The Sharks Are No Longer Circling




Fairfax was down 8% on Friday, and we will see further selling pressure today. Fairfax will likely test the $1.10 level on the downside today, with traders punting on a higher bid likely to exit the stock. I think Fairfax will find support around this level, and the markets will now refocus on the Domain demerger (which will unlock significant value) and the probable changes to the media ownership laws in August.

This is a stock chart for Fairfax media

Hellman & Friedman didn’t put in a binding bid on Friday (although they wrote a letter saying they had not walked away). TPG though has withdrawn, and also chose not to revise their offer to a lower one. Fairfax CEO Greg Hywood called an end to the private equity process, was reported as saying “Now this distraction is over it is back to business as usual… As you know the bids from the two private equity players were unsolicited.”

It is disappointing not to get a near term outcome on a private equity deal, and crystallisation of an associated premium, however putting the emotion aside, this scenario was not behind our investment thesis. A key driver was the tremendous value in Domain, and I expect we will see an announcement today, that the spin-off is progressing as originally planned. Fairfax will maintain a 60-70% stake, with the remainder going to existing shareholders.

Fairfax is currently capped at around $2.5 billion, and as we said prior to the arrival of private equity bids, Domain is likely to be worth more than that on its own. FY17 EBITDA for the digital unit is set to come in around $120 million, and we can see this growing to $150-$200 million over the next couple of years. Costs are also being taken out on the print side, and we now have media reform much closer than it was when we originally added the stock.

Gaming growth

The positive momentum in Macau’s casino sector continued in June, with casino gross gaming revenue (GGR) rising 25.9% year-on-year to 19.99 billion patacas (about US$2.49 billion). Despite the strength, the figure missed some analyst’s forecasts for a higher tally, but gaming was likely negatively impacted by China President Si Jinping’s visit to Hong Kong towards the end of the month, curtailing some VIP traffic from there to Macau.

VIP play has made a stronger than expected comeback year to date and the split between VIP and mass-market gambling in the second quarter of 2017 is due to be released later in the month.

June was the eleventh consecutive month that gross gaming revenues (GGR) exhibited year-on-year growth and the trend now is undeniably upward after a couple of lean (by Macau’s high standards) year’s. The Fat Prophets Global Opportunities, US and Asian Managed Account Portfolios are all overweight the Macau gaming sector via three Hong Kong listed casino operators, being Wynn Macau, MGM China and Sands China. We also hold Wynn Macau parent and Nasdaq-listed Wynn Resorts in the Global Opportunities Managed Account portfolio.

June’s growth was the highest pace for a year-on-year increase since February 2014. Coming on the back of the strong figures earlier this year, June’s surge in gross gaming revenue pushed year-to-date Macau gross gaming revenue up to 126.4 billion patacas halfway through the year, representing an increase of 17.2% on the comparable period of 2016. That was up from the 15.8% year-on-year at the end of May.

This is a table of revenues from Games of Fortune

Source: Macau Gaming Inspection and Coordination Bureau

We expect to see another strong year-on-year increase in July and August. After that the year-on-year comparisons will start getting tougher as it was late in 2016 that Macau began logging decent year-on-year increases in gambling spending.

That was around the time that some new high profile resorts began opening in the gaming mecca. These included Wynn Palace (from Wynn Macau) and The Parisian (Sands China) which both offer world-class entertainment, dining and hotel rooms.

Wynn Palace, in particular, is performing strongly. The property took some extra market share for both the VIP and mass-market segments in the first quarter of 2017. Volumes (i.e. rolling chip, slot, table drop) ramped up from the December quarter.

This is a stock chart

Wynn has a strong track record with its property openings, putting relatively little marketing spend on new properties until it establishes a baseline strength. The company then has turned these “careful” openings into strong commercial successes.

Although we expect year-on-year growth to begin moderating later in 2017, there is plenty of scope for upside for many years yet. MGM China has a new resort expected to open in late 2017 that will add to the world-class entertainment scene in Macau and additional resorts from other players will join the scene not long after.

Gambling in Macau is still well below peak levels seen in its heyday in 2014 and a shift towards a more family friendly approach will benefit from growth in Mainland China outward bound tourism in the years ahead. China’s outbound tourism is expected to grow at a double-digit pace for many years yet, as the percentage of Chinese with passports is still quite low and spending power of the middle class is growing.

Disclosure: The Fat Prophets Contrarian Fund declares a holding in Fairfax Media, Wynn Macau, MGM China and Sands China.

Carpe Diem!

CEO | Fat Prophets
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