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FALLS CHURCH, Va.–Colonized by the Portuguese in the 16th century, Macau was the first European settlement in the Far East. On 20 December 1999, Macau became the Macau Special Administrative Region (SAR) of the People’s Republic of China, based on an agreement signed by China and Portugal on 13 April 1987.

Macau covers a small area of 28.2 square kilometers (10.9 square miles) and is comprised of the Macau peninsula and the islands of Taipa and Coloane. Like Hong Kong, Macau has its own governor/chief executive and its own currency, the pataca (MOP), which is linked to the Hong Kong dollar at a rate of MOP1.03 per HK1.

Macau is in the midst of transformation on a huge scale that started with the liberalization of the gaming sector in 2002. GDP has been growing at a compound annual rate of 19 percent, and if it continues, Macau’s economy would reach USD30 billion by 2010.

Although Macau will experience boom and busts periods–some of them severe–it will ultimately become one of the premier mass-entertainment destinations in Asia. This is just one more aspect of Asia’s evolution into the major engine of global economic growth. The Macau story is a long-term bet, but it’s worth the risk.

China’s growth has been mainly responsible for Macau’s good fortune. The rise in income and the Chinese government’s decision to allow an increasing number of tourists to visit has given the city’s economy a huge boost. Keep in mind that until the summer of 2003, mainland Chinese were only allowed to visit Macau and Hong Kong on business visas or group tours. The change in regulation has led to an explosion of mainland Chinese visitation growth (see the chart below).

visits

Source: Macau Statistics & Census Service

It’s been estimated that capital investment will reach USD15 billion by 2010, as Macau completes the first phase of its economic development. The building of new casinos, apartment complexes and other infrastructure-related projects will be the main contributors.

The casinos being built in Macau are as good as–in some instances better than–those in Las Vegas. Casino developers have been paying top dollar to ensure that their investments will help Macau become an entertainment magnet in Asia. Consider that Wynn Macau cost USD700 million, the Grand Lisboa USD400 million, the MGM Grand Macau USD1.1 billion and The Venetian Macau USD1.8 billion.

Investors are willing to put this kind of money on the table not only because of huge potential returns but also because Macau is already the largest and fastest-growing gaming market in the world. Last year Macau recorded total gross gaming revenue (GGR) of USD7 billion, surpassing the Las Vegas strip in absolute numbers for the first time ever (see the chart below).

revenue

Source: Macau Statistics & Census Service, Nevada Gaming Commission

And although gaming will continue to be the main revenue driver for some time in Macau, casino developers have realized that for Macau to become the ultimate destination for a full entertainment experience in Asia, they need to follow the Las Vegas model.

Offering world class entertainment, luxury accommodation, gourmet cuisine, state-of-the-art convention facilities and high-end retail shopping will become extremely important. Note that growth is already being seen in these areas–retail sales, for example, have grown by 19 percent per year during the last four years.

It will take a while for Macau to realize its full potential. There will be many challenges along the way and spirits will run low, as they do during slow economic times in Las Vegas. But as long as China’s economic development continues, Macau will be one of the main beneficiaries of the rising wealth of the Chinese middle class. It won’t be a smooth ride, but it should be a rewarding one.

Pure Exposure

The only pure Macau gaming company listed in the US is Melco PBL Entertainment (NSDQ: MPEL), which debuted here in December 2006.

Melco PBL is a joint venture (JV) between two prominent Asian gaming/entertainment companies, Hong Kong-based Melco and Australia-based Publishing & Broadcasting (PBL). The JV was formed in 2004 and was set up exclusively to develop and operate casino gaming and entertainment resorts in Macau. Each partner owns 41.3 percent of Melco PBL, while 17.4 percent is the public float.

Melco, listed on the main board of the Hong Kong stock exchange, is an established company with interests in gaming, information technology and restaurants. Most important, the co-chairman and CEO of Melco PBL is Lawrence Ho, son of Stanley Ho, the man who monopolized casino operations in Macau for forty years.

Lawrence Ho was able, through his extensive business relationships, to secure Melco PBL’s initial interests in Macau and is expected to play an instrumental role in managing relationships with local players at every level of the industry.

On the other hand, PBL is Australia’s largest publicly listed diversified media and entertainment company. PBL owns and operates two casinos in Australia, the Crown Casino Melbourne and the Burswood Casino, near Perth. It brings to the table solid experience in developing and operating casino resorts. PBL is also expected to contribute to branding and marketing and to provide access to its international clientele, particularly in the Asia region.

Melco PBL has one of the most-balanced product portfolios among the six main players in Macao. The company’s strategy is to be a force in every level of the business, capturing important market share in every segment.

Its first casino project, the Crown Macau, is a five-star, high-roller-focused casino scheduled to open in April 2007. The casino will have 168 mass market tables, 52 high-roller tables and 520 slot machines. It will also have 184 deluxe hotel rooms, 24 high-end suits and eight villas. There will also be a number of fine dining restaurants.

crownmacau

Source: Melco PBL

The second project, the City of Dreams in Cotai, aims at being the “must-see” underwater-themed casino in Macao, catering to leisure tourists, conventions and mass-market customers. The location of this project– between the two anchor properties in Cotai, the Venetian and the Wynn Cotai–is superb (see the map below).

macauX

Source: Las Vegas Sands, SRI

The City of Dreams will feature an underwater-themed casino with approximately 400 mass-market tables, 50 high-roller tables and 2,500 slot machines. There will be four luxurious hotels at the City of Dreams with a total of approximately 1,600 rooms. The complex will also feature a performance hall that will be designed and built to the specifications of Dragone, the producer of the “Cirque du Soleil” and “O” shows in Las Vegas, and will provide daily performances at the City of Dreams in the future. The City of Dreams will also feature an upscale shopping mall of 50,000 square feet and a wide variety of mid- and high-end food and beverage outlets.

Melco PBL’s third project in the Macau Peninsula, scheduled to commence operations in 2009, will be close to the Sands Macao and will target the hard-core, day-tripper mass market. Day-trippers still account for about 50 percent of total visits to Macau. The company is currently exposed to lower market segments through its Mocha Clubs, which feature high-tech machines that imitate the real gaming experience closely but at a much lower minimum bet. Melco PBL has agreed to operate, for a fee, the casino for a new mass market-focused project to be owned by another company.

Note also that there will probably be changes to Macau’s tax structure, but any revisions will most likely enhance to bottom lines for casino operators. The current gaming tax rate in Macau is 35 percent on GGR, plus an additional 3 to 4 percent of GGR for social welfare contributions and other surcharges. That makes Macau’s the highest gaming tax rate among all gaming markets.

Industry sources indicate that Singapore’s government intends to charge only 5 percent of GGR from high-roller tables and 10 percent of GGR from mass-market tables from its future casinos as it continues to reposition itself as the place to live, work and have fun in Asia (see SRI, 11 October 2006, Testing…Testing). Macau will most probably consider a lower rate too, given the intense competition among Asian countries.

I’m adding Melco PBL to the Alternative Holdings Portfolio as a long-term (and volatile) play on what could be one of the most-interesting investment stories in the world during the next five years. Buy Melco PBL.