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IN-DEPTH 9 March 2016
Macau junkets: A broken model?
Julian Rogers shines a spotlight on Macau’s shadowy junket business and investigates whether the game could be up for these middlemen operating in Asia’s struggling gambling hub
By Julian Rogers

By bringing in Chinese high rollers and providing them credit to gamble at Macau’s glitzy mega-resorts where baccarat is the game du jour, junkets have long played a critical role in the revenue growth of the world’s largest casino gaming market. These junkets, which are largely bankrolled by corporate investors and Macau’s super rich, operate like mini-banks, lending and collecting money, as well as organising luxury travel, accommodation and other high-end services for well-heeled clients. Often the junkets will contract out VIP rooms at the former Portuguese colony’s casinos and they control the gambling action. The casinos then pay them a commission based on the amount gambled by the VIPs, while a junket’s agent collects the debt back in mainland China when the gambler returns.

In Macau – the only part of China where casino gambling is legal – some junkets have been known to engage in side-betting with clients, according to Steve Vickers, CEO of Steve Vickers & Associates (SVA), a specialist political and corporate risk consultancy. “Under the prevailing Macau junket system, a HK$1,000 bet in view of VIP room staff staff might have an additional value of five or six times its actual face worth; this agreed beforehand and settled privately afterwards. This has facilitated a host of criminal activities,” he says. “Some junkets also provide a means to outsource the collection of debts, relying on extra-legal mechanisms ranging from suasion to violence in the worst case. "By providing these services, the junkets have evolved into a major component of an informal financial system operating at the heart of the gaming sector in Macau. This model is now under extreme pressure.” In some cases, Vickers explains, high-end VIPs agree with junkets to sign dockets which show a gaming loss or win, taking account of any 'transaction fee'. The docket can serve as a means of legitimising a transfer from Macau to other jurisdictions. “This extensive use of extralegal services means that many junkets have close links to organised crime and triad societies.” Although many, but not all, junkets have ties to triads, some have attempted to break these connections and become more transparent, legitimate businesses.

Yet the whole junket model in Macau has faced huge pressures in the past couple of years. For a start, a faltering Chinese economy and the recent stock market plunges have led to investors withdrawing their money from the once-thriving industry that facilitated billions of dollars leaving mainland China. Meanwhile, the Chinese government has tightened outbound capital flows and undertaken a wide-reaching anti-corruption crackdown. The monitoring of debit cards has intensified and cameras have been installed in VIP rooms. Beijing has also sought to limit junket numbers, including forcing the closure of smaller players with connections to organised crime. The situation has spooked many VIP Chinese gamblers (two-thirds of Macau visitors come from mainland China).

Vickers, who spent 18 years with the former Royal Hong Kong Police commanding its Criminal Intelligence Bureau with a special focus on triads, organised crime and money laundering, says: “The Central Chinese government’s stance appears to have focused on removing ‘disloyal’ or overtly criminal junkets from the market, and by favouring those that demonstrate their willingness to cooperate with the government. Accordingly, a number of winners and losers in the junket sector have emerged. This policy shift, coupled with the central government’s corruption crackdown, means that a return to the boom years in Macau is highly unlikely in the VIP gaming space; even casino executives state that the junket model in Macau is broken.” If the system is indeed on the ropes, then it’s a devastating hit for Macau, which saw casino gaming revenue decline for the 19th straight month in December despite the opening of Melco Crown’s Studio City resort the previous month.

In fact, gross gaming revenue (GGR) crashed to MOP230.84bn for 2015 – 34% lower than the previous year. A noticeable shift in focus to the mass market visitor indicates that the junket model has hit the skids. Indeed, the days when 80% of a Macau casino’s profits were derived from just 5% of its clientele would appear to be over. “The junket model, for now, is broken,” Las Vegas Sands president Rob Goldstein told an audience in September, echoing others' sentiments. Wynn Entertainment CEO Steve Wynn said in October that almost half the Macau VIP business was gone and that this had “caused us to review our credit policies and relationships with junket operators”.

