Is MGM Resorts Making a Big Mistake in Cotai?

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Originally scheduled to open in 2016, MGM Resorts' (NYSE: MGM) new integrated resort in the Cotai district of Macau saw its debut pushed back once again after a typhoon swept through the region in August, causing $2 billion in damage to the gambling enclave's infrastructure.

But even with the opening now scheduled for January 2018, things don't look the best for the MGM Cotai as it's going to open with no VIP gaming tables.

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The rise, fall, and rise of VIP gamblers

Following a crackdown on corruption and money laundering through Macau, the region suffered through two years of falling gambling revenue, only to stage a dramatic comeback last year on the rising fortunes of Cotai. New resorts opened by both Wynn Resorts (NASDAQ: WYNN) and Las Vegas Sands (NYSE: LVS) turned the tide and sparked a return of VIP gamblers, who had gone into hiding as Beijing closely scrutinized operations on Macau.

In Sands' second-quarter earnings report, it noted Parisian Macao had become a "must-see destination" and the Cotai resort was delivering sequential growth in hotel occupancy, average daily rates, and gaming volumes. The Parisian's mass win per day of $2.44 million was the highest since the casino opened last year.

Similarly, Wynn has experienced growth with the Palace, though its results were more muted because it is still mired in a construction zone that makes getting to the resort difficult. Chairman Steve Wynn called it a "handicap" it has to deal with and it is one that may not get resolved until next year.

The common denominator across all Macau properties regardless of their location was the strength of the VIP gambler. According to Macau's Gaming Inspection and Coordination Bureau, VIP baccarat play accounted for almost 58% of the enclave's total gambling revenue in the third quarter. It represented 52% of total gaming revenue in 2016.

High-stakes baccarat is the preferred game of China's wealthiest gamblers and is considered a proxy for strength of VIP play.

Putting their cards on the table

These high rollers are brought in by junket operators who serve as middlemen between the gambler and the resort. Plying VIPs with perks and loaning them money to gamble, the junket operator earns a percentage of the money they drop at a particular casino.

Sands noted its second quarter was marked by particularly strong performance in the VIP gaming segment, where rolling volumes increased by 29% over the year-ago period. Rolling volume is the amount of chips wagered and dropped at the table by the VIPs.

Even with its construction difficulties, Wynn said the Palace opened strong with VIP gamblers, and that has only grown as time has gone on it said, noting the junket business has been significant for three straight quarters.

And that's where MGM is going to make a huge mistake. When it opens the MGM Cotai, it is going to do so without any VIP gaming rooms. It has already missed out on so much of the business that has come roaring back to Macau because its resort's opening keeps getting delayed, but now it is going to open without the thing driving its rivals' success.

A serious miscalculation

It should be noted that when Beijing allowed for expansion in Cotai, one thing it wanted was the district to be geared more toward a mass-market audience. It wanted a place where families from the mainland could go for entertainment, a theme-park-like atmosphere, and the resorts responded.

That's why you'll find a half-sized replica of the Eiffel Tower at the Parisian as well as a figure-eight Ferris wheel and a Batman 4D roller-coaster ride at other resorts. Wynn went in a slightly different direction, choosing to put in high-end retail outlets rather than theme park attractions, but it does have a gondola sky lift that offers spectacular views of the city.

What's disturbing about MGM's decision to not have VIP gaming is that it has been tried before, and failed. When Melco Resorts & Entertainment (NASDAQ: MLCO) opened Studio City, it also swore off the VIP angle, betting on the mass market for its success. Unfortunately, although the mass audience is more profitable than VIPs, the latter's higher volumes are more sustainable for a resort and Melco quickly backtracked and added VIP gaming tables. Since doing so its performance has rebounded.

Having spent $4 billion on the new resort, MGM Resorts needs to get the Cotai casino opened, regardless of the market it caters to. As Melco showed, such things can be adjusted if necessary. Still, it's a big mistake the casino operator is making at a time when the resort is becoming an albatross around its neck.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.