Is This Tiny Island a Threat to Macau Casinos?

Shares of casino operators with ties to Macau were sent lower after news surfaced recently that hotels on the tiny Chinese island of Hainan might begin offering low-stakes baccarat.

Where blackjack and poker are the preferred card games in Western casinos, baccarat is the favorite among China's VIP gamblers. And because Macau is the only place in China where gaming is legal, some believe that allowing it anywhere else will siphon off high rollers, which will hurt casino companies like Las Vegas Sands (NYSE: LVS), Melco Resorts & Entertainment (NASDAQ: MLCO), and Wynn Resorts (NASDAQ: WYNN), which all derive the bulk of their revenue from Macau.

But the fears look to be overblown because any low-stakes games on Hainan wouldn't be attractive to the VIPs the casinos count on, and the volume of gaming would likely be a tiny fraction of the $32 billion Macau generated last year.

Penny-ante gaming

The sudden interest in gaming on Hainan, often referred to as "China's Hawaii," is a result of a court decision that permits it. Mangrove Resort had been offering such entertainment, but four years ago it was shut down by the police. The court ruling now says such games are permissible, which led many to believe that Hainan could become a new gaming destination.

Yet some analysts also believe the Chinese government won't allow Hainan to establish full-fledged casinos because they are still forbidden beyond Macau's confines by the constitution. The games that the Hainan hotels will offer are reportedly prize-based -- the bets are in real money, but the payouts are in resort amenities and other prizes -- so they are considered for entertainment purposes only, which apparently does not conflict with the law.

Although Macau saw gaming revenue surge nearly 20% last year, the region is still subject to wild swings as doubts still swirl over whether the Chinese government will crack down on gambling in the region again. The last time it did so, Macau went into a two-year slide that it only managed to climb out of last year.

And because Beijing also directed that Macau casinos should not be overly reliant upon VIP gamblers, the Cotai district of Macau was created with a mass audience in mind. The idea was to make it more family-friendly. Melco's City of Dreams added theme-park-style attractions, and Sands Parisian casino opened with a miniature Eiffel Tower. Wynn has a gondola ride with views of the city, and luxury shopping.

A nonstarter

The Macau casinos are still on tenterhooks. The possibility of a new site that might siphon off mass market gamblers is seen by some as potentially ruinous, but analysts at the advisory firm Union Gaming are dismissive of the threat. The hotel-based gaming operations, they say, represent "no threat to Macau from virtually any point of view (quality, scale, amenities, culture, experience, luxury, customer service, and most importantly, true gambling)."

It was also pointed out that one of the benefits Macau offers the mass market is a convenient location, which Hainan doesn't have. So even if casino gaming were legalized on the tiny island, it would still be an inconvenient destination for most people.

While VIP gamblers might be swayed to go there, thus providing some risk to other casinos, it would be negligible since only a very small handful of casinos might open on Hainan, versus the more than 40 casinos that operate in Macau.

The stocks of the casino operators have recovered only a little bit of their losses brought on by the initial news. But the real insight from all this is just how sensitive the Macau region is to any inroads that might be made into its dominance. The latest figures for last month's gross gaming revenue were below expectations, which caused casino stocks to fall.

Although legalized casino gaming in Japan is still a few years away, and its prospective size has been greatly diminished from what was originally thought, it may be the real threat to watch.

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