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MGM - No Longer King of the Jungle

October 26, 2011 | About:
Invest E Gator

Invest E Gator

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In answering the question of what would be my target price for MGM Resorts International (MGM), I would have to answer no where near the current price of $10.84 a share. It will probably be best to sit tight until that decimal moves over one place to the left.

Would I be a buyer at this time? No, and I shall try to make a clear case for both of these answers.

MGM Resorts International is a holding company engaged in gaming, hospitality and entertainment. Primarily owning and operating casino resorts that include gaming, hotel, dining, entertainment, retail and other resort amenities. They have full ownership of 14 resorts: 9 of them in Las Vegas, 2 in other parts of Nevada and 3 in other states. They also have half ownership of 4 other resorts and full ownership in 3 golf courses.

The skinny

There are other things to be considered but, for anyone not interested in going too deeply into the subject, I can save you some time with this: After investigating the company, I am left wondering if, when the chips are down, their portfolio of properties, the equivalent of 16 fully-owned resorts, plus 3 minorly-consequential golf courses and some management agreements, is ultimately worth more than the total debt of $17 billion minus cash on hand of $921 million. About $1 billion per resort. How there is room for the investors' market capitalization for the company of $5 billion on top of that leaves too much for speculation.

Now on to the finer details...

The part laying doubt as to the value of the resorts having what we can call a "tough times" value of more than an average of a billion each is that they recently sold Las Vegas Treasure Island in 2009 to Billionaire Phil Ruffin for $746 million in net proceeds. According to the information in their supplemental dated March 17 of that year, when they sold Treasure Island, it calculates to a multiple of 7.4 times 2008 EBITDA. If we multiply all of their 9 Las Vegas properties by that same EBITDA multiple, it doesn't reach enough to pay off their long-term debt of about $12 billion. Are their five non-Vegas resorts, four half-owned investments and three golf courses enough make up the difference to cover all liabilities?

In 2009, MGM was effectively obligated by New Jersey regulators (aka "government mafia henchmen thugs") to put their half-owned New Jersey resort casino up for sale, with an original "enterprise value" of $1.3 billion for the entire asset, and have only had one offer of $250 million in October 2010 for their 50% ownership. The other half owner declined their first right of refusal at this price. If I am to give the MGM management an evaluation, putting themselves into such a deeply debted situation that forces them to hand their properties off to low bidders certainly keeps them from earning high marks. They have also been writing down billions upon billions of dollars in asset impairments over the last couple of years, defined as writing off a portion of a property's carrying value to meet with the fair value. This provides evidence that in all of the wheeling and dealing that seems to go on in this business, where property and money get traded around quite regularly, they could have done a much better job at the deal making.

Las Vegas is recovering from the shock of 2008, but MGM's competition is trending slightly better.

As far as the great city of Vegas goes, the award for the-best-of-the-best is currently held by Wynn Resorts (WYNN). They spent $2.2 billion on their annoyingly-luxurious Las Vegas flagship, breaking through barriers to become the only casino resort in the world to hold both the Mobil 5 Star and the AAA 5 Diamond ratings, thus bringing quite a threatening nuisance to the MGM lion's domain.

Things still are not yet at their best for the city of sin and excitement, but Wynn Las Vegas' fundamentals started showing signs of recovery from the 2008 crisis by their 2010 annual report, while MGM was still on the downtrend. MGM is only now starting to show a recovery in their recent quarterly reports, and it is striking me as a bit late, as the financial crisis was back in 2008. Sooner or later, we are going to go into another economic downturn. It's outside of the ability of my logic-oriented crystal ball to try and predict when, but history shows that the economic storms rage every couple of years and if it has taken this long for MGM to show an uptrend, the next downturn could very well be another financial catastrophe for any non-vigilant shareholders.

Another Las Vegas competitor that may be considered against MGM is Las Vegas Sands Corporation (LVS). For reasons of simplicity, and to save the reader from a case of information overload, I am leaving their performance numbers out of this report. However, I will add that their numbers are trending more like Wynn in that they took a hard hit from the 2008 financial crisis but had a slight glamorless uptick of some indicators by 2010. We can start by looking at the hotel performance numbers between Wynn and MGM.

Hotel Occupancy rate

MGM Wynn

2008: 92% 91.8%

2009: 91% 85.2%

2010: 89% 88%

Average Daily Room Rate

MGM Wynn

2008: $148 $288

2009: $111 $217

2010: $108 $210

Revenue per Available Room

MGM Wynn

2008: $137 $265

2009: $100 $185

2010: $ 96 $185

The hotel performance numbers were not hard to find and to compare between the companies in their respective annual reports. Casino indicators, on the other hand, were a totally different story. I spent quite a while squinting and clicking back and forth between their respective reports to try to find the most accurate point of comparison between the two companies.

For MGM I have been concentrating mostly on Las Vegas operations as they are so highly invested into that city and their earnings have likely been getting nabbed at with the opening of Wynn Encore. Unfortunately, I am unable to sift out reliable Las Vegas apples-for-apples figures from the way that they each write their respective reports. The next best thing would be to look at the net casino revenues. Wynn opened Encore in December of 2008. Despite having an expanded Las Vegas capacity, they also took a gambling revenue hit in 2009 but revenues did grow in 2010. The big Wynn 2010 increase in revenue is coming largely from their operation in Macau. MGM results are excluding revenues lost from the sale of Treasure Island in March 2009.

Casino revenues, net, in millions:

MGM Wynn

2008: $2,975 $2,261

2009: $2,618 $2,206

2010: $2,442 $3,245

Down went the MGM results on through 2010; however, they started showing a casino revenue uptrend in their recent quarterlies but with greater proportional increases going to Wynn's Las Vegas results for increases in both casino and room revenue for both 6- and 3-month periods reported. MGM is looking increasingly like a second-rate competitor. If someone put a gun to my head and said that I had to make a move on this stock, I would short it without second thoughts. The only lingering caveat to this would be hanging with the future of our overall economy. If we click into a long extended boom period, allowing MGM to get their financial house in order, that would do much to ease my doubts about the company.

The debt situation — the federal reserve is flooding our economy with artificially low interest rates, but interest expense for MGM is increasing?

It looks to me like the financial market is also becoming quite skeptical as to the future of MGM. They have been going through a flurry of eye-glazing refinancings to transition their more adjustable rate debt to long-term interest rates. If you ask me, the "long term" is not sufficiently long term, and these refinancings are causing this curious manifestation to occur:

Average interest payment increasing like this:

2008: $795 million

2009: $1 billion

2010: $1.1 billion

It's causing their weighted average interest rate to increase like this:

2008: 6.0%

2009: 7.6%

2010: 8.0%

All while their cash generated from operating activities, before reinvestment in property and equipment, is decreasing like this:

2008: $738 million

2009: $602 million

2010: $504 million

I should also note here that MGM's recent quarterly report, despite showing improvements in indicators, is showing a continued downtrend in cash generated from operations. Maybe more cash will come spewing out later but, for now, I worry somewhat about their ability to meet the needs of their debt burden.

The regulatory moat is draining.

Once upon a time Nevada was the only state that allowed gambling. Unfortunately for MGM, that story ended a long time ago. Vegas may remain as a fun playground destination with their world-class nightlife and entertainment, but the city's status as a gambling mecca has been dying out for decades, as other mini-meccas are continually popping up around the country.

People who like to gamble don't need to go to Vegas anymore, it is continually becoming more and more optional. A good case study on the importance of this regulatory moat can be found with Dover Downs (DDE), where they once sold at a $10+ per share range with net income in the mid-$20 million in the years around 2006, only to then plummet down to a price of $2 per share, with a net income now at $6 million and still dropping. Their downfall came as the states around Delaware-based Dover Downs began passing pro-gambling legislation and sprouting up casinos of their own. Every time a new casino opens up somewhere else, earnings at the other casinos become that much more difficult. This trend continually adds increasing amounts of dead weight to the value of MGM's existing casinos.



Sorry Mr. Kerkorian

The financial crisis of 2008 was not a friendly event for MGM or its shareholders. Kirk Kekorian, 24% owner of MGM Resorts International, who was once listed with Forbes magazine as having a net worth of $16 billion, saw his net worth drop to $3.2 billion. The 94-year-old casino tycoon is probably still gritting his teeth.

Outside of the uptick in the most recent quarterly reports, fundamentals are still down considerably. What we can conclude is that quite some time has passed since the last substantial economic downturn and, sooner or later, we are going to see another. It looks very likely that the combination of getting out-glitzed by competition on their Las Vegas turf, weakening overall national competitive landscape as local casinos are sprouting up from coast-to-coast, deteriorating fundamentals, the increasing debt burden on the company, all coupled with the premise that, sooner or later, the recessionary economic clock eventually strikes midnight, has a very high potential to hose investors bad.

Maybe another recession is years away and they will have time until then to brace themselves, but it has been quite some time and every day is one day closer. When it all boils down, I suspect they may be stuck in a situation of having to fire-sell off more of their prime real estate properties at eye-popping prices, water down investors' value by issuing more shares to meet debt requirements, or be faced with a crash-course trajectory directly into bankruptcy.

About the author:

Invest E Gator
I like to search out good values.

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