profitability of its assets here. In particular, the company tried to attract Chinese VIPs back to its casinos.
And its 2018 result suggests it has been successful.
VIPs have returned in droves, with VIP turnover rising 54.5%, to $51.5bn. Most of this increase was at Crown Melbourne.
However, things were more subdued on the main gaming floor, with total revenue rising 1.5%, to $1,681m. A 2.9% rise at Crown Melbourne offset a 2.1% fall at Crown Perth.
Overall, Crown recorded a 11.5% increase in earnings before interest and tax, to $592.4m.
And now that the uncertainty over whether VIPs would return has gone, investors appear more comfortable buying the stock. Crown has risen 37.7% (at the time of writing) from its $10.42 closing price on the day the arrests were announced. With dividends included, this rises to 57.2%.
But with more investors now comfortable owning Crown stock, the risk/reward proposition has also changed.
While ever increasing business and family links between China and Australia and a growing Chinese-Australian immigrant community bode well for Crown and, in particular, Crown Melbourne and Crown Sydney, risks are rising.
These include construction delays and/or overruns on Crown Sydney, and the company not achieving its goal of $800m in proceeds from the sale of apartments in the casino complex.
Moreover, current slow wage growth and rising interest rates could crimp Aussie punters’ discretionary income. And with Crown Melbourne still essentially determining how Crown performs, a material fall in east coast housing prices could also affect the amounts punters lose on Crown’s tables and gaming machines.
So while it is very difficult to pick the top in any stock, I’d recommend shareholders consider selling their Crown shares.
Disclosure: the author owns shares in Crown and intends to sell them.