Let’s set the stage with the Latin expression argumentium ad ignorantiam, which roughly translated means an appeal to ignorance in which ignorance represents a lack of contrary evidence. It stands as a fallacy of informal logic. It posits that a proposition is true because it has not been proven false or a proposition is false because it has not been proven true. This sets up a false dichotomy as propounded by the 17th century philosopher John Locke whose works are recognized as one of the intellectual inspirations of the American Revolution
So we are now inundated by arguementium ad ignoratium pouring like lava from an erupting media volcano every day blanketing everything 24/7 from the virus threat to our very lives to panic over the collapse of markets and our economic future. First, calm down.
My frontline doctor friend’s advice in brief: Check in on the CDC website twice a week or more for the most accurate possible source of hard info and best projections of duration going forward. Forget the rest unless you are prepared to pop a steady stream of Xanax in your mouth as from a Pez dispenser. “Binging on cable channel virus pontificators by too many half-credentialed fools, or twitter panic trolls with conspiracy theories is food feeding shattered nerves” the good doctor said. This is an excerpt from the long email he sent me:
“The daily press briefings we get from office holders are covered mostly by regular political reporters who bring their gotcha biases into their questioning. So what you get are questions posed to bash or embarrass leaders they dislike and softballs to politicos they slobber over. The reporters covering the coronavirus briefings should all be health reporters and possibly even only doctors asking the questions. If they were, you’d get a far truer grasp on the crisis” he said.
Much of the same seems to emanate from lots of what we read or listen to in the financial media about this stock or that industry or this recession or that depression lurking just around the corner There is only one certainty, according to my doctor friend now fighting the virus:: It will end.
The damage will be deep but repairable. It’s just a matter of how much and how long it will take. So in the light of that only certainty to date, we present our new prism: We look at stocks in the sector now as consultants on assignment rather than just financial analysts. So many standard metrics and forecasts post-virus are merely fancy fingers held to the wind. But a structural analysis of the business not just the numbers, leads us to conclude if a company is asset-sound, if it can get its act together. And if it’s still trading at a bargain-basement price, it’s a buy signal hard to ignore. To wit, MGM Resorts International Inc. (NYSE:MGM).
here is MGM PV (pre-virus) and MGM AV (after virus).
Our buy signal is based clearly on an MGM AV. We’ll pass on posting a PT in an atmosphere where an armada of swans may still be deciding whether to swim into our pond. “The virus will decide when it’s over,” said CDC’s Dr. Fauci. But we like the company post-virus because we sense the formation of a sounder, more profitable business model emerging.
MGM: A Bull case for today
We have been ambivalent about MGM for at least three years. There were things to like and also head scratch about former CEO Murren’s leadership. And today, at its battered price along with its sector peers, it represents in our view, a great buy with the post-virus recovery in mind.
Historic bargains abound in the gaming sector. If you are in a panic freeze and are content to pass them up regardless of price, it’s entirely understandable. It is a sector ordinarily volatile WITHOUT a virus threat. So if you aren’t tempted by the current absurdly low entry points, stay on the sidelines. We have written on some great gaming buys to date and will write on others to come.
But if you believe that post-virus, we will see a slow but steady pace of consumers shrugging off wariness and cabin fever and return to casinos, you owe yourself the time to consider getting into the sector now. Human proclivities will assert themselves, hotel occupancies in gaming jurisdictions will rise at an accelerating rate across the nation. Earnings will ramp, stocks will recover and probably beat the highs of 2019.
MGM is where one of several in the sector you’ll want to be.
The basics of the bull case for MGM
Under what we see as a new management focus forming post-virus that stresses operations, not transactions per se, it’s a business model we like. You have fortress Las Vegas, strategically-sited regional properties, a two-property footprint in a slowly re-ramping Macau. We like the balance here.
1. We believe the departure of MGM’s CEO James J. Murren and Bill Hornbuckle’s succession as acting CEO, will pilot MGM with a long-term steady hand should he be appointed permanently. Murren, who came out of the financial sector, has always had a transactional mentality as his core leadership vision for the company. Hornbuckle, who has been a good soldier as COO, is a solid day one gaming operations veteran with 37 years on the front line of running gaming businesses.
He came out of UNLV’s hospitality curriculum, got his firing line skill set from a front desk beginning at Hilton. In 1984, he joined Steve Wynn’s Golden Nugget and stayed on at the company in operational roles at the Mirage through its explosive growth curve till 2000. (Below: Bill Hornbuckle, a veteran gaming guy with an operations mentality in contrast to his predecessor Murren, who was transactionally inclined). Source: CEOs You Should Know video).
