Special Situations Report: Asia Entertainment & Resources (AERL) -- Taking a closer look at the recent move in a pure play on the growth in the Macau VIP Gaming Market (11.66 +0.10)Asia Entertainment & Resources (AERL) is seeing continued strength this session (+7%) following a 11% pop on heavy volume yesterday. The Casino space is strong today (LVS, WYNN, MPEL, MGM) following positive commentary from JP Morgan. This comes as no surprise. On Monday, the Macau Gaming Board reported December Gaming revenue rose 66% to a new all time record (October was the previous record). After growing at a 30% annual rate since 2002, the Macau market grew 58% in 2010. Growth in the Macau market continues to impress the Street. As such, we wanted to share our thoughts on this little-known pure play on the booming Macau VIP gaming market.
AERL is a VIP gaming promoter at three VIP gaming rooms in Macau. The company has profit interest agreements with each casino and extends credit to its VIP clients. The company promotes a VIP room at the Galaxy Star World and MGM Grand in Downtown Macau and in 4Q10 acquired a 3rd VIP room at the Venetian Resort on the Cotai Strip. Following this acquisition, 90% of revenue comes on a fixed commission basis (as opposed to a win/loss split basis), where AERL's gaming promoters receive 1.25% of the Rolling Chip Turnover (aggregate volume of VIP bets).
Yesterday, AERL popped 10% late in the session on big volume. Last night, Forbes reported that the Chairman of AERL said in an interview that the co aims to double the number of VIP rooms it operates to six.
AERL just acquired its third VIP room in Q4. With only two VIP rooms, AERL reported Q3 revenue +105% to $28.5 mln; with earnings +1850% to $7.3 mln (EPS of $0.40). The earnings would have been higher absent the low win rate at the MGM, where 43% of commission comes on a win/loss rate (creating more earnings volatility).
AERL has guided for FY11 Rolling Chip Turnover per month of $1.15 bln (+32%, annualized), with net income of $55-60 mln (+53%). Using the current share count, (22.5 mln) and the midpoint of guidance, AERL is expected to generate FY11 EPS of ~$2.56, which means AERL is trading at ~5x earnings, with a PEG ratio of ~0.1. We would note that the share count will continue to rise through the dilutive nature of the deal to acquire King's Gaming Promotion (the Venetian Macau VIP room). But, based on November and December's Rolling Chip Volume of $1.20 bln and $1.34 bln, respectively, Rolling Chip Turnover guidance for FY11 looks conservative. Keep in mind that for the first 10 months of 2010, AERL only had two VIP rooms.
It is well known that the Macau gaming market has ties to organized crime -- the VIP market especially. Therefore, AERL's business model and the relationships it must maintain may lead to scrutiny. However, even considering that risk, the stock still looks very cheap.
The Macau gaming market is one of the hottest secular growth stories in the world, driven by strength in the VIP market. With a mid-single digit multiple and triple digit top-line growth (in addition to last night's report of plans for additional market share gains), this growth stock may see more momentum as the Street picks it up as a pure play on the Macau VIP gaming market.
We picked up on the name after Tuesday's December Rolling Chip Turnover report and were very intrigued. Unfortunately, the due diligence required as a result of our justified skepticism caused us to miss the ~18% move over the last three sessions. We still find the name very attractive on a valuation/growth basis, but wanted to make clear that there is the prospect of potential consolidation of gains before an extension higher. As such, the best approach if considering an entry would probably be to scale in.
In my experience the best, most sustainable increases in stock prices come when companies in a group achieve multiple expansion due to a secular, positive trend. Obviously the Macau story has captured the imagination of investors and for good reason. The growth is tremendous and likely will not abate any time soon.
The multiples in the group are already in nose bleed territory based on 2011 estimates (LVS-29, MYNN-48, MPEL-223) with the notable exception being (AERL-4.6). Were the stock to even approach peer multiples it could easily hit $30 this year.
Surely there will be growing pains along the way as the company expands. But Macau is a multi-year growth story with a bright future. This stock is going to be a monster for 2011.
How can you compare AERL to WYNN,LVS? The latter own the casinos and the brands. What does AERL really own? They own the right to promote a gaming room in a casino they do not own. It looks to me like there is a lot of risk that commissions can fall and costs to renew these contracts will only rise as the amount of business exopands at the casino's.
I do not see how they have any kind of long term sustainable business model. Perhaps I am missing something??
I think the stock is a buy because it is in such a hot space, but it looks to me like this stock is just a good trade right now, not really a longer term investment.