Crown’s reputation in China has been tarnished following the detainment of 18 employees including Executive VP of VIP International, Jason O’Connor. The share price reaction to this news was swift and brutal, falling around 15% over the last week. News such as this often creates panic in the market as investors clamour to protect their capital against further possible downside. Sometimes this reaction is warranted but sometimes, it is not. We feel Crown’s current predicament falls into the latter, and therefore represents an opportunity for value investors.
To provide some context, roughly one third of Crown’s revenues are generated from International VIP, of which less than half is from visitors from Mainland China. As a result, it would seem that around 12% of earnings are at risk. However, upon closer analysis we have concluded that the junket channel, which makes up ~60-70% of this segment’s revenues, is not at risk and that only the direct marketing channel, comprising the remaining 30-40%, is at risk. On this basis, current concerns relate to just ~5% of CWN’s total revenues and less at the profit line, which could be closer to ~2-4%.
Factoring in these assumptions, our valuation has fallen ~$0.30 to $13.71 in FY17. We value CWN using a sum-of-the-parts valuation, which splits the International and Australian businesses, as well as the forthcoming REIT to be spun out of CWN next year. Given the impact on the Australian business’s earnings is currently unknown, we have increased its required return until these issues are resolved. Outside of this, there have been no changes to the valuation.
Figure 1. Crown’s three distinct businesses following the proposed spin-off
As David Walker recently mentioned in his model portfolio update, recent history could provide a guide as to what happens next. In June 2015, 13 gaming managers from Korean casinos and 34 of their Chinese agents were arrested in China for allegedly marketing foreigners-only casinos in South Korea to Chinese gamblers. In the next quarter, Chinese VIP turnover fell 46% with total VIP turnover down 29%. Over the subsequent year, Chinese VIP turnover declined 32% with total VIP turnover down 17%. These effects are material but remember, any such declines would only be applied to around 5% of CWN’s total revenues. This obvious question in our view is whether a $1.4bn decline in the market value of the business is justified by the possibility of a $20 million decline in net profit.
We believe the answer is no but once again this issue does highlight the perils of operating in China, where political risk is heightened. With Chinese tourism into Australia remaining one of the most exciting themes in the market, this is an important point for investors to remember.
CWN also recently had its AGM, at which time it updated the market on its performance since June 30. We have included a summary of the update below, which was generally in line with our existing forecasts.
Figure 2. AGM market update – summary