Once upon a time the only way to get rich in a casino was to own one. These days, however, casino ownership has lost its gloss. Star Entertainment Group Limited, Australia’s largest listed casino operator, illustrates how challenging the casino business has become.
Star also provides an excellent demonstration of how AI software can detect financial problems at a company well before investors or creditors voice concerns.
Table of contents
Introduction
Originally known as Echo Entertainment Group, the company was established in 2011 after demerging from its parent, Tabcorp Holdings Limited. This move allowed Echo to focus on expanding its casinos and entertainment venues across Australia, a portfolio that includes The Star Sydney, The Star Gold Coast, and Treasury Brisbane. In July 2015, Echo won a bid to build the Queen’s Wharf Brisbane, a major tourism development, rebranding itself as Star Entertainment in the process.
Star could seemingly do no wrong. Revenue was booming, largely thanks to the lucrative high-roller gaming business, and the Queen’s Wharf project promised to sustain growth well into the future. In February 2018, its share price peaked at A$4.61.
And then Covid-19 happened. The suspension of international tourism to Australia killed Star’s high-roller business and subsequent regulatory problems have prevented a full recovery in this premium segment. Covid helped fuel the rise of online gambling around the world, hammering land-based casino businesses.
At the time of writing, Star’s share price has tumbled 94% from its 2018 high. The company has reported billions of dollars of losses and sought more than A$1.3 billion in capital to stay afloat.
How bad are things in Star’s financial statements? To answer this question, we turned to our AI-powered Manipulation Risk Analyzer, which evaluates the quality of a company’s accounting.
The MRA gives Star a manipulation risk rating of 85% for its 2024 accounts, which puts Star in the weakest 2% of all companies measured by our system globally for accounting quality and transparency.
It’s worth noting that Star has logged poor scores from our system for a number of years, even as its share price rocketed. Its most recent score is exceptionally high and reflects issues related to both accounting quality and risk of business failure. The MRA suggests that Star warrants extreme care in relation to income quality, credit, asset quality, smoothing activity and corporate governance. We will dive into some of these risk signals further down.
First, some background.
Rising competition
Star’s decline reflects both industry and company-specific factors. Casinos operate in a tough competitive environment. Since casinos compete on opulence and facilities, they involve enormous fixed costs and enormous debt. Onerous debt means that casinos are highly sensitive to changes in interest rates and changes in the competitive environment.
The competitive environment includes not only rival casinos and other traditional forms of gambling, it also includes online gaming (iGaming) and sports betting. iGaming boomed during the global pandemic when most casinos were closed or faced heavy restrictions, and travel restrictions kept regular gamblers at home.
With such tough competition, some believe traditional casino operators face prospects similar to blacksmiths with the advent of the motor vehicle.
Some believe traditional casino operators face prospects similar to blacksmiths with the advent of the motor vehicle.
iGaming has substantial advantages over the traditional casino model. It does not require heavy fixed investment because the software can be licensed, it can attract global players, is 24 hour, is ineffectively regulated in comparison to brick and mortar casinos and, as a consequence, pays substantially less tax. iGaming is not lightly regulated. However, it is subject to a complex framework of laws and regulations that vary across different jurisdictions that make evasion possible.
PwC expects online gambling in the US to reflect a compound annual growth rate (CAGR) of 24% from 2022 to 2028. Growth rates elsewhere are expected to be similar, stealing revenue from traditional gambling markets, such as casinos. As a consequence, casinos will be increasingly reliant on high-roller business or other forms of entertainment to generate revenue.
High rollers
Prior to the pandemic in 2020, high-end international gamblers flocked to Australian casinos in great numbers. These high rollers accounted for between 15% to 30% of Star’s total gaming revenues, while representing a mere fraction of its operating costs. As a consequence, the high-roller segment likely represented well over 30% of net profit and may have subsidised some of the group’s other operations.
Unfortunately, the high rollers came with a catch.
High rollers generally came from China and, in the casino business, Chinese high rollers do not materialise from thin air. They are recruited by specialist operators, known as junkets, which enhance the casino experience by providing clients with incentives such as complimentary travel, accommodations, and other luxury services.
Anyone familiar with Macau will know that junket operators have a shady reputation due to alleged triad links. Earlier this year, junket links to organised crime were detailed in a special report by the United Nations Office on Drugs and Crime (UNODC). This report, “Casinos, Money Laundering, Underground Banking, and Transnational Organized Crime in East and Southeast Asia: A Hidden and Accelerating Threat,” details how junket operators evolved from mere recruiters into financial conduits for criminal organisations.
The report details how triads frequently funded junkets, assisted with debt collection, helped junkets evade regulations, used junkets to enable money laundering and helped several junkets expand into online gambling. In essence, the operational model allowed high-net worth individuals to avoid China’s strict currency controls. They simply hand their money to a junket operator which then provides access to gambling funds in another jurisdiction.
Under this arrangement, UNODC argues that organised crime groups utilise casinos as fronts for their operations, treating casino accounts like traditional bank accounts for transferring and receiving money.
The authorities responsible for policing money laundering across Asia have long been aware of the problem with junkets but enforcement is difficult due an absence of proof.
Challenging times
Any casino desiring access to lucrative Chinese high-rollers must play the junket game.
In 2019, allegations surfaced that Crown Resorts, Star’s main competitor, was involved in money laundering and had connections to organised crime through junket operators. A subsequent NSW enquiry concluded that Crown was unsuitable to hold a licence for its new casino at Barangaroo. Similar inquiries followed in Victoria and Western Australia. AUSTRAC, Australia’s anti-money laundering watchdog, also investigated Crown’s compliance with anti-money laundering laws.
Crown’s woes were a short-term boost for Star but the company was already the subject of regulatory scrutiny. Regulatory and media reports indicated that between 2014 and 2021 the company had attempted to recruit high rollers linked to criminal activities.
Most important, a probity report conducted in 2015 assessed the suitability of Hong Kong-based Chow Tai Fook Enterprises (CTFE) as a casino operator and included evaluations related to their associations with junket operators. This mattered for Star because it’s building the A$3.6 billion Queen’s Wharf Brisbane project with CTFE and Far East Consortium, another Hong Kong company.
Queen's Wharf Brisbane. Image source
The probity report was significant as it laid the groundwork for future investigations into CTFE’s relationships with individuals like Alvin Chau. In July 2019, media reports surfaced indicating that Chau was suspected by Australian law enforcement agencies of large-scale money laundering. These reports highlighted concerns regarding the operations of junket operators at casinos including Star's.
Following these revelations, multiple inquiries were launched by state gaming regulators in New South Wales, Queensland, Western Australia, and Victoria. On September 13, 2022, a report by the NSW Independent Casino Commission found Star unsuitable to hold its Sydney casino licence due to its conduct related to money-laundering risks. As a result of these findings, Star faced significant penalties including a A$100 million fine and operational changes under new management.
The results of the NSW inquiry were so damning that the company insisted on a second review. In August 2024, this second review repeated the findings of the first. Star was found unfit to operate a casino having “failed to address a culture of unethical conduct and criminal infiltration.”
Because of Covid, and amidst these regulatory issues, Star’s revenues and share price plummeted. In 2023, the company required two capital injections to stay afloat. It borrowed A$595 million in February and, in September, it raised A$750 million more.
The company reported a loss for the financial year 2023-24 of A$1.69 billion. While an improvement from the previous year’s A$2.44 billion loss, it still signifies a substantial deficit. The opening of the casino and hotel operations at Queen's Wharf in August 2024 will boost revenue but the profit contribution remains uncertain. The entire project will not be fully complete until 2030.
To avoid the loss of its gaming licence in NSW, the company hired yet another management team to untangle the mess. Efforts to keep Star afloat and keep its licences are ongoing. However, the reputational damage has been immense.
Star Entertainment's accounting quality
Transparently.AI's MRA has been trained to recognise risk signals and patterns by observing similar signals and patterns in more than two decades' worth of publicly disclosed financial statements. As such, the observations that our system makes of Star are based on what it has seen before, in thousands of examples of aggressively managed corporate accounts.
What follows is a discussion on risk signals that the MRA found in Star's accounts, along with some observations on what these signals might indicate, based on what similar signals have indicated in previous historical examples where they've been detected. We make no allegations of any wrong doing by Star, nor are we privy to any of the company's internal workings.
With that disclosure in mind, we return to the analysis. Even during Star’s boom years, Transparently’s MRA was not enthused. The MRA produces company accounting risk reports on demand, and, for 2018, it gave Star extreme risk signals for asset quality, working capital signals and high risk signals for income quality valuation manipulation.
As we mentioned earlier, the MRA gives Star a manipulation risk rating of 85% for its 2024 accounts. It suggests that Star warrants extreme care in relation to income quality, credit, asset quality, smoothing activity and corporate governance. It suggests high caution with respect to cash quality, business manipulation and working capital signals.
It is important to remember that the system looks for patterns associated with manipulation risk, and the score is not additive, but rather depends on the combination of anomalous patterns observed.
Some combinations, such as those evident in Star, are potentially more serious than others. In this discussion, we shall focus on income, asset and cash quality.
Income quality
The system gives Star low marks for income quality because it detects that:
- A significant proportion of income is derived from non-operating activities, and
- Star has a very high level of extraordinary charges.
Not all income is created equal. Income from core operations is typically recurring and is of higher quality than income from non-operating sources. Non-operating sources can include income from affiliates, gains from investing activities and extraordinary items.
These items are subject to considerable discretion from management and thus impede transparency and provide opportunities for manipulation. Too much reliance on non-operating income can indicate that a company's core operations are too weak to sustain the business. A high level of extraordinary charges can be a sign that a company has been too optimistic in valuing assets.
In this case, the system assesses that Star has abnormally high levels of both non-operating losses and extraordinary charges (see Figure 1). Casinos are relatively self-contained businesses, generating most, if not all, of their revenue on site. It is thus unusual for a casino operator to have significant non-operating earnings or losses.
In FY2024, the company reported a significant non-cash impairment of A$2.2 billion related to goodwill and property assets across its casinos in Sydney, Brisbane, and the Gold Coast. This charge represents the continuation of a pattern of write downs and exceptional credits at the company since 2020.
