In December 2005, Galaxy Entertainment became the first Macanese casino operator to access the international bond market, where it set an impressive precedent. Galaxy chief executive Anthony Carter reveals why the B1/B+ company chose the bond market over other forms of financing and why the locally-owned operator is different from US casino giant Wynn.
Galaxy Entertainment Group, which was previously Hong Kong-listed K Wah Construction Materials, bought Galaxy earlier this year from its chairman, Hong Kong businessman Lui Che Woo, for HK$18.4bn ($2.37bn).It is one of the six casino operators with a license, and the only one that is neither an international giant of the industry or the former monopoly.
Why did you decide to launch a high yield bond rather than take any other financing route?
The high yield bond for us made sense. We are a very particular case and both Merrill Lynch and Morgan Stanley spent a lot of time with us on this. We looked at the [loan] syndication market very closely and decided against it; the reason is basically that we have to take into account the market conditions as they relate to Galaxy rather than the macro market conditions.
We spent the whole of the first few months of last year restructuring Galaxy, which was extremely time-consuming; we spent the whole of the next few months reversing Galaxy back into K Wah Construction Materials Ltd and that was enormously complicated and time-consuming because no casino operation had ever been listed in Hong Kong and the regulators did not understand the business.
The education process we went through, bearing in mind that we had just one casino, was exhausting; I think they had 1,200 questions on the offering memorandum. That makes me wonder how Stanley Ho, is going to do it when you think that we had just one casino and that was hard enough. [Stanley Ho, for 40 years Macau's sole casino boss, plans to list his Sociedade de Jogos de Macau, which owns 11 casinos, in Hong Kong for up to HK$15bn ($1.93bn).]
By that stage we had got to September and we needed to be able to raise the money quickly, have done with it, and get on with running the business. So Morgan Stanley and Merrill Lynch came to us and said they really thought the high yield bond issue was the way to go, and we decided that we didn't want to spend any more time than was necessary on syndications and securities and dealing with the government.
So we did the bond issue instead, and I still think it was the right thing to do because one of the main reasons for doing it was to raise the profile of the equity. If I say to you: "You're going to play tennis this afternoon and you're playing with Roger Federer and the world is watching", you're going to say: "Wow what do I do?" It's the same for us in Macau. We're not just starting with the local competition — we're dealing with the world's greats in the gaming industry. So you've got to say to yourself: "How am I going to get people to believe in my stock price when everybody is asking me how I am going to compete with Wynn and Venetian and all these other guys?" So by having a very successful bond issue — by getting the senior analysts in the United States to understand the gaming story — we were able to raise the profile of the equity and bring in long term investors and people who understood the company.
To be honest, I don't expect the local market really to understand this too much because the local market trades in and out every five minutes and what I'm looking for are the long term institutional investors who are going to hold the equity and the bond because they believe in the added value the company is going to create over the next two, three, four years, because of our particular business plan. Now we can't be — and I don't pretend to be — a Wynn or Venetian, because we're not; it took them 15, 20 years to get where they got and we've got to do the same thing. But we have to start somewhere, so by doing the bond issue we excited a lot of interest in the equity and that interest is spilling over to the fact that I have personally done over 60 investor relation interviews or discussions in the last four weeks.
Were you telling investors the Macau story or Galaxy's?
Well, you have to do both. You have to educate people as to Macau and you have got to educate people about where Galaxy fits into Macau, and where Galaxy fits into the competition, because the invariable question is always going to be, when you are on the road — how are you going to compete with Wynn and Venetian and Stanley Ho and people like that?
For people to understand that, they have to understand the market and your business plan relative to that market. We've positioned ourselves very much as a company that is not attempting to go head to head with Wynn and Venetian and the really big operators because we do not have that capital base yet. In addition, we are not certain whether we want to compete at the top end of the Macau market because it is a very thin top end.
Gaming in Macau depends on two things: it depends not just on the volumes of people pouring across the border; it depends on those people having money in their pockets. If they haven't got the money in their pockets to pay for all these expensive things then you may just as well not have them, frankly.
We look at the market differently in Macau. We are positioning ourselves very much for the mass market, and I'm not talking about the top end of the mass market.
