Monday, August 08, 2022

Flying the kite?

Melco Resorts and Entertainment’s decision to file for an initial public offering for its Studio City joint venture took analysts by surprise, with many speculating the proposed listing is being used to fish for a valuation for the resort.

Melco owns the Hollywood-themed IR through a partnership with New Cotai Holdings. Analysts have long expected Melco to buy out its partner’s 40 percent stake to gain full ownership, giving it access to the full revenue stream and the potential for operational synergies.

However, in August, it filed for an IPO in the U.S. According to some analysts, the filing may be a way of establishing a valuation for the unit prior to a full buyout by Melco after the two sides were unable to reach a price in private negotiations.

“It is unclear what the ownership motivations are of both Melco and New Cotai,” says Colin Mansfield, director at Fitch Ratings. “But the IPO would provide clarity on Studio City’s valuation, which could facilitate future discussions around ownership changes at the Melco and New Cotai level.”

There are other possible reasons for the planned IPO: Bernstein analysts Vitaly Umansky and Zhen Gong suggest Melco might be seeking to improve the valuation of its own stock.

Writing in a recent note, they said: “Melco may see Studio City as a hindrance to its own valuation. The stock currently trades at a significant discount to most other Macau casino stocks. By creating a separate Studio City stock, Melco’s low valuation may be highlighted and the Melco stock may adjust accordingly.

“This scenario assumes that Studio City can be priced at a robust multiple that would highlight a low multiple being applied to the rest of Melco's business; the Melco stock price would then adjust upward. The IPO may not need to happen under this scenario – a continued low Melco price would likely cap a valuation for Studio City.”

In short, if Melco’s stock price remains relatively low, the valuation of a Studio City IPO would likely be low, meaning the listing would be less likely to take place as it would not be attractive to its current owners.   

Another purpose for the IPO could be to raise additional capital for future developments, particularly Studio City’s proposed Phase II project. Bernstein says New Cotai is coming under increased pressure to put the plan in motion either from the government, Melco, or both.

But raising funds would only happen if the IPO actually takes place. And there is significant doubt among most analysts that it will. The complex ownership structure of Studio City is bound to cause headaches and inefficiencies, and will likely deter investors from getting involved.  

Melco Resorts and Entertainment is a subsidiary of Melco International Development, while New Cotai Holdings is jointly owned by private equity firms Silver Point Capital and Oaktree Capital Management, which itself is listed on the New York Stock Exchange.

According to the filing made by Melco with the Hong Kong Stock Exchange, Melco International Development would remain Studio City’s majority shareholder post-listing, although its interest in the operator would be reduced somewhat.

In addition, when announcing the IPO, Melco pointed to market conditions as one of the contingencies for the listing to commence. A meaningful correction in Macau-oriented equities “may stall things,” says Mansfield, although the overall performance for major Macau-oriented equities is still up year-to-date.

Michael Zhu, vice president, operations planning and analysis at The Innovation Group says these factors will mean the IPO is unlikely to go ahead.

“It would be a very lengthy and cost in-efficient IPO process due to the complex ownership structure of Studio City. It’s more likely the two parties will come back to the table and reach an agreement for a Melco buy-out without having to deal with external hassles, which would be a win-win situation.”

But if the IPO does go ahead, it would likely be more beneficial to New Cotai Holdings than Melco. It would provide the private equity firm with a clear and simple exit strategy, which in turn would relieve some of the capital pressure currently pushing down on its shoulders.

A Melco buy-out would make more sense for both parties. New Cotai would still be able to step aside leaving Melco in the driving seat to realize synergies in marketing, operations, general administration and table allocation/utilization. Zhu argues this structure would unlock the true potential of Studio City.

“With the current market conditions and the VIP momentum in Macau, Studio City’s market potential would be better realized and captured under a more consistent corporate structure, which a Melco-buyout would provide – much like what they were able to achieve with Melco Crown Entertainment,” he adds, referring to the recent transaction in which Melco bought out its joint venture partner Crown Resorts.

The proposed IPO comes at a time when Studio City is riding a solid ramp-up curve in performance. Macquarie believes this performance will continue for some time, or at least until the opening of MGM Cotai and Grand Lisboa Palace. As such, it has raised its Studio City FY17 revenue growth to 18 percent YoY to US$5.3 billion.

Much of the current growth is being driven by a rise in VIP revenue after the opening of another VIP room in mid-May; Mansfield says rolling chip volume increased 31 percent in the second quarter compared to a 1 percent growth in mass market table drop. This helped drive a 19 percent increase in EBITDA QoQ to $81 million.

“Studio City now seems to be on a healthy and steady ramp-up curve performance-wise,” says Zhu. “But I think it could achieve better results with the synergies in marketing, operations, admin and so on should Melco acquire full ownership of the entity and run it at full speed.”

That, in all likelihood, will be the eventual outcome of the proposed Studio City IPO. But Umansky and Gong say they believe any market valuation obtained via an IPO would be at a “substantial discount” to Melco’s valuation for the business.

“At this stage, we do not foresee Studio City receiving an adequate valuation based on the property’s current performance and structure,” they said.

Melco may well be flying a kite with its proposed Studio City IPO and while there are some grounds for wanting to spin off and separately list the entity, all signs point to Melco and New Cotai eventually reaching a solution behind closed doors.


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