Is Crown Resorts Ltd a value trap?

Credit: soundingblue

Unless you’ve been living under a rock the past few weeks you would have witnessed the dramatic plunge in share price of Australian casino operator and entertainment king, Crown Resorts Ltd (ASX: CWN).

Following a spate of arrests of Crown employees in China early last week (including its head of international VIP gaming) Crown’s share price plummeted 15% as concerns over the entertainment behemoth’s VIP operations cloud its future.

With its share price rebounding modestly on Tuesday, the big question on investors’ lips is whether Crown shares are a buy at current prices. Here’s what I think.

Criminal allegations

As part of the Chinese government’s crackdown on illegal money laundering and offshore gambling, 18 employees of Crown were detained by Chinese police for questioning over their role in ‘soliciting’ high-roller gamblers to Crown’s Australian casinos

Although the details of the arrests remain unclear, the criminal allegations cast shadows over Crown’s VIP gaming strategy, placing doubt on its future earnings in my opinion.

Whilst Crown’s chairman indicated last week that it’s still too premature to determine whether the ongoing investigation will have a material impact on earnings, its full-year 2016 results reported that approximately 28% of full-year revenue was derived from international VIP gaming (with 12% of this coming from mainland Chinese VIPs).

Whether the recent arrests deter these high-rollers is yet to be seen, however,  given Crown’s meaningful reliance on Chinese VIP gamblers I’d be hesitant to buy shares at current prices (despite the shares trading on a cheap trailing price-earnings of 8.2x).

Upside potential

Amidst all the controversy over the China scandal, investors may be forgiven for missing a key announcement last Thursday which re-iterated management’s plans to pursue an IPO of part of its Australian resorts business.

Under the proposed demerger of Crown’s Australian businesses, the casino operator would demerge its international business which includes Melco Crown Entertainment. Crown owns a 34% joint-venture stake with Lawrence Ho’s Melco International Ltd in Melco Crown. It will also list 49% of the Australian resorts via a new ASX-listed property trust.

If the demerger proceeds in its current form, the Australian-listed property trust would hold Crown’s flagship Metropol and Promenade hotels in Perth and Melbourne, providing investors with stable income and an attractive growth profile backed by inbound tourism tailwinds.

Foolish takeaway

As is evident from past demergers in the industry, such as Tabcorp Holdings Limited (ASX: TAH) and Star Entertainment Group Ltd (ASX: SGR), this proposed demerger could unlock substantial value for both the existing Crown business and the newly floated property trust. This would make it favourable for long-term investors.

However, I believe purchasing shares in the casino operator at current prices is a gamble, given the repercussions of the ongoing Chinese investigation are still unknown. Although Crown has substantial upside potential if the whole issue blows over, Crown’s reliance on VIP gaming revenues leaves it vulnerable to an earnings downgrade in the near term. This positions it as a value trap in my opinion.

Accordingly, whislt the IPO provides potential upside to investors, I would wait for further information on the developments of the Chinese saga before buying shares in Crown.

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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