Genting Malaysia

· The Case Against The Acquisition

· The Case For The Acquistion

Genting Malaysia Bhd (GenM) is acquiring Genting Singapore PLC’s casino operations in the UK (Genting UK) for £340 million (RM1.67 billion) cash.

Genting UK’s operations consist of four companies — Nedby Ltd, Palomino Star Ltd, Palomino World Ltd and Genting International Enterprises (Singapore) Pte Ltd. The acquisition was in line with its strategy to grow its core businesses of leisure, hospitality and entertainment internationally, beyond Malaysia.

Genting UK’s operations have the largest number of casino properties in the UK with 44 casino properties, including five located in London. They come with established gaming brands such as Crockfords, Colony Club, Maxims, Circus, The Palm Beach and Mint.

As at Dec 31, 2009, the four companies had a total revenue of £194.1 million and a net profit of £6.7 million. This means, at the acquisition price of £340 million, the transaction is priced at a historical price-to-earnings ratio (PER) of 51 times. The four companies had collective net assets of £288.9 million as at March 31, 2010, implying an acquisition price-to-book ratio of 1.2 times.

GenM said the proposed acquisition represented a good opportunity for the group to grow its earnings and revenue base.

However industry observers say there is no earnings accretion from this. Working out the numbers, the profit that would flow into GenM from the companies that are being acquired would be about £6 million to £7 million. That would come up to over RM30 million.

Compare that to the interest income foregone of RM32 million (RM1.6 billion times 2%), that would mean there is no earnings flowing in at all from this deal.

There is the argument that the acquisition would give GenM an opportunity to go into the European market, but is that an attractive gaming market today? Revenues for gaming companies there are down while taxes are going up for them.

GenM does have the financial capacity to expand the business. But then again, Genting Singapore’s net gearing is 24% which is still manageable. However, from an EV/Ebitda point of view, the acquisition price works out to 11 times FY11 earnings, which is not exactly that cheap. In Macau, where the gaming market is promising, the EV/Ebitda is about 10 times to 15 times.

As at Dec 31, 2009, the GenM group had no borrowings. However, after this acquisition the group would have a gearing of 0.05 times upon completion of the acquisition as a result of the consolidation of the borrowings of the four companies.

The four companies had borrowings of about £99.2 million as at March 31, 2010. The valuation of the equity value of the four companies as conducted by JPMorgan Securities (Malaysia) Sdn Bhd was between £310 million and £370 million. The original cost of investment of Genting Singapore into the four companies with gaming business in the UK stood at £699.4 million

Aside from the UK, the proposed acquisition would also give GenM access to the gaming market in Egypt. GenM noted that a subsidiary of Nedby has been selected as the new operator of the casino to be opened at The Nile Ritz Carlton Hotel in Cairo, Egypt. This hotel, located on the banks of the Nile and in the heart of the Egyptian capital, is undergoing extensive renovation and refurbishment and is expected to re-open in early 2012. The casino concession for the hotel is for an initial period of 10 years from the commencement of the hotel and casino operations.

The Case Against The Acquisition …

Critics say the investment as pricey for a risky market, provides little growth catalyst and may require more capital injection in future.

First, it said the acquisition was pricey. The acquisition cost of £340mil values the transaction at 11.2 times financial year ending Dec 31, 2011 (FY11) enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) which was at a 76% premium to Genting UK’s larger peer Rank Group PLC, which was currently trading at 6.3 times FY11 EV/EBITDA.

Therefore, this may result in further impairments at Genting Malaysia level.

Second, there is a high probability of further capital injection as Genting UK may be at a heavy capex stage.

Genting Malaysia mayneed capital expenditure of around £20mil to £30mil a year refurbishing the old and rather dingy looking casinos to attract a younger and more vibrant crowd.

Also it is considered another a related party transaction.

The acquisition is also negative for Genting Malaysia due to the regulatory risk, nascent economic recovery and intense competition in the British market. Accordingly, Genting Singapore has to-date written down 59% of its £699mil investment.

Moreover there is minimal synergy from the British operations.

