MGM Resorts: Smart Corporate Strategy Is The Engine For Much Higher Valuation (MGM)

Well, do anything, if you do something right, we’ll use it, if you do something wrong, we’ll fix it, but do something and do it now…” Louis B. Mayer (The “M” in MGM till this day) (1884- 1957) movie mogul

Earnings call Feb. 8th.

We reach way back to ancient history of the founding of a movie company in 1924 headed by the immigrant son of a junk dealer. He was among those who transformed American entertainment bringing the psyche of a dreamer together with a tough realist into the corporate DNA. Much of that skill set inhabits the best corporate c-suites of today’s gaming companies. The casino sector has had its dreamers like Steve Wynn, Sheldon Adelson, Bill Harrah, Sam Boyd Kirk Kerkorian, Jay Sarno and yes, Bugsy Siegel. Smart and tough as hell.

All these men coupled a flint-eyed gaze on real world obstacles in the business but always gambled on the what ifs as well. In today’s world of belt and suspenders managers, such talents are scattered and not always visible when share prices are valued strictly on a mix of earnings and ratios.

Valuations are still largely ruled by a handful of metrics which do not always reflect prospects when Black Swans and pandemics suddenly diminish the viability of much standard share metrics. They now play supporting roles, off center stage. Baking in prognostications of what may happen is tough at best, so next best option is to evaluate management. The c-suite’s impact on the entire organization is where, in our view, the judgment calls tell the tale of whether a stock may be fully valued, overvalued or undervalued entirely linked to earnings or various ratios.

Nassim Nicholas Taleb shook up our precepts of what guided real valuations with his Black Swans and Anti-Fragile insights into the behavior of markets. The inescapable conclusion: Pre-ordained biases can always find standard metrics to fit, look nice, and of course, be wrong. Furthermore, mother nature has now had her not so friendly say by imposing a catastrophic pandemic in 2020. Out of where? Wuhan, maybe. Her mischievous bag of tricks, as students of history have come to learn, never runs on empty over centuries of war, plague, famine, political upheaval, stupidity, greed, and mass hysteria.

So today as we seem to be tip-toeing finally out of the Covid disaster, we still have bone chilling macro events to rattle Mr. Market: inflation, recession, the Ukraine war, not to mention the persistence of bad decisions coming out of many corporate c-suites. Our view: It is no longer enough to run through the usual array of complex algorithms applied to valuing stocks at any given point in their lives. What is mandated now before a single button is pushed on a buy, sell or hold order, is a hard look at the people in the c-suite and their batting averages.

MGM: Out of pandemic triggered chaos, a coherent, smart corporate strategy has emerged that has produced a real bargain for investors now.

Above: This trend will quicken as Macau’s pace of recovery speeds up, among other tailwinds headed the way of MGM shares.

MGM Resorts International’s (NYSE:MGM) prior top management was headed by Jim Murren, 61, who resigned in February 2020 after a 22-year stint with the company that began under my own former colleague, J. Terrence Lanni. He was a Morgan banker with a transactional mentality brought in as CFO. The company was then still a majority holding of Kirk Kerkorian. During a phone call on an unrelated matter, Terry told me he had hired Murren to bring just that – a stabilizing of the financial operations of the company. He had come to know Murren when he was one of the lead bankers who worked on an MGM refi.

During Murren’s long tenure, MGM did transition from essentially a Vegas-centric operator with 16.2% of its stock owned by legendary Kirk Kerkorian. He died in 2015. His family trust, Tracinda Corp., was set up to gradually sell off his entire stake. In the five years that followed, Murren led the company to a much broader and sometimes a bit shakier grounding.

His track record was a decent mix of good and bad decisions. But the transactional – not the gaming mentality – is essentially what produced the levels of performance of the company and its shares. There was a brief downward drop in MGM shares after his resignation was announced, primarily because the market didn’t quite see who would replace him.

Murren’s core strategy was best summarized by himself when he told investors that MGM was moving toward an “asset light” orientation. In brief this meant a policy to convert as much of MGM’s real estate to REIT ownership. Part of that was the creation of its controlled subsidiary REIT, MGM Growth Partners, subsequently sold to VICI Properties Inc. (VICI).

