Macau Gaming:Melco International to acquire 13.4%stake in MPEL from Crown

Melco to consolidate MPEL, with interest lifted to 51.3%

    On Dec 15, Melco International (200.HK; Neutral) announced it had signedan agreement to acquire 13.4% equity stake in MPEL (MPEL.US; Neutral)from Crown Resorts for US$1.188bn cash, or US$18/ADS, a 3% premium toits last closing price. After this transaction, Melco’s interest in MPEL wouldrise from 37.9% to 51.3%, hence the need to consolidate MPEL’s financials,while Crown’s stake in MPEL would decline from 27.4% to 14%. Thepurchase price will be adjusted if the transaction closes after Mar 1, 2017(i.e. 0.5% of the purchase price per month for Mar 1-Apr 30, and 1% permonth for May 1-Jun 30). The proposed deal is subject to the consent ofMacau government, and already has approval from major shareholders.

    Unlocking value for Crown. Question on how Melco will fund it

    We believe Crown’s further divestment of its MPEL stake is not entirely asurprise to the market, after it did so the first time in May by selling a 9.6%interest back to MPEL. In fact, Crown also announced today that it was indiscussions to sell its remaining MPEL stake and would no longer proceedwith the planned demerger of its international investments (MPEL, LasVegas development, Alon, Aspers, Nobu) to create a separate listed holdingcompany. Our Australian team believes the outright disposal could achievesimilar result of unlocking some of the hidden value in Crown.

    One unanswered question from this announcement is how Melco willfund the US$1.188bn share purchase. As of end-1H16, the group had onlyUS$369mn cash at the holdco level. As shown in our SOTP breakdown(Exhibit 2), 97% of Melco’s asset value comes from its MPEL stake. The restof its businesses (i.e., minority stake in the Vladivostok casino project heldwith Summit Ascent, 64.8% interest in NASDAQ-listed EGT, 40.7% inMelcoLot, 16.7% in MCR) do not generate much cash flow or dividend.

    With Melco’s market cap of US$2.2bn, issuing new shares to fund theUS$0.8bn cash shortfall could be dilutive to shareholders, especially as thestock is trading at a deep NAV discount of 37% (vs. historical avg. of 33%).An alternative is to uplift cash from MPEL by special dividend, which couldbe viewed positively by MPEL shareholders. As of end-1H16, MPEL hadUS$1.6bn cash on hand and US$3.8bn gross debt (including US$1.8bnnon-resource financing for Studio City, US$318mn Philippines Notes forMCP). MPEL’s dividend policy is to distribute 30% of recurring earnings