It is also an inefficient use of resources (net cash will drop to RM2.2bil from RM5.2bil). Genting Malaysia may be better off investing in strong growth potential markets or return capital to shareholders.

Although the Genting UK acquisition will be earnings accretive – boosting Genting Malaysia’s earnings before interest, taxation, depreciation and amortisation by 10% – return on investment is estimated at a meager 5%.

However, the disposal of Genting UK was positive for Genting Singapore as this would enable it to focus on the Singaporean gaming business.

The disposal would also reduce pressure on Genting Singapore’s balance sheet and enable it to explore integrated resort projects in other jurisdictions.

However there are some longer-term silver linings

Genting Malaysia is buying the casino assets at probably the trough of Britain’s and the EU’s economic conditions. If we take a three to five-year view, the British economy may rebound, lifting asset prices.

The pound may also rebound when the financial markets and economy improve. there was also a potentially minimal downside to gaming regulatory risk in Britain as the current tax structure was already at the hefty 50% tax bracket.

With RM3.6bil left, the group will actively continue to evaluate business opportunities.

Once the deal is completed, it will be interesting to see how Genting Malaysia will differ from Genting Singapore in the way it deals with the UK operation.

The Case For The Acquisition …

Gening M is now training its sights on UK casino operations following the proposed acquisition of four casinos from Genting Singapore.

The concerns are that, although the assets have been written down, GenM is buying the casinos at a time of uncertainty as it is not known if the worst is over for the UK gambling industry.

Genting UK lackluster earnings (it posted a net of 6.7 million pound in FY2009) are a reflection of the tough environment in the UK where the casino market has been affected in recent years by legislation. On top of the global recession in 2008 that weakened the UK economy, the gaming landscape has made tougher with up to 50% higher taxes imposed on gaming operators.

Genting Singapore has written off over 400 million pound of its investments in Genting UK since it acquired the assets for 699 million pound in 2006. However, GenM’s management is confident that the negative developments in the casino market are easing off and Genting UK’s earnings can be improved substantially.

The returns can be improved even further by tweaking some of the marketing strategies for Genting UK’s casinos.

There should be no further impairment provisions for the casino business there. The impairment losses are to reflect the underlying costs of investments made by GenS. If GenM can improve on the business of Genting UK’s casinos, or even if it maintains it at the current level (July 2010), there should be no impairment losses.

At that time, asset prices were high given that the UK economy was robust. The acquisitions were also viewed then as giving GenS the advantage of getting a license to operate a super casino there.

Now GenS has already done the hard work needed and the assets are all cleaned up. With that behind them, the UK businesses are ready to take off.

It said that the acquisition price for Genting UK is effectively lower than the potential value since the London casinos, which are located in prime locations, have not been revalued for the past seven or eight years.

For 340 million pound, GenM are getting not only the 44 casino licenses for the UK operations, but also properties with a net book value of 289 million pound, and GenM has not even included the revaluation gains yet.

Due to the global financial crisis, and subsequently the strengthening of the ringgit, the pound has been trading at below the rm5 since mid March 2010, a level which has not been seen since 1997. For GENM, whose businesses are mainly ringgit denominated, there is no better time than now (July 2010) to acquire overseas assets.

So when the economy improves, there will a competition for assets and prices will increase significantly. If it wants to expand, it has to be within these 1 ½ years.

Genting UK is the only first of overseas assets that GenM intends to acquire and grow.

It is worth noting that the balance sheet of GenM and GenS Are rather different. GenM is still in net cash position even after forking out RM1.67 billion to acquire the 44 casinos in the UK.

Apart from 86 million pound in debt in the UK, there are no borrowings on GenM’s balance sheet. In contrast, GenS is in a net debt position, as it has accumulated long term debt of S$3.65 billion from the Singapore IR Resorts. Given its huge borrowings, GenS is unlikely to return to a net cash position in the near term.

GenS may have an exciting growth story to tell as its five star resort is probably more attractive to rich gambler, but it is not the only one in the island. But while GenM may not have much to shout about in terms of earnings growth as it is already making over RM1 billon a year in net profit, its low cost business model and the monopoly it enjoys have made it resilient.