NagaCorp November 23, 2015

(1)

[email protected]

[email protected] MORGAN STANLEY ASIA LIMITED+

Alex Poon

+852 3963-3838

Praveen K Choudhary

+852 2848-5068

NagaCorp

( 3918.HK, 3918 HK )

Hong Kong/Macau Gaming / Hong Kong Stock Rating

Stock Rating OverweightOverweight

Industry View

Industry View CautiousCautious

Price target HK$6.30

Up/downside to price target (%) 25

Shr price, close (Nov 23, 2015) HK$5.04

52-Week Range HK$6.48-4.33

Sh out, dil, curr (mn) 2,282

Mkt cap, curr (mn) US$1,484

EV, curr (mn) US$1,280

Avg daily trading value (mn) HK$21

Fiscal Year Ending 12/14 12/15e 12/16e 12/17e

ModelWare EPS (US$) 0.06 0.08 0.07 0.05

Prior ModelWare EPS (US$)

- 0.06 0.06 0.06

Revenue, net (US$ mn) 404 558 532 557

EBITDA (US$ mn) 176 248 225 230

ModelWare net inc (US$ mn) 136 193 174 173 P/E 13.7 7.7 9.6 12.2 P/BV 3.0 2.1 2.3 3.0 RNOA (%) 34.1 41.5 35.4 34.5 ROE (%) 22.7 30.9 24.5 22.4 EV/EBITDA 9.5 4.9 5.1 4.7 Div yld (%) 5.1 7.8 6.0 4.2 FCF yld ratio (%) 3.2 12.4 9.6 7.9 Leverage (EOP) (%) (32.6) (39.4) (42.7) (46.7)

U n less oth erwise n oted, all m etric s are based on M organ Stan ley M odelWare fram ework e = M organ Stan ley Researc h estim ates

Industry View

Cautious

Stock Rating

Overweight

Price Target

HK$6.30

NagaCorp

November 23, 2015

AP Summit Takeaway – Growing Mass

Gambling

Solid growth in mass and VIP, bottoming of earnings revisions,

lower regulatory risks compared to Macau, and attractive valuation

should continue to support the stock's performance. However, a

change in gambling law end-2015 and expected share dilution

(declining DPS in 2016/17e) remain overhangs.

Key takeaways from Asia Pacific conference

Strong 2H15 results expected –

We expect EBITDA/net profit growth of

30%/34% in 2H15, driven by 23% growth in mass revenue (17% YoY in 3Q)

and 52% growth in VIP revenue (luck +60bps YoY). Our forecast is based on

seasonally stronger 4Q vs. 3Q and higher spending/capita and traffic helped

by table buy-in, TITO and charter flights. Our revised 2H15 EBITDA/net profit of

US$115mn/US$92mn are 25%/29% above consensus.

What's changed –

We increase our 2015/16/17 EBITDA estimates by

33%/14%/13%, driven by one-off slot income of US$40mn for 2015 and

stronger mass growth. We think consensus earnings revisions have bottomed.

Our 2015-17 profit estimates are 1-12% above consensus. However, we retain

our price target of HK$6.30, as we factor in higher non-gaming obligation

payment growth of 30% p.a. and maintenance capex.

Two overhangs on the stock

–

1) The new gambling law in Cambodia due to

be approved by the end of 2015; this implies a potential tax hike, although we

think the likelihood of this is not high, due to low government reliance on tax

revenue from casinos and the low debt/GDP ratio in Cambodia; and 2)

Morgan Stanley does and seeks to do business with

companies covered in Morgan Stanley Research. As a result,

investors should be aware that the firm may have a conflict

of interest that could affect the objectivity of Morgan

Stanley Research. Investors should consider Morgan

Stanley Research as only a single factor in making their

investment decision.

For analyst certification and other important disclosures,

refer to the Disclosure Section, located at the end of this

report.

Mass: Table buy-ins and TITO have driven higher spending per

capita –

Table buy-ins and TITO were introduced on 85 mass tables and

1,300 slot machines in July and September respectively. In 3Q15, mass

and slot volume grew 8%/5% QoQ, beating seasonality of 4%/3%. Charter

flights from Changsha/Xiao began in July/October translates to higher

hotel occupancy by ~10%. NagaCity Walk is due to open by the end of

3Q16.

VIP: margin improvement in January 2016

, as the company has

agreed with junkets to lower the revenue-sharing cap from 80% to 70%.

This translates into US$20mn of savings for 2016 (9% of 2016e EBITDA)

and GP margin improvement of the VIP business of 700bps (1H15:

31.9%).