Working 15 years for Wynn, Hornbuckle absorbed operational gaming smarts from the master, a very tough, demanding brilliant genius – apart from his human flaws. Example: Once back in the day, I dropped in for a lunch with Wynn. We talked about management styles. I recall him saying, “Look, this business is all about who you talk to and how often you talk to them. You talk to employees, you talk to customers. Forget the rest. They’ll give you a better education in how to operate these joints than you’d get at the Harvard Business School.”
After the sale, MGM’s CEO, my former boss and colleague, J. Terrence Lanni, recruited Hornbuckle, who was then itching to exit his top post at a recently sold Caesars Palace. He was tapped to run the MGM Grand. He’s been at the company in many roles over the last 21 years with great success.
I believe his hands on operations mentality will sharpen forward focus on defining just what MGM will become post virus crisis. It won’t be immediately apparent, but over time, it augers well for better defining the future MGM to investors.
2. The jury is out on Murren’s tenure. He has moved the company in a few positive directions, but also led it up a considerable number of dead-end streets triggered by misplaced enthusiasms about what the company needed to become. It seemed to me at times that he was chasing a failed business model in Caesars (NASDAQ:CZR) pre-bankruptcy.
You had over-aggressive debt-financed acquisitions, a wide geographic spread beyond competitive balance, too much central control, and heavy corporate overheads. Murren even struck deals to do joint venture hotel management deals with China operators, One deal with was signed in 2014 and exited a year later. Also, why own a WNBA team and 5 golf courses? The Murren transactional mentality kept running up dead ends.
A similar management approach is why CZR eventually became a perfect target for Carl Icahn. Add to it all the ill-considered MGM decision to invest near a billion in a questionable market like Springfield, Massachusetts and you had a puzzle: Just what was MGM? Yet the decision to build at National Harbor Maryland was by contrast, solid, as was the development of the second Macau property. So the endgame of the Murren tenure was a mixed bag: A great Vegas asset base, good and bad regional moves, a Macau presence, and an aggressive pursuit of one of Japan’s IR licenses. It produced a balance sheet that paled in comparison to nearest competitor, Las Vegas Sands (NYSE:LVS).
Murren also put in place a program aimed at producing $300m in annual savings. Much of it has been achieved, all to the good.
3. Under pressure from activists, Murren led the company to create the MGM Growth Properties (NYSE:MGP) to use as a piggy bank thus: MGM made acquisitions with debt, then spun off the realty of existing properties (gems and zircons both) to the REIT, using the cash to replenish the coffers or pay down debt than make another acquisition. It was to an extent, a legal three-card monte game. Finally, Murren announced a long-term vision two months ago. MGM was to become an “asset-light” company, focused entirely on being an operator of casino resorts, a purveyor of entertainment, not an owner of buildings. We grade Murren’s tenure as somewhere between a C and a C+ with the National Harbor property and MGM Cotai Macau lone standouts at a B+.
So this MGM puzzle palace of “asset-light” problems and potential has now been turned over to Hornbuckle to wrestle with in the middle of a horrific global crisis. Time will tell but according to many colleagues in Vegas I’ve spoken to, the consensus was that his appointment “looks like a good start.”
The MGM board checks all the boxes for diversity but is fundamentally a pit stop for financial types who dominate. And that suggests to me they might well not be averse to a big merger transaction once out of the virus disaster zone.
4. The massive debt load and the REIT shuffle has still left MGM sitting on $15.5B in long-term debt. But it also has $4B to withstand the cash burn during the crisis. Our calculation concludes that will comfortably provide around 12 months of liquidity cushion at least. It’s unclear whether they will need to press MGP to moderate rent payments, or want to, but at this point, the transition is an operations game. You withstand the threat during the crisis yes, but how soon and how well can you ramp up afterwards?
Thus far, MG has said no thanks to the government stimulus bailout just passed. It’s good optics but we shall see. (Below: The MGM Grand one of 17 total properties in Vegas and regional markets operated which presents two opportunities: One improved performance post-virus, or Two, possible sell-downs in which proceeds can be directed to reduce debt).
5. Big issues post-virus loom. Will the customer base, particularly the crucial convention/corporate segment, move only after a vaccine has been mass inoculated to put the stamp of relief in the convention planner’s comfort zone? That could be well over a year away. So while the virus case load will finally peak and rapidly tumble before the arrival of a vaccine, how do you get bodies into MGM properties, representing half of all the rooms in Las Vegas?
There are MGM’s regional properties in the US whose governors may have differing ideas about just when it will be safe enough to reopen casinos. What looks like a realistic time frame for the ramp in Macau after its closure and very tentative numbers in this early stage of reopening? Nobody authoritative knows when China will lift visa bans.
