David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Is Japan's $40 billion casino industry about to be strangled in its cradle?

That's one way of looking at proposed regulations that would effectively ban junket operators from the gambling resorts the country is due to start opening early next decade. Activities such as exchanging money for chips and lending money for wagers will have to be handled in-house rather than farmed out to third parties, Isabel Reynolds and Takashi Hirokawa of Bloomberg News wrote Wednesday.

Such a crackdown would certainly deal a mortal blow if implemented in Macau. The territory's big six resorts rely on junket operators to recruit mainland high rollers to its gaming tables, and get around rules that prevent Chinese residents from taking more than $50,000 a year out of the country.

Aces High
VIP gambling makes up the majority of Macau's gaming revenue
Source: Bloomberg

Even in recent years when Beijing has tried to rein in the activities of high rollers, VIP gambling, where junkets predominate, has made up between 50 percent and 60 percent of Macau's casino revenue.

That's just revenue, though -- and any business with an eye to investment will want to pay attention to earnings, too. On that front, the advantages of VIP gambling are much less apparent, because high rollers are notoriously low-margin customers.

A table dedicated to a VIP gambler can see tens of millions of dollars staked over the course of a night. That's attractive to casino owners both in terms of productivity per square meter of property, and cash liquidity for the casino as a whole.

Win Some, Lose Some
VIP games make up the vast majority of bets at Las Vegas Sands' Macau casinos, but mass-market games score more revenue
Source: Bloomberg, Gadfly calculations

VIP gamblers aren't stupid, though. They overwhelmingly play baccarat, where the probabilities are only slightly more in the house's favor than a coin toss. Moreover, they have the pick of Asia's gambling resorts to find whichever table will offer them the best chance of beating their odds. They expect private-jet flights, breathtaking penthouse suites, and Michelin-class meals, and the junket operators will want their cut of the profits, too.

At Las Vegas Sands Corp.'s Macau casinos, winnings from VIP tables came to just 3.2 percent of bets last fiscal year, versus 22 percent of the wagers on mass-market tables. VIP bets amounted to two-thirds of the cash staked at the resorts, but just 29 percent of the money that came in as revenue through house wins.

That's even before you consider some of the risks involved in getting enmeshed in the junkets trade. One issue, highlighted by the panel drafting Japan's new regulations, is crime. "The junket system brings the risk of money laundering, organized crime and illegal high-interest loans," Masayuki Watanabe, a lawyer with Miyake & Partners in Tokyo and a member of the panel, said in a report. 

Rolling the Dice
Operating return on assets at Las Vegas Sands' Singapore casino has outstripped Macau
Source: Bloomberg

Even chasing Chinese VIPs directly carries risks. Staff of Crown Resorts Ltd. are due to appear in a Shanghai court this week on charges related to promoting gambling, a crime on the mainland. The Australian company has shuttered most of its Asian offices and sold out of a 27 percent interest in Macau's Melco Resorts & Entertainment Ltd. since the employees were arrested last October.

A much better model for Japan's casinos can be found in Singapore, which bans junkets at its two casino resorts. That conservatism doesn't appear to have done the city-state's casino investors any harm: Operating return on assets at Marina Bay Sands has been markedly better in recent years than at Las Vegas Sands' Macau properties. Return on invested capital at the other resort operator, Genting Singapore Plc, has only modestly underperformed Melco, the Macau company rated most highly by analysts.

Capital Flight
Return on invested capital at Genting Singapore is more or less in line with Melco Crown, Macau's most highly-rated casino business
Source: Bloomberg

For all its gilded image, junket-based VIP gambling in some ways resembles a high-volume, low-margin business like discount retailing more than it does a luxury industry. Japan, with its vibrant pachinko-parlor gambling culture and wealth of tourist attractions, will find that its casinos get by just fine without it.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net