(2)

Price Target HK$6.30

Derived from base case DCF. Our price target is based on 2,681mn

shares, after the first dilution of 399mn shares at end of 1Q16.

Bull

HK$7.90

4.5% dividend yield 2016e

Strong visitor growth of 20% for 2016/17; Mass win/table/day

growth of 20% p.a. to US$4.5K/US$5.4K in 2016/17. Inclusion of

Russian project – HK$1.00 per share

Base

HK$6.30

4.8% dividend yield 2016e

Continued growth in visitation and improved outlook for VIP

business: Visitation growth of 5% for 2016/17; Mass win/table

growth of 5%/5% for 2016/17; Inclusion of Naga2 – HK$0.70 per

share.

Investment Thesis

Strong VIP and mass strategies to drive earnings

growth in the medium term

Attractive dividend yield of 7.6%/6.6% on our

2015/16 estimates

Lower demand risks compared to Macau

However, share dilution remains an overhang till

2017 from NagaCity Walk and Naga2 potentially

driving lower EPS and DPS in the next few years

Key Value Drivers

Visitors growth, especially Chinese

Mass revenue growth

New VIP rooms, tables and EGMs

Naga2 potential to boost capacity by 2.5x for

tables and hotel rooms by early 2018

Potential Catalysts

Stronger than expected earnings growth in 2H15

Mass growth to accelerate in 4Q15, driven by

table buy-in and TITO installed in July and

September respectively

Risks to Achieving Price Target

Unfavorable change in gambling law in Cambodia

e.g. higher tax

Reduction in dividend payout ratio

Regional competition (e.g., Philippines, Korea,

Macau, Singapore, etc.)

Delay in opening of Naga2 and Russia casinos

Higher-than-expected operating costs and capex

Political instability and/or natural disasters in

Cambodia

Bear

HK$4.00

5.2% dividend yield 2016e

Downturn in overall economy, more competition from Vietnam,

and reduced visitation. Visitor arrival drop by 15% p.a. for

2016/17; Mass win/table decline by 25% per annum in 2016/17.

Risk Reward

Mass growth and Naga2 opening in 2017 drive upside

(3)

Key Takeaways from Morgan Stanley's Asia Pacific Summit

1. Mass – volume growth and yield improvement continue

We expect mass growth to remain strong in the next two years on the back of: 1) newly installed table buy-in

(July 2015) and TITO (September 2015), 2) charter flights from Changsha/Xian (July/October 2015) and more

cities in future, and 3) the opening of retail mall in 3Q16.

In 3Q15, table buy-ins up 8% QoQ, beating seasonality of +4% (Exhibit 1) and yield also reached record high for

both table and slots (Exhibit 2). Foot traffic to the property remained stable, implying rising spending per capita.

The company does not intend to increase the number of mass tables nor minimum bets (grind mass at US$40

since early 2013) in the near term.

Charter flights

– flights from Macau, Changsha and

Xian to Phnom Penh commenced in late 2014, July and

October 2015 respectively (2-3 flights/week for each

city). Load factor remains high at around 90%,

translating into ~10% occupied rooms for each flight.

Government support to drive Chinese tourism

–

The Prime Minister of Cambodia, Hun Sen, aims to

increase the number of Chinese visitors to Cambodia to

1.3mn per year (2014: 560k) and has called on CNTA

(China National Tourism Administration) to assist with

tourism promotion. He also planned to make RMB to be

more widely used in Cambodia, increase the number of

direct flights, and open more Chinese consular offices.

The National Bank of Cambodia estimates that

income

generated by casinos from non-residents

represented about 40% of the total amount spent by foreign visitors in 2014 of US$2bn

.

Exhibit 1:

Mass table buy-in grew 8% QoQ in

3Q15, better than seasonality of +4% QoQ

Source: C om pany data, Morgan Stanley Research estim ates

Exhibit 2:

Rising mass yield momentum could

continue driven by table buy-in and TITO facilities

Source: C om pany data, Morgan Stanley Research

Exhibit 3:

Chinese visitors growth could remain

robust supported by charter flights and

government support

(4)

2. VIP margin improvement in 1Q16

Volumes and VIP arrivals from Southeast Asia continue to grow, driven by Macau and Malaysian junkets (Exhibit

5). Jimei has started bringing in strong volumes in 3Q15. We think the anti-corruption campaign in China has

had limited impact on NagaCorp because: 1) Naga targets lower-end VIPs who are not the subject of the

campaign, 2) Naga's VIP volume was only 2.6% of Macau's junket VIP roll in 3Q15 (Exhibit 7), and 3) Malaysian

VIPs represent the majority of VIP arrivals (49% of total in 9M15 – Exhibit 4), followed by Greater China at 23%

(vs 10% in 2014) and Singapore at 10%. The company expects the mix of customers from Greater China to keep

growing, and for Malaysian VIPs to remain stable.