If you look at it like a pyramid, Wynn is in the top end — he has to be, because otherwise he can't possibly afford what he's paid for. Venetian and MGM are also going to try and get in there, but that still leaves the huge area down the bottom which is what they call the 'grind action' market. So Galaxy will very much position itself in the mass grind market (along with SJM).
These guys are spending so much money on their construction and facilities that they have to focus on the top end to get the bang for the buck. If you want another way of looking at it, you could say that the overall market — the mass market — will divide itself into two parts: the high roller (which in the States they call the VIP market) and the grind. You also have slots, which are gaining speed in a remarkable way in Macau — far faster than we ever thought they would.
The average guy coming over the border with HK$2,000 in his pocket, which is usual, will be here in the grind market. But let's say he's betting anything up from HK$2,000 [per hand], then he will be moving up into this market.
We also have what we or Stanley Ho calls the Macau style-VIP market — and last year this was 62% of the market. Here you only have Galaxy and SJM; US operators aren't in here and can't be in here.
Once all these casinos open, we will have six operators bidding for business. But even as we lose market share the pie is continuing to grow. About 18m people visited Macau last year and the Wall Street Journal estimates that by 2010 that will be 35m people arriving in Macau. With disposable income gradually rising in China there is no reason why it can't be $10bn and — believe me — that is super-conservative. In fact I am regarded as ultra-conservative by the Americans because I think there is going to be a big shake. If everything gets built [that is being planned today] there will be 28,000 hotel rooms; if all the tables get built, even allowing for the old ones being torn down, that will be 4,600 tables (compared to 1,400 today).
Are the US operators projecting what happened in Las Vegas in the last 15 years on to Macau?
Very much so. They are telling the market to look at what's been happening in Vegas in the last 15 years — and no one's going to deny that — and therefore that can happen in Macau. But what they're not saying is that people in America are significantly richer on a per capita basis than people are in China today. On a 10 year view Macau is a slam dunk — whoever is in Macau with a license over a 10 year period is going to make a huge amount of money, providing they're sensible.
But on a shorter term — a two, three, four year basis — it will be different, because there will be a lot more tables and a lot more hotels coming on the market, because government infrastructure may not be able to keep up with it, because arrivals might slow, and will they have the necessary money in their pocket to fund and pay for these vast projects that are being created? I have been in Hong Kong for over 35 years.
Look out the window [in 1960s-built Hutchison House, above all the land reclamations] and none of that was here before; what they are doing in Macau is transforming it over five years. So that's why I'm more realistic about this [in the short to medium term].
Did that make a longer term bond easier to sell?
It was actually easier to sell to investors on a seven year basis because they want the coupon, which is 9.5%, and they didn't want it to be repaid early because they had faith in the product and wanted to keep that high yield as long as possible. And naturally we had to pay a high yield because we were effectively a start-up. It was significantly oversubscribed with a book of $3bn. On a stabilised basis, once you'd stripped away all the overbidding, it was probably closer to $2.2bn but still if I had wanted to — if I could have serviced the debt — I could have raised $1.5bn.
It was mainly sold in the US?
We did a very long roadshow. We started in Singapore, came back to Hong Kong and then we went to Geneva, Paris, London and then started in New York and then basically blitzed the US.
Obviously because of the coupon it was going to attract a lot of retail and private banks that would put this paper away but it was also going to attract a lot of fast money too because of the coupon, volatility and carry. What was your approach to trading accounts and hedge funds in particular? Did you feel you wanted these buyers behind you?
I wanted to go for a mix because I wanted stability. But at the same time I wanted to capitalise on the bond issue in terms of the equity side of the story. I was as interested in getting the hedge funds in as big shareholders as I was in getting them in from the fixed income side. And that has happened; there has been a lot of interest in the equity since the bond — from the hedge funds, from the mutual funds and from other big institutions.
The hedge funds have in many ways taken more interest than the mutual funds. It was very interesting on the roadshow, the difference in the intensity of questioning that we got. I was really very impressed with the way that some of the analysts in hedge funds could skewer you with questions whereas the big mutual funds didn't quite have the same intensity — although I wouldn't say they were more relaxed about their questions.
What were the toughest type of questions you were asked?
