Emperor Entertainment Hotel Limited: 296-HK (Hong Kong Stock Exchange) Low-profile casino to benefit from pent-up demand

for Macanese gambling; $7.00 price target INDUSTRY Positioned for strong growth - Macau is the gambling capital of the world1 o 2012: $38bn in Macau gambling sales (11% yoy growth) = 6x Las Vegas - Located in Pan-Pearl River Delta = 400 million people living within 2-3 hours of Macau - Huge demand driven by ban on casinos in mainland China - Most profitable, fastest-growing segment: mass market gamblers, esp mainland Chinese o Pent-up demand due to transportation time, border control, etc - Catalysts currently in progress: improving border access to reduce long lines and waiting time to get into Macau; new high-speed rail in southern China; expanding Macanese airport; potential relaxation of visa restrictions Built-in barriers to entry - Macau highly regulates gaming industry - Scarcity due to the Three Ls2 o Licenses: granted by government, very few and very valuable o Land: Macau is 28 sq km in area (1/6 size of DC); land is also controlled by govt o Labor: Strict labor controls (rising wages potential headwind) o Cap on number of tables: Macau passed a plan that capped tables at 5,500 until 2013 and provides for a 3% annual increase thereafter3,4 until 2022 (compliance is imperfect: # tables now at 5749) Due to favorably constrained supply and strong demand, growth in casinos and tables is far outpaced by growth in industry revenue:
#casinos #tables table growth gross gaming revenue revenue growth 2006 24 2762 57521 2007 28 4375 58% 83847 46% 2008 31 4017 -8% 109826 31% 2009 31 3998 0% 120383 10% 2010 33 4791 20% 189588 57% 2011 34 5302 11% 269058 42% 2012 35 5485 3% 305235 13%

Strong, sustained growth in mainland Chinese visitors, especially individual visits who comprise the mass market demand for Chinese gambling and who benefit directly from improved border access and rail lines to Macau:
visitors (thousands) visitors (from china) visitors (from china, individual visit policy) %china individual visits/total visitors 2006 21998.1 11985.6 5795.5 26% 2007 26993 14866.4 7165.2 27% 2008 22933.2 11613.2 6586.4 29% 2009 21752.8 10989.5 4809.9 22% 2010 24965.3 13229.1 5486.2 22% 2011 28002.3 16162.7 6588.7 24% 2012 28082.3 16902.5 7131.9 25%

http://www.economist.com/news/business/21584995-although-it-has-growing-number-rivals-macau-worlds-casinocapital-set-new 2 http://www.umac.mo/iscg/publication/Publications/ExternalResources/Macau%20scarcity.pdf 3 http://online.wsj.com/news/articles/SB10001424127887323375204578269222492146936 4 http://macaubusinessdaily.com/Gaming/%E2%80%98Table-count%E2%80%99-expands-ahead-table-cap

COMPANY Emperor Casino (all figures in HK dollars) - Mass-market-focused casino provider o Operates mass market halls, VIP rooms, slot machines, & Emperor Hotel Macau o Targets middle-class visitors, what it calls the premium mass segment o Founded in 1942 and headquartered in Hong Kong o Revenue by segment: 91.5% gaming, 8.5% hotel5 - Emperor is uniquely poised to benefit from the growth in mass-market, middle-class gambling due to mainland Chinese demand for games of chance - Relatively small (operates 67 mass-market and 10 VIP tables, or just over 1% of Macau total) o Market cap 5,402mm HK; EV 4,197mm HK; PE 8.8x; EV/EBITDA 4.1x o Shares out: 1.3 bn o FCF yield: ~25% (5yr avg) - Because of barriers to entry, this is a sustainable high-margin, high ROE business

Gross Margin

Net Margin

Return on Equity

See appendix for revenue breakdown

Operating leverage: EBITDA (20% 5yr CAGR) outpaces revenue growth (10% 5y CAGR)

Revenue VALUATION

EBITDA

Extremely rough DCF: At 10% discount rate, I simply project FCF at -5%, 5% and 15% growth (bear, base, bull) to get 19%, 17%, 68% upside. Peers:6 Emperor EV/EBITDA 4.1 P/CF 5 Galaxy 27.1 25.1 Wynn 22.7 20.3 MGM 21.4 15.9 SJM 15.3 12.3 Melco 19.4 n/a Sands 30.1 27.6

WHY UNDERVALUED - Relatively small casino targeting mass market gamblers o Not one of the 6 licensed and highly publicized casinos; most Macanese casinos of Emperors size are privately held o Doesnt get the luxury premium assigned to fancier, high-end casinos o Mainstream reporting (Economist/WSJ/FT articles) about Macau gambling focus on the big casinos; Emperor is never mentioned - Foreign company headquartered in HK o Part of conglomerate that includes jewelry and property companies o Main website in Chinese with accompanying English version o MGM, Sands, Wynn, Venetian are all based in US/Western countries Larger gaming entities, better covered by research analysts - Highly invested management [?] o Director Semon Luk owns 62% of shares out - Focused operation o One-roof casino, unlike Wynn or Galaxy (many casinos/intl operations) o Leads to stronger cash generation (~25% FCF yield, compared to 5-10% for comps)
6

While this illustrates an enormous disparity in price multiples, its important to remember that these other 6 companies are large and officially licensed casinos that may well deserve some degree of premium to Emperor

RISKS Softening demand for gambling due to exogenous factors Unpredictable or unfavorable governmental regulation Assets provide margin of safety: $1.51 NWC/share; $3.14 book/share; $3.05 tangible book/share

Appendix Revenue breakdown: