Is There a Ticking Time Bomb on Macau's Casino Industry?

By Markets Fool.com

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Las Vegas Sands' Venetian Macao resort has been a profitable venture for the casino operator, but there's the possibility that a looming deadline will run the canals dry. Image source: Venetian Macao.

Las Vegas Sands (NYSE: LVS) just reported earnings that -- although showing that profits slid hard in the second quarter -- saw mass market gaming revenues rise for the first time in two years, giving everyone hope the Macau casino market had finally reached bottom. After 25 straight months of declining gaming revenues, maybe casino operators could expect an upturn in the near future.

That's possible, though with three new mass market casinos scheduled to go live over the next few months, Sands, MGM Resorts (NYSE: MGM), and Wynn Resorts (NASDAQ: WYNN) may instead find themselves scrambling to attract a finite base of customers. Worse, investors in the casino operators may not be aware of what could be a ticking time bomb in the Chinese gambling oasis, one that's set to start going off within the next four years and could undermine whatever profits the gambling houses are generating.

Making something out of nothing

When Macau was opened to gambling competition in 2002, breaking the stranglehold that Chinese billionaire Stanley Ho had held on the casino market there for 40 years, the government put up for bid three concessions that saw SJM Holdings (NASDAQOTH: SJMHF) and Wynn Macau easily win two of the licenses. A feud between Las Vegas Sands and Galaxy Entertainment Group (NASDAQOTH: GXYEF), however, almost caused both to lose the chance to operate a casino on the island. In the end, the Macau gaming commission made a Solomon-like decision to split the concession in two, awardingGalaxy theprimary one and giving Sands a sub-concession. Two years later, Sands Macau opened, and Galaxy's first hotel-casino, Star World, opened in 2006.

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Having thus created something out of thin air, the gaming commission went on to create two more sub-concessions, one each for the licenses held by SJM and Wynn. The former ended up partnering with MGM, while the latter hooked up with Melco Crown Entertainment (NASDAQ: MPEL). Today, these are the only six casino operators allowed to operate in Macau, and they're developing the island at a breakneck pace.

Riding the Cotai-tails

At the end of 2015, there were 35 casinos in operation,and the newest tract being built up is, of course, the Cotai strip -- the spit of land that is under orders to become a family-friendly destination spot within the next five years. Next month the Wynn Palace mass-market oriented casino is expected to open, followed by Sands' Parisian Macao, and the MGM Cotai thereafter.

The casino operators, though, have been suffering from a corruption crackdown by Beijing that has snared several junket operators -- the middlemen on whom the casinos rely to fly in VIP high rollers and loan them money to gamble. Amidst the crackdown, a softening Chinese economy, and the rise of nearby gambling locales, gaming revenues have been on a steady track lower, though the decline appears to have all the earmarks of easing.

While that suggests that a turnaround is possible, it might not come soon enough to save the casino operators, as the concessions -- and sub-concessions -- all came with a 20-year expiration date. That means that beginning in 2020, SJM and MGM will be up for renewal, followed in 2022 by Galaxy, Sands, Wynn, and Melco.

Although it seems quite likely that the original concessionaires will win renewal because their licenses were legally and competitively bid on, the sub-concessions that were created by regulatory fiat without any public input may have a tougher time gaining approval.

Doubling down on a reup

According to a report in Macau Business Daily, analysts at Japanese brokerage firm Daiwa Capital Markets believe changes may be coming. For example, it's quite possible the length of concessions may be shortened considerably from their current 20-year length, and there may be a public outcry over the sub-concession holders' continuing to own them.

While the brokerage finds it difficult to imagine any of the sub-concessionaires being stripped of their licenses because of the substantial investments they've made in Macau, there are no certainties, and it's an unknown risk for the operators -- a potential time bomb whose fuse is quickly burning down, blowing up any recovery that may be under way.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.