To be honest, there were no embarrassing moments where we didn't have a legitimate answer to something. The concerns were primarily a perceived shortfall between the total bond fund amount and the total cost to open StarWorld and Cotai phase one. That was really the thing I think that concerned people.
To the extent that some investors would have preferred a bigger one?
Well, certainly we were under a lot of pressure to increase the size of the bond but we couldn't do it, merely because of the cashflow side of things. We did increase it by $100m; obviously we would have liked to have taken more because it was there, but we are conservative so we controlled ourselves on that.
But the big issue was the perceived shortfall, which we demonstrated fairly effectively did not exist.
People were concerned obviously about our ability to repay the debt and because you're not allowed to give projections on these roadshows it was difficult to explain to people clearly that we are able to repay it but they got the message in the end. We were able to introduce parallels so they could draw their own conclusions. They were concerned about the VIP operations because they didn't understand those and they asked us to explain why we had done it and why the return was only 4.2% on the first casino we opened, but we were able to explain why we did it and how that figure was pure profit for us.
But we didn't have any sticky moments; there was a lot of intense questioning; Merrill Lynch and Morgan Stanley drove us unbelievably hard. It was quite common for us to be sitting in our first meeting at 6.30 in the morning and that would run through to seven or eight at night and then we would get on a private jet, go to a new location, get there at 12 or one in the morning, have a debriefing, get to sleep and then be back at the table at 6.30 in the morning.
Did you talk to other investment banks before doing the bond issue?
We recognised from the outset that the ability to understand the gaming story doesn't really exist in Asia, and does not really exist in Europe to any great extent; it is really an American phenomenon. Therefore if you want to go into the high yield market and you want people to buy, you have to go into the US market. So it was natural that we used the leaders, which were Morgan Stanley and Merrill Lynch.
Do you expect other casino operators to issue high yield bonds?
All are going for financing in one way or another, because the capital requirements are huge. The question is whether you go to the bond market or the loan market. Whether people will follow Galaxy into the bond market I don't know. If you've got gaming revenue coming in, it is very much easier to do an unsecured bond like we did; if you have no gaming revenue because you don't have a license it will be much harder and you may have to go the project finance way.
Were you under pressure to raise secured financing?
No. That was very much the reason we went to the bond market — because we could do it unsecured, whereas a secured financing effectively would have meant us having title to the land and having to mortgage things. And as a start-up, clearly we couldn't do that, because it takes so long to get land title and then it is only a leasehold from the Macau government.
You can secure against the shares?
You can secure against shares, but remember that in Macau there is some provision about being able to foreclose on the shares of a casino license holder and I'm not sure that the government would allow a license to change hands by virtue of a foreclosure situation.
Did you feel that the covenants and various forms of investor protection were much more restrictive than you would have been able to get in the loan market?
I wouldn't say much more: when we draw down our bond it is a very complicated process and we have to justify every time why we are drawing down; we have got to have certificates, much as you would on a project finance basis. We had to put the interest payments into a long term escrow account, for example. Merrill Lynch and Morgan Stanley required us to very much follow the market practice for a bond issue of this nature. To what extent that exceeded the average I don't know — you'd have to ask [the lead managers]. But certainly it was done in a way that provides significant protection for the bondholders. Put it this way, nobody on the roadshow complained to us that the covenants were too weak or that certain arrangements were not in place — that was never an issue at all.
What happens next as regards financing? Will you be back in the market or was this very much a one-off financing and is that how you presented it?
There is certainly a requirement for capex, yes. You can see the scale people are building in Macau and these projects are very capex-intensive. The demand for money for building in Macau is going to be quite extraordinary. As far as Galaxy is concerned we will certainly need, long term, more money. The questions are: do we raise it in the debt market? do we do private placements? and, do we do joint ventures? There are quite a number of options open to us and we haven't yet determined the way we are going to go and the reason for that is that — again — you have to look at us as a start-up.
We don't have the liberties of some of the really big players in this market; we must be seen in the market to really know what we are doing. So I want to get StarWorld open and it to be a success and I want Cotai phase one to be opened and it to be a success. When StarWorld is opened, one can spend more time on the second and third phase of Cotai. We could do a joint venture, for example, where we put the land in and someone else puts the money in. But capex requirements for everyone will be very significant.