Many observers believe the beleaguered junket business will be transformed completely within the next 12 months. It’s likely that the industry will experience additional consolidation, a trend that began two years ago, explains Grant Govertsen, managing director of Union Gaming Securities Asia. “We expect to see many more of the ‘mom and pop’ junkets either be consolidated within large junkets or simply close their doors with their agents and customers migrating to other junkets. At the same time, it would not be shocking if one of the big junkets, so the top five, were to fail.”

For much of the past decade, Macau was the poster child of worldwide casino gaming. Its GGR is still almost four times the size of what the Strip in Las Vegas can muster, but the upshot is that a number of these gambling promoters have collapsed and there continues to be precious little investor confidence in the big six Macau casino operators. Govertsen says: “While many investors are keenly watching the space given the dramatic declines and ‘cheap’ valuations, very few have any degree of confidence that Macau is on the cusp of turning a corner and entering another growth mode.”

With VIP gamblers from mainland China drying up, dozens of junkets have either shuttered VIP rooms or cashed in their chips and abandoned Macau to focus on other established and emerging Asian gambling hubs. Figures show that officially registered junkets fell from 235 in 2013 to below 140 in November 2015, which was partly driven by consolidation as a result of plummeting revenues. A reversal of the decline in numbers isn’t anticipated this year. “Revenues have already been halved and the outlook is for continued, albeit smaller, declines,” Govertsen points out. “At this point there are not any incremental customers who are just now feeling the heat of the anti-corruption campaign in China. Rather, continued declines will be driven by such factors as the economic slowdown in China or, to a lesser extent, the availability of gambling elsewhere.”

To compound matters, junkets are having trouble collecting debts accrued from the money loaned to VIP gamblers. Kwok Chi Chung, president of Macau’s Association of Gaming & Entertainment, recently told Bloomberg Business that operators are only recovering 20-30% of their debts, while VIP wagers had nosedived at least 70% to about HK$200bn ($26bn) a month since 2013. Legally, there’s not much the junkets can do because gambling debts are illegal in China. And with liquidity evaporating, credit has become significantly harder to come by for VIP gamblers.

Some argue that junkets, which are illegal in China but can receive licences to operate in Macau, have for too long been allowed free rein to go about their business with scant oversight. In fact, Macau Gaming Watch project leader Jeff Fiedler pulls no punches when he says junket regulation to date has been “far too superficial” and “wholly inadequate”, while vetting of individuals isn’t up to scratch. “Current policy requires only on-paper shareholders and directors for junkets to undergo ‘suitability’ investigations, which examines an applicant’s personal, professional and financial background. These reviews are critical to weeding out potential junket licensees with poor business and financial histories or, more importantly, associations with criminal elements.

“However, the government does not apply these licensing protocols for many key powerbrokers in the junket systems, such as third-party profit participants, credit guarantors, major financiers and off-paper shareholders of junkets. These under-regulated – or perhaps simply unregulated – individuals and entities are positioned to exert substantial influence over a junket operation.” He continues: “Unsuitable figures connected to Macau junkets avoid regulatory attention by simply staying off official paperwork and operating as a credit guarantor, a profit participant or an off-books shareholder.”
‘A DIVERSIFIED POSITION’
Of the six main Macau casino operators contacted for this article, only MGM China agreed to speak to Gambling Insider. Declining the opportunity to answer specific questions on the topic, the firm instead released this statement about its use of junkets:

MGM China continues to diversify its business and products to adapt and innovate in the Macau market. While the majority of our business (approximately 80% of EBITDA) comes from the main floor or mass business, having an exposure to both main floor and junket business allows us to maintain a diversified position in this competitive market and create opportunities for future growth.
Furthermore, the reputation of the industry has sustained damaging blows of late following a number of headline-grabbing thefts. Last September, junket operator Dore Entertainment reportedly had $38m stolen internally by a cage manager, sending shares in Wynn Resorts tumbling (Dore operated VIP rooms in Wynn Macau) and leaving investors out of pocket. The theft came a little over a year after a heist from the Kimren Group in which a shareholder allegedly absconded with around HK$10bn. “In cases like the Dore or Kimren thefts, people should be able to know exactly which casinos might have been affected,” Fiedler asserts, referring to the fact that, unlike Macau, other jurisdictions identify the casinos that have contracts with junkets. “It is also in the public interest that the government publishes more information about the junkets' key financial backers so that investors can better assess risk, particularly with junkets that consolidate into financially independent networks.”

