AFTER A MONTHS-LONG

losing streak, Macau casino operator Melco PBL Entertainment's luck seems to be changing. Fierce competition hit Melco and several rivals hard last year as more and more casinos opened, driving down margins as they fought for customers.

Melco PBL

Las Vegas Sands

Wynn Resorts

More recently, however, Melco's hand has improved. It's found ways to grab more customers, and has a huge new casino on tap. The Chinese government is now limiting new competition, aiding all the local houses. Meanwhile, shares of the Sands and Wynn are getting pounded by fears about a weak U.S. economy.

Bargain hunters have begun to take note. "This is a very interesting story, and one worth beginning to start revisiting," says Philip Ehrmann, an Asia specialist and long-term Macau skeptic at Jupiter Asset Management in London. Others say that Melco's stock, which has risen from a low of 8.2 to 13 recently, could top its recent high of 19, about a 50% gain, and even go well beyond that in the next few years.

Melco's ups and downs mirror those of other casinos in Macau. In 2006, gaming revenues at the former Portuguese colony outstripped those of Las Vegas as lavish new casinos attracted China's newly rich. The Sands casino made back its investment in its first year, and there are high hopes for its Venetian Macau.

But a spate of openings began to pressure results: Macau currently lets six companies operate 29 casinos. Last week, the Sands announced it lost money in its first quarter, hurt by competition from MGM Mirage and from the loss of high rollers to rivals like Melco's Crown Macau, which grew out of Melco's partnership with Australia's Crown Ltd. (CWN.Australia), run by casino impresario James Packer.

The company came public in the U.S. last summer, and is 38% owned by Melco International Development (0200.Hong Kong), in which Lawrence Ho has a big stake.

Melco didn't get off to a fast start. It opened Crown Macau in a remote corner called Taipa Island, where it snagged just 1% of the market, unlike the stellar performances of the local Wynn or Sands resorts, or the market-dominating Sociedade de Jogos de Macau run by Ho p re. But Ho fils quickly boosted his numbers by striking a controversial deal with A-Max Holdings (959.Hong Kong), a company that represents 10 junket operators that are paid commissions to bring in high rollers, or VIPs. To qualify for VIP status, a gambler must plunk down at least HK$1 million ($128,000) at the tables per visit.

The arrangement sacrificed some margin: "We really adjusted," recalls Ho, who was educated in Canada.

As he explains: "Slots have the highest Ebitda [earnings before interest, taxes, depreciation, and amortization] margins about 40%. For mass [market], it's 30%. But for VIP, it's in the high single-digits." Still, that's offset by volume.

Shun Tak Holdings

(242.Hong Kong), operator of the Hong Kong-Macau ferry and MGM's Macau partner.)

The grand opening of Melco's mega-casino City of Dreams in '09 should focus more attention on Melco. Ho raised $1.7 billion last year. The casino is now fully funded.

The government of Macau has also helped build value for casino operators. It recently said it wouldn't issue any more gaming licenses or grant new land for gaming purposes. And it imposed a moratorium on new tables and slots, and said junket commissions would be regulated. "Macau gaming's barriers to entry have gone from being high to insurmountable overnight," wrote UBS analyst Robin Farley in a recent note.

Under Lawrence Ho, Melco International is also getting into Chinese ski resorts, and expanding its gaming activities to South Korea, the Philippines and elsewhere in Asia. "He's bringing new blood with a product strategy that's very different from Legacy Macau, including six-star properties with non-gaming amenities and plans for mass-market visitation," says Deutsche Bank analyst Bill Lerner.

In the next few days, Melco PBL will report its first-quarter numbers. Ho won't discuss those, but does outline the investment case: "This is a play on Asia and specifically the Chinese consumer. We have minimal exposure to a U.S. recession. Will we continue to grow? Yes."

The Bottom Line

Shares of Melco PBL Entertainment could rise 50% or more as China indulges its love of gambling.

Joe Fath, the gaming analyst at T. Rowe Price, thinks that Melco will post Ebitda of $70 million for the first quarter, putting it well on its way to beating estimates of $100 million to $150 million for the full year. Analysts, on average, think Melco will earn 19 cents a share for '08, 65 cents in '09, and 95 cents in 2010. That puts the stock's valuation at a nosebleed 68 times earnings for the current year, but just 20 times '09. "In three years, you should get a double on this stock," says Fath. Not a bad bet.