Margin improvement

– The company plans to dial back revenue sharing with overseas junkets (contributing

>70% of VIP volumes) to a maximum of 70% from the current 80% starting in January 2016. Malaysian junkets,

which brings in the majority of its business, have already agreed with the new arrangement. Commission to

local junkets and direct VIP are based on 1.1-1.35% of rolling chip volumes. Hence, we expect the blended

commission as a percentage of VIP revenue to drop to 58% from 65%, i.e., a gross profit margin improvement

of 700bps from 31.9% in 1H15.

Exhibit 4:

VIP arrival mix in 9M15 – greater China

represents 23% of total VIP headcount

Exhibit 5:

Number of VIP arrivals from Southeast

Asia continued to grow, driven by Greater China

Exhibit 6:

Margin improvement in 2016, driven

by lower commission rate

Source: C om pany data, Morgan Stanley Research (E) estim ates

Exhibit 7:

NagaCorp VIP roll is about 2.6% of

Macau junket VIP roll in 3Q15

(5)

3. Tax and change in gambling law

Uncertainty about non-gaming tax –

In 1H15, the

company incurred US$9.4mn of tax related to

non-gaming earnings from prior years. The obligation

payment for the non-gaming operation is reviewed

annually, with less visibility in terms of future hikes, in

our view, compared with the payment for gaming

activities, which is fixed at US$365k per month in 2015

and is set to grow at 12.5% per annum till 2018. The

obligation payment for non-gaming operations hiked

by 30% in 2015 to US$214k per month, the highest

increase since its introduction in 2002 (Exhibit 8). We

have assumed 30% p.a. growth in the next three years.

Change in gambling law

and potential tax hike

–

Lawmakers in Cambodia are likely to approve a bill to

regulate the management of casinos (to combat illegal

gambling and money laundering) before the year end, according to the

Phnom Penh Post

newspaper. Also, Ros

Phearun, deputy director of finance industry for Cambodia's Ministry of Economy and Finance, believes

the

new law can increase tax revenue from casinos by two times

.

We think there is a risk of a significant tax hike or replacement of the current flat rate with a variable amount

depending on GGR, despite double-digit growth in tax revenue from casinos in the past few years. Unlike

Macau, tax revenue from casinos in Cambodia only contribute ~3% of total tax revenue collected by the

government vs. ~80% in Macau. Also, gaming tax as percentage of GGR is only 1-2% in Cambodia vs. 39% in

Macau.

On the flip side, the allowance of more online gaming operations in Cambodia will also expand the base of

gaming revenue chargeable for tax. The tax collection from casinos in 9M15 of US$28.8mn also exceeded the

full-year target of US$26mn set in March 2015 (total tax from casinos collected in 2014 was US$25mn). Ten

new licenses were granted by the Ministry of Economy and Finance in 3Q15 alone, and the country had a total

of 75 licenses as at end of September. Government debt to GDP ratio of Cambodia is also one of the lowest at

33% compared to 39%-242% of other Asian countries (Exhibit 10).

Exhibit 8:

Obligation payments - non-gaming

portion is reviewed annually as opposed to a

fixed term of 12.5% p.a. hike for gaming portion

So u rce : C o mp a n y d a ta , M o rg a n Sta n le y R e se a rch (E ) e stima te s

Exhibit 9:

Tax on casinos in Cambodia is minimal

compared to Macau

Note: 76.6% for Macau is based on governm ent budget in 2016 Source: Ministry of Econom y and Finance, Morgan Stanley Research

Exhibit 10:

Cambodia's external public debt is

well within acceptable limits according to IMF

Note: *Singapore's high public debt is not a reflection of lax fiscal policy but is due to the governm ent's efforts to develop debt m arket

(6)

4. Dividends

We think the company may not return its payout ratio back to 70% in 2H15 from 60% in 1H15, as: 1) the 2015e

dividend yield, based on a 60% payout, is already high at 7.8 % (Exhibit 12), and 2) the company has to retain

cash for its Russia project, expected to break ground in 2Q16. We expect 21% DPS growth in 2015 to US$5.08

cents, but then a fall of 23% in 2016 (Exhibit 11), due to 1) share dilution at end of 1Q16 by 399mn shares (or

17% of existing share capital) and 2) 10% decline in net profit due to absence of one-off slot revenue of

US$40mn in 2015.

