Australia | Jun 26 2013
– Echo counters Crown's Barangaroo proposal
– Brokers impressed with scope
– Return potential under question
By Greg Peel
Echo Entertainment ((EGP)) has found itself caught between a rock and a hard place. Echo is the operator of Sydney’s only casino, The Star, located on the Pyrmont side of Darling Harbour. Now that construction is underway of the massive Barangaroo development on the Walsh Bay side of Darling Harbour, rival Crown ((CWN)) has lobbied the NSW government to build a casino and hotel establishment as part of the complex, with a focus on attracting VIP gamers – the so-called “high rollers”. Despite wide community protest, the government is very tempted by the idea.
If Echo remained on the sidelines, and the Crown proposal were to be approved, the risk is Crown’s casino would split the Sydney market and suck away Echo’s revenues. If Echo counterbids and offers to build the second casino itself, in an attempt to head off Crown, the second casino would still cannibalise the revenues of the first.
Echo has thus come up with what analysts feel is a very compelling counterbid for the government to consider.
Echo will spend $1.1bn to convert The Star from what now is arguably just an oversized RSL into an international resort and gaming complex, featuring 500 hotel rooms across two five and six-star hotels, luxury villas, 20 new restaurants/bars, a rooftop water park, and improved infrastructure in the Pyrmont precinct, funded by the company, including a pedestrian bridge crossing Darling Harbour from Barangaroo and additional public amenities.
Moreover, Echo will pay the government $250m for a 15-year extension of The Star’s exclusivity, including $100m upfront. It is a proposal that will surely have the government licking its lips. Barangaroo is the iconic site, being close to the CBD and other Sydney landmarks, while The Star is located on the cheaper side of Darling Harbour as a seeming extension of the tacky shopping mall adjoining the convention/exhibition centres, which are also supposed to be past their use-by dates. Yet Citi notes Echo’s plans fit the government’s tourism ambitions and drives infrastructure investment in the Pyrmont area. BA-Merrill Lynch suggests a hotel roll-out has strategic merit in the underpenetrated Sydney market. And what’s more, a casino already occupies the Pyrmont site, suggesting no community backlash would stem from The Star simply growing upward.
Echo has also offered the government a second option. Echo will go ahead and build its resort/casino complex at Pyrmont and concede a Barangaroo casino to Crown if Crown is restricted to building a VIP-only casino rather than a general gaming establishment competing directly with The Star. Under option two, there would be no $250m exclusivity payment.
Deutsche Bank sees the Echo proposal as “strategically astute”. Merrills believes it offers an impressive and competitive alternative to Crown and Citi believes it compelling and increases its chances of success. The problem is as to whether after spending $1.1bn to build the new Star, with another $250m paid out for exclusivity in option one, the returns will be there for Echo to justify the investment. Option two omits the $250m but may not sit well with Crown, and also loses Echo lucrative high roller business potential.
Merrills sees the scope for higher returns “to be challenged”. Citi notes the size of the exclusivity payment would limit valuation upside. Macquarie suggests there is very little clarity on the earnings uplift Echo could expect, and clearly the proposal anticipates a significant pick-up in visitor numbers on the back of better on-site attractions and improvements to local infrastructure.
There is general agreement that Echo’s balance sheet can handle the deal, although another $1bn spent on the Brisbane casino may push the debt limits and Merrills would not rule out an equity raising at some point. Macquarie believes Echo’s Sydney licence positions the company well to capture further growth and increasing returns on capital and that the property has corporate appeal. Both Macquarie and UBS believe the risks surrounding the Crown issue are already priced into Echo shares at current levels.
A period of uncertainty will now follow, as we await a government assessment of the proposal and a response from Crown.
Macquarie and UBS both retain Buy or equivalent ratings, while Deutsche Bank, Merrills and Citi are comfortable with Hold amongst the uncertainties. Other FNArena database brokers are yet to update their views, leaving a Buy/Hold/Sell ratio of 3/4/1 on a consensus target of $3.62.
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