Fiedler calls for the Macau government and the casinos to be able to better follow cross-border money movement and debt collection, as well as deeper investigations into how junkets capitalise and finance their activities. Likewise, Bruno Nunes, managing partner of BN Lawyers Macau, would like to see a raft of future regulatory changes introduced. “Stronger background checks, accounting obligations and financial reporting obligations are among top priorities, namely to prevent future situations where junkets offer to private citizens above-market interest rates in order to obtain the funds necessary to extend credit to VIP players,” he suggests.

As to why the Macau government hasn’t addressed these issues sooner, Fiedler says those at the top were happy to watch gambling revenue and tax receipts balloon with minimal oversight. “No-one wanted to rock the boat by asking questions about how these mainland high rollers were bringing their millions into the city and where those millions came from. And no-one wanted to raise issues about some of the questionable individuals backing the territory’s biggest junkets. The Macau government only started reacting when Beijing perceived this dynamic as a threat to Communist Party power and government.”

In the meantime though, 2016 is already shaping up to be another turbulent year for the remaining junkets, not to mention Macau’s 36 casinos, which account for around two-thirds of the territory’s economy. With VIP gaming taking a massive hit, casino owners are placing their bets on the middle income Chinese visitor – the mass market focused Wynn Palace, Sands China Parisian and MGM Cotai are due to open their doors in 2016. And just like Studio City, the Lisboa Palace reportedly won’t house any VIP gaming when construction is finished in 2017. According to Vickers, 2016 will be “wrenching” for Macau as the junket era draws to a close. “The casinos must now find a new model, even as the regulatory climate heightens the risk of investigations. The less nimble may struggle to do so.” Whether the VIP gambling sector and, more importantly, the junkets can rebound to previous highs in the near future looks doubtful. For now, it seems, those in the know are right to describe the Macau junket model as broken. It’s looking like one hell of a repair job is needed.

This article first appeared in the January/February Issue of Gambling Insider
DISCUSS THIS ARTICLE
IN-DEPTH 16 August 2019
Roundtable: David vs Goliath – Can startups really disrupt the industry?

(AL) Alexander Levchenko – CEO, Evoplay Entertainment

Alexander Levchenko is CEO of innovative game development studio Evoplay Entertainment. He has overseen the rapid expansion of the company since it was founded in early 2017 with the vision of revolutionising the player experience.

(RL) Ruben Loeches – CMO, R Franco

Rubén Loeches is CMO at R. Franco Group, Spain’s most established multinational gaming supplier and solutions provider. With over 10 years working in the gambling, betting and online gaming industries, he is skilled in operations management and marketing strategy.

(JB) Julian Buhagiar – Co-Founder, RB Capital:

Julian Buhagiar is an investor, CEO & board director to multiple ventures in gaming, fintech & media markets. He has lead investments, M & As and exits to date in excess of $370m.

(DM) Dominic Mansour – CEO, Bragg Gaming Group:

Dominic Mansour has an extensive background of nearly 20 years in the gaming and lottery industry. He has a deep understanding of the lottery secto,r having been CEO at the UK-based Health Lottery, as well as building bingos.com from scratch, which he sold to NetPlay TV plc.

What does it take for a startup to make waves in gaming?

DM: On the one hand, it’s a bit like brand marketing; you build an identity, a reputation and a strategy. When you know what you stand for, you then do your best to get heard. That doesn’t necessarily require a TV commercial but ensuring whatever you do stands out from the crowd. Then you have to get out there and talk to people about it. 

AL: Being better than the competition is no longer enough; if you’re small, new and want to make a difference – you have to turn the industry on its head. Those looking to make waves need to come up with a new concept or a ground-breaking solution. Take Elon Musk, he didn’t found Tesla to improve the existing electric cars on the market, he founded it to create the industry’s first mass-market electric sports car. It’s the same for online gaming; if you want to make waves as a startup, you have to bring something revolutionary to the table.