5. Future developments

NagaCity Walk –

Construction will be completed by the end of 1Q16, followed by interior fitting and open by

end of 3Q16. China Duty Free will operate roughly 80% of the total retail space of 420k sq ft. Although we do

not expect rental income to be material, we expect the shops to increase domestic traffic significantly.

The Angkor Duty Free opened in Siem Reap in December 2014 and has attracted 20mn shoppers and

contributed US$300mn in tax revenue. China Duty Free Group recently signed a cooperation agreement with

Beijing Huachao United Assets and Teshehui Group to boost sales in Siem Reap as the Cambodian government

seeks to increase the number of Chinese tourists to >1mn per annum (2014: 560k ).

Naga2 –

This remains on schedule, with construction to be completed by the end of 2016/early 2017 and

opening in six months following completion of construction. The asset will be debt free, like NagaCorp. Recent

news in the media regarding alleged improper construction practices has not interrupted the schedule. This

news was related to some features introduced by the architects that attracted public concern – these will be

removed based on the instructions from the prime minister, according to the company. In terms of staffing,

some dealers of existing property will be moved to Naga2, as the company has been increasing headcount

gradually.

Russia

– The company expects construction work to start in April/May 2016, with the opening of Phase 1 due in

2018. Total budget for the project remains unchanged at US$350mn, with US$200mn for Phase 1. To date, the

company has incurred minimal investment on the project, and it expects to step up its investment in 2016.

Incheon project in South Korea

is pulled back –

The company thinks the return on investment is

unfavorable, due to its being a foreigner-only casino and the high minimum investment of US$1bn. Hence, the

company did not proceed further with its request for the concept.

Cyprus –

The project is still in the exploration stage and looking for a payback period of four years.

Exhibit 11:

NagaCorp DPS to grow 21% in 2015e

but fall 13% in 2016e, due to share dilution at end

of 1Q16 and decline in net profit

Source: C om pany data, Morgan Stanley Research (E) estim ates

Exhibit 12:

NagaCorp 2015e dividend yield above

Macau peers

(7)

2H15 EBITDA/Profit growth of 30-34%

We expect revenue, EBITDA and net profit growth of 37%, 30% and 34% to US$293mn, US$115mn and

US$92mn respectively for 2H15, driven by 23% growth in mass revenue (17% YoY in 3Q) and 52% growth in

VIP revenue (luck +60bps YoY based on 3.70% in 3Q and normalized 2.85% in 4Q). Our forecast is based on

seasonally stronger 4Q vs. 3Q, as well as higher spending/capita and traffic helped by table buy-in, TITO and

charter flights introduced in 2H15.

Our revised 2H15 EBITDA of US$115mn and net profit of US$92mn are 25% and 29% above consensus

respectively.

Exhibit 13:

We expect 2H15 EBITDA and profit to grow 30% and 34% YoY respectively

(8)

Valuation – Maintain OW and price target of HK$6.30

We raise our 2015-17 EBITDA estimates by 13-33%, driven by stronger-than-expected mass and slot revenue in

3Q15 (both beating seasonality), which we think can be sustained with the help of catalysts introduced in 2H15.

The revision for 2015, includes the one-off slot income of US$40mn. Stripping that out, the revision would have

been 12%. We think negative earnings revision has bottomed (Exhibit 15 and 16). Our revised 2015/16 EBITDA

and net profit are +10%/-3% and +12%/+1% vs consensus respectively.

Exhibit 14:

Earnings revisions

New Old Change

US$ mn 2015E 2016E 2017E 2015E 2016E 2017E 2015E 2016E 2017E

Revenue 558 532 557 467 512 534 19.5% 4.0% 4.4%

EBITDA 248 225 230 186 197 203 33.2% 14.2% 13.0%

Net Income 193 174 173 143 151 154 34.7% 15.7% 13.0%

EPS (US cents) 8.46 6.75 5.31 6.02 5.62 5.73 40.6% 20.2% -7.2%

So u rce : M o rg a n Sta n le y R e se a rch (E ) e stima te s

Exhibit 15:

Morgan Stanley vs. Consensus

MS Consensus Variance

US$ mn 2015E 2016E 2017E 2015E 2016E 2017E 2015E 2016E 2016E

Revenue 558 532 557 518 557 666 8% -4% -16%

EBITDA 248 225 230 225 232 243 10% -3% -5%

Net Income 193 174 173 172 172 171 12% 1% 1%

EPS (US cents) 8.46 6.75 5.31 7.50 6.50 4.90 13% 4% 8%

So u rce : Th o mso n R e u te rs, M o rg a n Sta n le y R e se a rch (E ) e stima te s

