The Darker Side of Gaming in Macau

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Gambling in Macau has long been known as a somewhat seedy business. Stanley Ho, the man who ran a gambling monopoly in Macau for four decades, was often linked to organized crime. MGM Resorts (NYS: MGM) was forced to divest from its Atlantic City resorts because of its relationship with his daughter Pansy Ho.

Today the mob ties have mostly been swept under the rug in the public's eye, but the business of money laundering is apparently booming in Macau.

The racket
The process is fairly simple. A Chinese citizen is brought to Macau by a junket that lends the player money that will be repaid in Chinese yuan. The player gambles for a period of time, and when he or she cashes out in Macanese patacas or Hong Kong dollars, that amount can then be deposited in a bank in Hong Kong or somewhere else.

The original funds may be corporate profits, embezzled government funds, or family wealth, but Chinese nervous about new leaders in the Communist Party are finding ways to preserve what cash they have outside China.

A Bank of America Merrill Lynch report warned of "hot money" flowing from China this year in anticipation of the government change.

What effect will this have on Macau casinos?
The question for casinos is twofold. Will the flow of money through Macau slow gaming growth, and will junkets be hurt by clients fleeing China with laundered funds?

Up to now, there is little data to show how much of Macau's gaming wins may be laundered money and how much is just good old-fashioned gambling. Therefore, it's tough to gauge what the impact may be if the money flow slowed down. But the impact could be huge. VIP play accounts for nearly three-quarters of the gaming at casinos, and Wynn Resorts (NAS: WYNN) , Melco Crown (NAS: MPEL) , and Las Vegas Sands (NYS: LVS) all rely on high rollers and junkets to drive profits.

If China is truly concerned about money laundering, I could see visa restrictions enacted again, as we saw in 2008. Otherwise, it looks very hard to control.

As for junkets like Asia Entertainment & Resources (NAS: AERL) , the risk is much higher. Junkets lend money to players, and if these players are suddenly unable to pay back loans, their liquidity could dry up quickly. According to wealth researcher the Hurun Report, as many as 46% of wealthy Chinese are considering ways to leave the country, in part to maintain their current wealth -- and that could leave junkets high and dry.

A mass exodus could be bad news for junkets and casinos that play a vital role in Macau's not-so-secret money-laundering trade. And this darker side of Macau may explain exactly why Chinese gamblers use junkets in the first place instead of borrowing from the house, the way players do in the United States.

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At the time this article was published Fool contributorTravis Hoiumhas sold puts in Melco Crown. You can follow Travis on Twitter at@FlushDrawFool, check out hispersonal stock holdings, or follow his CAPS picks atTMFFlushDraw.The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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