How China's middle class will drive Macau's next gaming boom

For many investors – and gamblers – Las Vegas is the centre of the universe. But Las Vegas is small stakes compared to Macau, the island close to China that's (by far) the world's largest gambling complex. After a two year high-growth hangover, Macau's gambling business is on a roll again. But it's not rich VIPs driving profits. It's China's middle class – and a Las Vegas-like business model. A Portuguese colony until it was transferred to China in 1999, Macau – like Hong Kong – is operated under the "One Country, Two Systems" principle. So it's governed by mainland China, but isn't part of China. Gambling has been legal in Macau since 1847. But it wasn't until 2002 that international casino companies were allowed to operate there. That's when gambling revenues skyrocketed… Macau casino gaming generated about US$2.7 billion in revenue in 2002. By 2013, revenue hit over US$45 billion, meaning Macau raked in nearly 7 times more gaming revenue than Las Vegas.

Gambling has long been a part of Chinese culture. So a nearby island where gambling was legal – and that mainland Chinese could easily visit – was in a great position to win big. Even more importantly, Macau has also been the beneficiary of China's growing wealth. China's middle class is expected to be 76 percent of the urban population by 2022 – that's up from just 4 percent in 2000. That will be more than 550 million people. And nearly 90 percent of gamblers visiting Macau are from Hong Kong or China.  But after peaking in 2013, Macau's gaming revenue fell 35 percent in 26 months. But this August saw the island's first year-over-year monthly gain in revenues in two years – and it's been improving since then. The decline of the VIP visitor In Macau, casino customers are broadly split into two groups: VIPs ("very important persons") who have at least a few hundred thousand dollars to gamble at tables where the minimum bet is around US$500... and mass-market gamblers who sit at the US$100 (or lower) minimum tables. In the past, VIPs accounted for around two-thirds of Macau's casinos' revenues. Just one VIP who bets US$10 million might generate as much revenue as 1,000 gamblers who bet around US$1,000 each. The only problem is that many VIP gamblers all too often used Macau gambling "junkets" to get around Chinese capital withdrawal limits and to launder money. With the help of junket operators, VIPs could easily transfer millions of dollars overseas from Macau (while claiming the cash was "lost" at the tables) – circumventing the official Chinese government limit on currency that Chinese citizens are allowed to take out of the country. One report estimated that more than US$200 billion (or roughly four times the GDP of Macau) was laundered through the island every year through 2013. In addition, "triads" – organised crime organizations – infiltrated junkets, using them as a way to launder money. However, as part of an extensive anti-corruption campaign led by Xi Jinping, the Communist Party general secretary, a crackdown on junkets began in 2013. Criminals were driven into hiding, and many wealthy Chinese (and government officials) became very skittish about ostentatious displays of wealth, so as not to draw the attention of the authorities. With visits and revenue from VIP high rollers sharply curtailed, Macau gaming swooned. Macau's turnaround That is, until recently. In August, Macau gaming revenue posted a surprise year-over-year gain of 1.1 percent. Then in September revenue was up 7.4 percent, followed by an 8.8 percent jump in October, and a 14.4 percent increase in November.

Stronger VIP revenue, a more upbeat outlook for China's economy, and new resort openings have helped drive the improvement. A slight softening of the Chinese government's anti-corruption push – though that's difficult to quantify – may also have boosted revenues. More broadly, the slow shift in strategy by some casinos in Macau is attracting more tourists. They are moving towards more of a full resort experience, like Las Vegas, instead of an intense, seedy, gambling-focused environment. As we've discussed previously, the Chinese middle class is growing rapidly. And one of the things this growing middle class will spend money on is travel – not just to gamble, but also for fine dining and live shows and family entertainment, all which Macau is increasingly providing. By one estimate, 300 million Chinese people are wealthy enough to visit Macau. But only 25 million of them have ever visited. And with the island's ongoing transformation from a hard-core gambling destination, to a gaming resort with middle class appeal, Macau's gaming companies could be in the early stages of a long winning streak. But casinos aren't the only way to invest in China's middle class. We've discovered other exciting opportunities. You can click here to learn more about "Project H".

Kim Iskyan