The MRA associates a consistently high level of extraordinary items with manipulation risk. For example, large write downs are frequently associated with improper capitalization of expenses or income manipulation via affiliates.
Figure 1: Extraordinary charges as a percentage of total assets
Source: Transparently.AI
In general, companies recognize asset impairment when it can longer be hidden. It is not a positive because it can sometimes mean that other aspects of the accounts have also been exaggerated.
In addition, the system notes that Star has an unusually low contribution from abnormal income/expenses when compared with other aspects of the report. The system has found that this combination can be associated with higher manipulation risk. For example, if a company makes a massive write-down of assets, it will normally be associated with efforts at cost reduction, such as job cuts and renegotiated long-term contracts. These will show up as abnormal expenses.
If the system sees big asset write-downs without accompanying expenses associated with cost cutting, it can mean that underlying problems have not been properly addressed and thus poor profitability might continue.
Asset quality
When a company demonstrates both poor income quality and poor asset quality, the potential significance of each signal is increased because the system identifies a higher risk of accounting manipulation when both of these risk clusters are triggered.
Star has high asset quality risk on the system because it has high investments in associates, because its depreciation rates have collapsed, and because it has written down significant intangible assets in recent years.
Investment in associates takes place when a company owns between 20% and 50% of the voting shares of another company. It means that the company holds a significant influence over the management of another company, without having formal control. Investment in associates offers scope for manipulation, especially in the acquisition price and in the reporting of earnings since associate earnings are not consolidated.
Figure 2: Investments in associated entities relative to total assets
Source: Transparently.AI
In recent years, Star’s investment in associates has been around three standard deviations above its regional and sector average. In FY2024, Star’s investments in associates fell to 8.52% of total assets from 12.75% in FY2023.
The system interprets the high level of investment in associates combined with the sharp reduction in their value as a pattern frequently associated with risk of manipulation. It might suggest, for example, that these assets may have been overvalued. The system has determined that the mark-down of easily manipulated assets, such as investments in associates and intangibles is typically a negative sign, not a cause for optimism.
Star had an exceptionally high level of intangibles on its balance sheet until 2022. In the subsequent two years, intangibles fell from 31.5% of total assets to just 3.8%. A high level of intangibles typically means that a company has intellectual or relationship assets that confer competitive advantage and supernormal profit. When the value of such assets is written down, it either means this advantage has been lost or that the assets were overvalued.
Figure 3: Total intangibles relative to total assets (%)
Source: Transparently.AI
While still on the subject of asset quality, the system detects that Star’s rate of depreciation relative to net fixed assets was 34% lower in 2024 than in 2023, meaning that the company drastically cut its depreciation assumptions. The system interprets sharp changes in depreciation rates as evidence of manipulation risk.
Cash quality
The MRA gives Star low marks for cash quality because it detects abnormal changes in working capital, a disparity between interest paid and interest expense, and the absence of a dividend in spite of large cash holdings.
Changes in working capital in the cash-flow statement can be difficult to reconcile with changes in other areas of the accounts and are thus a key area of account manipulation. As a consequence, the MRA system pays close attention to changes in working capital in relation to sales, cash-flow generation and short-term payables and receivables.
In this case, the system detects that Star exhibits a very high risk signal for change in working capital. This essentially means that the system detects irregularities in the relationship between working capital requirement and other measures of business activity.
This evidence of irregularities in working capital is mirrored in other abnormal patterns that the system associates with risk of business manipulation. Specifically, the system is flagging an unusual increase (and/or levels) in production activity relative to sales. Basically, the cost of sales appears to have risen sharply in comparison with revenue. This shift in the relationship could partly reflect the loss of high-roller business, but this would have occurred earlier than 2024 so questions remain.
Whatever the cause, the system assesses that Star has high cash quality risk. The absence of a dividend is another factor influencing this assessment. The absence of a dividend is not surprising given the losses sustained by Star in recent years, but nevertheless reveals a lack of confidence on the part of management and is seen as a negative by the system.
Another tell-tale of cash risk identified by the system is that interest expense on Star’s income statement was significantly less than what it actually paid in cash. Such a discrepancy can be a sign that a company may have capitalised some of its interest expenses instead of recording the expense immediately.
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Disclaimer: Views presented in this blog are the author’s own opinion and do not constitute financial research or advice. Both the author and Transparently Pte Ltd do not have trading positions in the companies it expresses a view of. In no event should the author or Transparently Pte Ltd be liable for any direct or indirect trading losses caused by any information contained in these views. All expressions of opinion are subject to change without notice, and we do not undertake to update or supplement this report or any of the information contained herein.
About the author: Mark Jolley has been an investment strategist for almost 40 years and has advised some of the world’s biggest investment funds, public companies and notable investors. In the mid-1990s, as a global investment strategist with Deutsche Bank, Mark produced a daily note read by more than 16,000 investment professionals including voting members of the Federal Reserve and the European Central Bank. In the 2000s, Mark worked as Deutsche Bank’s Asian strategist and then as strategist for China Construction Bank. He is now an independent analyst.
