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NagaCorp (3918 HK) Summary

Core Content

NagaCorp is a leading integrated casino-hotel operator in Cambodia, with a strong position in the gaming market. The company is initiating coverage with a Buy rating and a target price of HK$7.90, based on a sum-of-the-parts (SOTP) valuation of its properties. The report highlights the company's strategic moves to enhance both its VIP and mass market segments, as well as its expansion into new gaming jurisdictions.

Main Points

1. Investment Thesis

• Competitive Franchise: NagaCorp has a monopoly in the Cambodian gaming market, with no limit on the number of gaming tables.
• Low Operating Costs: The company benefits from a favorable tax rate of 1.5% on gaming operations and long amortization periods for licenses.
• Geographical Advantage: Its location in Phnom Penh is close to major Asian markets like Vietnam, Thailand, and China, facilitating access to tourists.
• Growth Potential: The company is well-positioned to benefit from the growth of the Asian gaming market, which is expected to grow faster in terms of population and GDP.

2. VIP Business Expansion

• Revenue Sharing Program: Introduced a new revenue-sharing model for junkets, increasing their commission from 1.7% to 2%, which is higher than Macau's 1.25%.
• Attracting Higher Rollers: The program aims to bring in more serious, higher rolling gamers, especially from China.
• Facility Upgrades: NagaCorp is expanding its VIP capacity with new terminals and private gaming suites, expected to be operational in 2015.
• Strategic Focus: The company targets mid-range VIP players, aiming to capture a "shoal of big fish" rather than a few "whales".

3. Mass Market Growth

• Customer Base: The mass market includes local and international tourists, with 40% of customers being locals holding foreign passports.
• Growth Drivers: Increased visitor numbers and higher spending, supported by economic growth in Indochina.
• Infrastructure Improvements: NagaCorp is improving travel services from mainland China to Cambodia and enhancing F&B offerings to cater to Chinese tourists.

4. Naga2/3 Expansion

• Naga2: A second casino resort expected to open in 2016, doubling NagaCorp's capacity and boosting earnings in the long term.
• Naga3: A third complex planned as an iconic local landmark.
• Russia Project: NagaCorp plans to enter the Russian gaming market with a 21.6-hectare project near Vladivostok. The project is at the negotiation phase and will not be included in the target price yet, but it is expected to be a long-term earnings driver.

5. Valuation

• Target Price: Based on SOTP valuation, with a 10x EV/EBITDA multiple applied to NagaWorld's FY15E EBITDA and Naga2's FY19E EBITDA.
• Discount Rate: The enterprise value of Naga2 is discounted at 12.4%.
• Share Dilution: Already factored into the target price, with new shares issued to Dr. Chen for the Naga2 project.
• Dividend Payout: Expected to maintain a 70% dividend payout ratio, supported by its substantial cash reserves.

Key Financial Forecasts

Summary of Growth Drivers

• VIP Growth: Revenue-sharing model, higher bet limits, and new VIP facilities.
• Mass Market Growth: Increased tourist arrivals, improved travel services, and F&B enhancements.
• New Capacity: Naga2 will double the company's gaming capacity and provide additional traffic.
• Diversification: Entry into the Russian gaming market as a new long-term growth driver.

Risks and Considerations

• Russian Project: Still in negotiation phase, with potential delays due to geopolitical tensions.
• Tax Uncertainty: Post-2018 tax arrangements with the Cambodian government are under discussion.
• Margin Pressure: VIP business may have lower margins due to increased commission costs, but it is expected to be offset by higher volume.

Conclusion

NagaCorp is strategically positioned to benefit from the growth of the Asian gaming market, particularly through its expansion into VIP and mass market segments, as well as its planned Naga2 and Russian projects. The company's low operating costs, favorable tax treatment, and strong balance sheet support its growth potential. The target price of HK$7.90 reflects a comprehensive valuation approach and is based on expected future earnings and growth.