Exhibit 16:

2016 EBITDA revision

Source: T hom son Reuters, Morgan Stanley Research estim ates

Exhibit 17:

2016 net profit revision

(9)

We maintain our price target at HK$6.30

. The impact

of 13-14% uplift in 2016/17 EBITDA was offset by 1)

higher maintenance capex of US$25mn p.a. (previously

US$18mn) , 2) higher growth of obligation payments

for non-gaming activities of 30% (previously 20%) and

3) lower net cash of US$212mn at end of 1H15

(previously US$245mn at the end of 2015). The equity

value per share for existing casino of HK$5.60 implies

10% upside and 5.4% dividend yield for FY2016e.

In our DCF model, we assume: 1) WACC of 11.7% based

on A) debt to equity ratio of 20: 80, B) Cost of equity of

12.4%, based on beta of 1.2, risk free rate of 4.0%, and

equity risk premium of 7.0%, C) cost of debt of 9.0%

(unchanged); 2) Medium-term growth rate of 5.0% from

2017 to 2023 (unchanged); 3) Terminal multiple of 8.5x

with terminal growth rate of 0% (unchanged). We value

Naga2 using separate DCF (unchanged).

Exhibit 18:

Discounted cash flow

So u rce : M o rg a n Sta n le y R e se a rch e stima te s

Exhibit 19:

NagaCorp EV/EBITDA discount vs.

Macau (ex SJM) on consensus estimates

Source: T hom son Reuters, Morgan Stanley Research

Exhibit 20:

NagaCorp EV/EBITDA on consensus

estimates

Exhibit 21:

NagaCorp P/E discount vs Macau (ex

SJM) on consensus estimates

Exhibit 22:

NagaCorp P/E on consensus

estimates

(10)

Exhibit 23:

Valuation comps - Macau vs NagaCorp

(11)

Financial Summary

Exhibit 24:

NagaCorp financial summary

(12)

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Analyst Certification

The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Praveen K Choudhary; Alex Poon.

Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

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Important US Regulatory Disclosures on Subject Companies

In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Galaxy Entertainment, Melco Crown Entertainment Ltd, MGM China Holdings Limited, NagaCorp, Shun Tak, SJM Holdings, Wynn Macau, Limited.

Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from Melco Crown Entertainment Ltd, NagaCorp, Wynn Macau, Limited.

Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: Galaxy Entertainment, Melco Crown Entertainment Ltd, MGM China Holdings Limited, NagaCorp, Shun Tak, SJM Holdings, Wynn Macau, Limited.

Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: Melco Crown Entertainment Ltd, NagaCorp, Wynn Macau, Limited.

Morgan Stanley & Co. LLC makes a market in the securities of Melco Crown Entertainment Ltd.

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Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution

(as of October 31, 2015)

For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.

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COVERAGE UNIVERSE INVESTMENT BANKING CLIENTS (IBC)

STOCK RATING CATEGORY COUNT % OF TOTAL COUNT % OF TOTAL IBC % OF RATING CATEGORY

Overweight/Buy

1210

36%

340 43%

28%

Equal-weight/Hold

1445

43%

346 44%

24%

Not-Rated/Hold

91 3%

9 1%

10%

Underweight/Sell

651 19%

95 12%

15%

TOTAL

3,397

790

Data include common stock and ADRs currently assigned ratings. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months.

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Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

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(14)

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INDUSTRY COVERAGE: Hong Kong/Macau Gaming

COMPANY (TICKER) RATING (AS OF) PRICE* (11/23/2015)

Alex Poon

NagaCorp (3918.HK) O (02/06/2015) HK$5.04

Shun Tak (0242.HK) O (03/27/2015) HK$2.98

Praveen K Choudhary

Galaxy Entertainment (0027.HK) O (09/25/2015) HK$23.10

Melco Crown Entertainment Ltd (MPEL.O) E (10/29/2015) US$16.10

MGM China Holdings Limited (2282.HK) U (07/08/2015) HK$10.46

Sands China Ltd. (1928.HK) E (09/01/2015) HK$26.25

SJM Holdings (0880.HK) U (10/03/2014) HK$6.01

Wynn Macau, Limited (1128.HK) U (03/16/2015) HK$10.08

Stock Ratings are subject to change. Please see latest research for each company. * Historical prices are not split adjusted.