JB: Unique IP is key, particularly in emerging (non-EU) markets. As does the ability to release products on time, with minimal downtime and/or turnaround time when issues inevitably occur. A good salesforce capable of rapidly striking partnerships with the right players is vital, as is not getting bogged down too early on in legal, operational and admin red tape.

How easy it for startups to bring their ideas to life? How do they attract capital?

AL: It depends on the people and ideas behind the startup. Of course – the wave of ‘unicorns’ is not what it used to be. Some time ago the hype was a lot greater in terms of investing in startups, but that’s changed now. Investors now want more detail – and even more importantly, to evaluate whether the startup has the capacity (as well as the vision) to solve the problem it set out to address. That’s not to say investors are no longer interested in startups – they certainly are – but now more than ever, it’s important for startups to understand their audience as well as dreaming big.

JB: To get to market quickly, you need a great but small, team. If slots or sportsbook, the mathematical engine and UX/UI are crucial. Having a lean, agile dev team that can rapidly turn wire framing and mathematical logic into product is essential. Paying more for the right team is sometimes necessary, especially when good resources are scarce (here’s looking at you, Malta and Gibraltar).

Building capital is a different beast altogether. You won’t be able to secure any funding until you have a working proof of concept and, even then, capital is likely to be drip fed. Be prepared to get a family and friends round early on to deliver a ‘kick-ass’ demo, then start looking at early-stage VCs that specialise in growth-stage assets.

How do you react when you see startups coming in with their plan for disruption?

RL: We welcome the innovation and fresh thinking startups bring. This is particularly the case in Latin America, with a market still in its infancy. One area we’d especially like to see startups making waves is in the slot development sector. Latin America is a young market that needs local innovation suited to its unique conditions – especially in regard to mobile gaming.

Operators eyeing the market have Europe‐focused core products, which creates a struggle to work to the requirements of players and regulators. To succeed there, it has become more important than ever to work with those with a knowhow of the local area to adapt products and games to besuitable from the off; we welcome the chance for local talent to develop and grow.

Do you think it’s easier for established companies to innovate and establish new ideas? 

AL: From a financial perspective, yes. It is without a doubt easier for incumbent companies to establish a pipeline of innovation via their R & D departments, as well as having the tools to hand for data gathering and analysis.

But it stops there. Startups hold court in every other way. Not only are they flexible, they can easily switch from one idea to another, change strategy instantly as the market demands and easily move team members around. Established companies know this – and this is why we’re seeing an emerging trend for established companies to acquire small, innovative online gaming start-ups. They have the right resources and unique ideas, as well as the ability to bring a fresh approach to businesses’ thinking.

RL: For me, it’s always going to be established companies. Only with the resources, industry experience and know‐how can a company apply technology and services that truly make a difference. Of course there are exceptions. But when it comes to providing a platform that can be approved by regulators across multiple markets – as well as suiting an operators’ multiple jurisdictions – it is simply impossible for a couple of young bright minds with a few million behind them to get this done.

DM: I actually think it’s harder for established companies. It’s key to differentiate between having a good idea and executing one. That’s where the big corporates struggle most. They’re full of amazing people with all sorts of great ideas but getting them through systems and processes is nearly impossible.

Is it essential to patent-protect innovative products?

AL: It’s a very interesting subject. If we take IT for example – patents can actually become a block to the evolutionary process within the industry. Of course, getting a patent future proofs yourself from the competition copying your concept but, having said that, if you’re looking to protect yourself from someone more creative, smarter and agile, you’ve probably lost the battle already!

In our industry everything is moving faster and research takes less time than the development itself. No matter how good you are at copy pasting, you can’t copy Google or Netflix. The most important thing is not the tech itself but rather its ‘use-case’ – or in other words, does it solve what it’s meant to solve? Competition is healthy and the key to innovation. If you spend your whole time looking behind you, you’ll never be able move forwards.

JB: Tricky question, and one that depends on what and where you launch this IP. It can be difficult to patent mathematical engines and logic, mostly because they’re re-treading prior art. Branding, artwork and UX is more important and can easily be copied, but the territories you launch will determine how protectable your IP will be once patented. US/EU/Japan is easy but expensive to protect in. But China/South East Asia is a nightmare to cover adequately. Specialised patent lawyers with experience in software, and ideally gaming, can help you better.

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