SVA Update – Sino-US tensions – Implications for foreign participants in the Macau gaming sector

The steep deterioration in US China relations, coupled with the savage impact of the corona virus outbreak, pose serious threats to foreign firms engaged in the Macau gaming industry. Investors should be mindful of these new risks.

A grinding halt

Macau’s reliance on gaming and leisure has meant that the unrest in Hong Kong in late 2019, and the spread of the coronavirus in early 2020, have taken a major toll on the city.

Gaming revenues, which rose from USD14.9 billion in 2009 to over USD37.85 billion in 2019, have plummeted. Fitch has predicted a deep economic contraction for Macau in 2020, with GDP declining at least 24% in 2020, and gaming revenues falling by 40%.

The latest signs are negative. Gaming revenues slid by 97% in April 2020, year-on-year, and by 93.2% in May, to just USD220.9 million that month. Revenues have now dropped about 49% in the first quarter.

Now, frictions between the US and China over trade, the pandemic, Hong Kong and the South China Sea pose an additional threat to the industry, not least by overshadowing plans to tender for new gaming concessions.

All bets are off

This changing environment means that the looming end to the current gaming concessions, in 2022, presents a huge vulnerability for those six companies that hold rights to provide gambling services.

Assumptions of “business as usual” are misplaced. After all, Beijing will surely ask whether US-controlled casino companies should profit mightily at the expense of China’s gamblers.

The commercial argument for US involvement – that Chinese companies needed American expertise – is derelict. Macau is now of age; and its casinos and junket promoters can often provide services better geared to the Chinese market than those offered by American companies.

The tender process

Uncertainty about “refreshing” the concessions had already been on the rise. Macau’s new Chief Executive Ho Iat Seng has, so far, promised only to release information in the second half of 2020 – late in the process, given the scale of the investments in play. Moreover, his cryptic comments suggest that the numbers of concessions will not increase – and could fall.

Beijing chose Ho Iat Seng in part owing to his limited links to the gaming industry, meaning that he would prioritise national goals over local interests. Indeed, Ho had already hinted at a brief to clean up the industry, perhaps by trimming the number of satellite casinos in operation, or by rooting out some of the less savoury junket promoters.

This stance had cast doubts on the prospects of large junket promoters securing a concession on their own merits. Now, Ho’s mandate seems liable to stretch to geopolitics.

So what comes next?

The strategic sensitivities will only intensify in the months ahead. Relations between Washington and Beijing show no signs of arresting decline, but rather risk becoming hostage to events. Nasty rhetoric is drowning out calm discourse, and a cycle of tit-for-tat responses may follow.

This descent into acrimony highlights how Hong Kong and Macau sit uneasily on a fault line between great powers. Their locations have, over the decades, facilitated rapid growth in (sometimes ambiguous) commerce. Now, though, living on this frontier represents a huge, strategic vulnerability – and few sectors are more exposed than is Macau’s casino industry.

That exposure stems chiefly from the industry’s longstanding reliance on capital outflows from China; and capital flight could once again become a matter of national security, if international discord affects the value of the Chinese yuan (and, perhaps, of the Hong Kong dollar). Of course, exchange rate instability seems unlikely for now – unless Washington imposes financial sanctions on Chinese entities.

Even so, the regulatory risks facing the casino sector will rise. The authorities seem sure to strengthen currency controls, so as to pre-empt financial turbulence, as in 2012 and 2015; and, in doing so, they will be mindful that independently-positioned companies could hinder efforts to shore up defences.

Implications for concession renewal

In this context, the authorities may gear the tendering process so as to ensure the loyalty of those operating in Macau, perhaps by favouring local champions, or by scaling down the role of foreign concessionaires. Such an approach would be in line with Chinese industrial policy in other areas.

Moreover, should relations deteriorate further, the Chinese and Macau authorities have a wider range of options to hand, ranging from squeezing out foreign interests, to punitive action against US concessionaires.

Certain companies present obvious targets, given links to the Republican Party, while others, perceived as loyal, or, at least, compliant, could benefit – but perhaps at the expense of interests in the US.

For now, direct or punitive action against US companies remains unlikely – but the risk is escalating. After all, a year ago, few would have predicted that unrest in Hong Kong would lead to the imposition of a national security law, nor that relations between China and the US would have degraded so rapidly.

Now, businesses must accept that they are operating in a much harsher political and economic climate, in China and the US alike.

What should investors do?

Companies must evaluate these growing strategic threats, so as to be in a position to mitigate any impact on their investments. SVA advises that companies should:

  • Evaluate geopolitical exposure, so as to identify those companies likely to suffer in the event of a descent into “tit-for-tat” actions – and those likely to benefit. Courting favour with one party may result in disdain elsewhere.
  • Assess statements on tendering, in Macau and mainland China. The pace of change is striking, and political considerations will loom large in any tender.
  • Examine the exposure of particular businesses to sudden changes in the broader market, taking into account business operations, and the structure of the investment/s in question.
  • Monitor enforcement measures on capital outflows, so as to establish whether regulatory action is liable to affect Macau’s casino sector, and, if so, which entities are most at risk.
  • Take stock of the risks posed by counterparties, such as major banks, casino companies or junket promoters, so as to brace for any systemic shocks.

SVA has a great deal of experience examining the gaming sector in Macau, and can assist in any of these, and other, measures.

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