6. MGM, through its partnership with the UK’s GVC, has been the most aggressive pursuer of sports betting legalizations and subsequent deal-making with teams, leagues and tech providers. Their sports books and online site are poised to pounce whenever games resume. Prospects for significant EBITDA and footfall contributions from sports betting in MGM’s crosshairs at this stage seem dim. The 2020 mega events are either cancelled or postponed, including the much hoped-for boost from the debut of the NFL Las Vegas Raiders this fall.
The NFL says it will play per schedule. It’s a hope, not a promise at this point.
7. Post-virus, MGM looks either like a very tempting target for an activist mischief-maker or a candidate ripe to don the protective armor of a merger with one of the major regionals, putting it out of reach. Either way if there is movement on these fronts, shareholders are in for a great ride as the valuation of the business even in re-ramping mode, will not approach fair value in our view.
So wearing my consultant’s hat, and seeing my SA readers as clients, I present the bull case for the stock using a selected number of metrics I think fit into a bullish outlook for the stock now sitting around $12.15 at writing.
MGM full year 2019 selected baseline numbers for context
Gross Profit: $5.296B
Operating income: $4.096B
Net income: $2.046B
Asset sales: Bellagio to Blackstone (MGM will pay rent annual rent of $245m), and Circus Circus to Phil Ruffin total proceeds net to MGM: $4.3B
Long-term debt: $15.5B
Note: In 2017, MGM generated $10.4B in revenue producing $1.95B in earnings.
In 2019, revenue rose to $12.4B producing $2.0B in earnings.
The additional $2.5B in revenue only produced $10m in incremental gross profit. There are many reasons that can play into this poor performance, but it is inescapable to conclude that MGM has been buying revenue at far too high a price. The swerve produced by a management change and the disruptive aftermath of the virus in our view bodes bullish going forward.
EV/EBITDA: The golden metric that is the codebreaker in unlocking the truest valuator of a gaming stock in our view
The 52-week trading range of MGM is $5.90-$34.14 showing a collapsed market cap of $5.8B at this writing.
Comparing 1Q19 to 1Q20:
2019: 40.86, wildly overvalued.
2020: 3.80 decimated by the virus of course but applying the “old normal” yardstick for a company’s health in the sector at around 10.2, even in a “new normal” world, this means at the current price you are buying the MGM asset base in net property plant and equipment and goodwill is at $33.8B. The sector in general shows a broad collapse of EV/EBITDA ratios below 10.2 due to the virus. But as we’ve noted, we’re looking at the business from a post-virus perspective. What the company will be worth back to even a new normal vs. what you can buy its assets for today.
Analyst forward earnings estimates 2020: Run the range of $0.29 high to a –($2.59) low for 2020. Not a reason to buy or pass on the stock. They are well meant, but fingers held in the wind in our view. Think like an acquirer. You can buy MGM’s 17 operating properties with a commanding presence in Las Vegas, geographical diversity regionally and a footprint in Macau based on an EV/EBITDA ratio at a historic, never to be matched low. Even if you take the gloomster position that no casino operator will be worth taking a shot on until the vaccine arrives and mass inoculations are complete, that means you sit with the stock for 15 months and in the aftermath lie back and pat yourself on the back as it rockets back even no higher than say its 52-week high in 2019.
New CEO with strong gaming credentials suggests sharper management focus on operations, decentralization of functions, more cost cutting, possible asset sales to reduce debt.
Tracinda interests (Kirk Kerkorian estate) are gone as of last September when they sold their last 27.2m shares or 4.8% of the outstanding to the company. This gives MGM more currency to pursue a possible merger. Paul Salem, new company board chairman is a Tracinda guy.
Return of live sports betting to the MGMbet platform when total of legalized states could be 18.
While all gaming stocks are bargains, MGM post-virus returns to action with a powerhouse Las Vegas presence of more than 50% of the total room inventory, a regional portfolio that can be massaged to either produce better EBITDA contributions or sold off with proceeds going to reduce debt.
MGM’s two Macau properties will probably begin to recover earlier than the US as the China infection rate levels and travel bans now in place are removed. We estimate whenever they are removed will be worth a 20% spike in the stock alone. (Below: The design forward MGM Cotai. It was ramping well before the virus and will participate in the Macau recovery quickly as soon as visa bans are lifted by Beijing).
MGM, as the only viable bidder, has a clear path to the license for an integrated resort in Osaka, Japan. Its partner is a major Japanese financial services company with an immense consumer database. Orix Corporation (NYSE:IX)
If you hold MGM, don’t sell. Consider the current trade as a solid buy to put away as a sleep tight investment in a business that will find its way to a solid upside regardless of what the “new normal” will be.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.