While this liberated considerable cash, it did not unto itself ameliorate the massive debt accumulated by MGM during Murren’s tenure.

Long term debt under Murren:

2019: $11.b

2020: $12.3b Murren resigns in February

2021: $11.77b

2022: $7.21b

The ballooning of debt was one reason among many that contributed to the lackluster performance of MGM stock. Clearly the pandemic was a prime culprit both in the US and Macau. And the sell-off of MGM realty by Murren played a role in rebuilding cash and using proceeds to reduce the debt.

Murren’s proclivity was to raise his hand whenever any prospect of a new market opened. A bit too soon in the case of Massachusetts. When that state legalized, Wynn Resorts Ltd. (WYNN) won first prize with the Boston metro site. Despite real questions as to viability, MGM went ahead with its $950m MGM Springfield project in Western Massachusetts which would be aimed at the Greater Hartford demo. The property has since joined other MGM realty in a REIT sale. It remains a problematical decision till this day in my view.

What sellers missed was the strong pivot the board would make to top MGM executive William Hornbuckle, now 62. I then wrote on SA an article in which I believed he would succeed as CEO. MGM’s board appeared to come to the same conclusion They liked Hornbuckle’s long, hands on experience as a gaming executive that began with the Golden Nugget, moved on to Caesars and then headed various units of MGM during the Murren era. What was clear to me then was that the company, under Hornbuckle and his own management team, would pave the way for a far more coherent corporate strategy going forward.

When Japan approved casinos in 2018, major gaming operators from Macau, the US and some from Asia, the EU immediately ignited activity to snare one of the three licenses slated for issuance. But between the endless bureaucratic delays, public discomfort about spikes in problem gambling and other political turmoil, the initiative has lingered. As cost estimates exploded, nearly every major gaming operator said thanks but no thanks, and withdrew. MGM remains committed to a 50/50 partnership with a Japanese consumer finance partner, to plowing ahead to the finish on an Osaka development.

At earliest, a property could possibly be developed, built and opened by 2028-2030. The cost could rise to $10b. Whether MGM stays on board or not for its $5b commitment remains a question. But the fact that it is the lone “survivor” of the original enthusiasts for the market is telling.

What the strategy is today

Above: The flagship Bellagio, its realty sold, its position at the upper end of the market segment continues to lead competitors in REVPAR averages.

The broad based strategy of MGM’s today is clear: Wherever big time gaming goes, we will be there. The MGM portfolio presently holds 32 properties covering its dominant position on the Vegas strip, US regionals in key markets and of course, MGM China Ltd. It also owns half of BetMGM, which it says now has a 13% overall share of the sports betting market and as much as 20% in states where it went live on day one.

Above: MGM properties in Las Vegas lead the way in non-gaming revenue bases, while its Macau properties gaming revenue dominates.

Without a fly on the wall but on my own long tenure in the c-suite of major casino operators is my best guess for what MGM’s corporate strategy’s fundamentals suggest:

Remain a fortress operator on the Las Vegas Strip regardless of what additional properties may materialize going forward. MGM produced over $2.3b in revenue in 3Q of this year off its strip properties, up 66/66% vs. 2021 due to the surging post Covid recovery of pent-up demand. Its regional properties produced $973m in that quarter, up 5.3%, a solid performance, but perhaps subject to some recessionary sentiment. MGM China is just now beginning to experience an early exit from China’s zero tolerance travel ban policies. Its two properties in Macau held a 9.5% share of market pre-pandemic. Our calculations indicate a move into double figures to 11.3% by this midyear. Overall revenue recovery in Macau has started to show in the Chinese New Year period just ended. The month’s total market showed a dramatic increase in footfall for the holiday to over 450,000, representing ~33% of the pre-Covid holiday arrivals. So MGM China should begin looking like a positive EBITDA contributor to the group performance by 2Q of this year whereas now, it is the principle source (with BetMGM) accounting for an operating loss).

BetMGM is expected to end 2022 with $1.44b in revenues clocking an EBITDA loss of ($400m). But 2023 projections have the unit turning profitable in late 2023 when revenues are projected at $1.8b to $2b. The company’s offer to buy out the UK’s Entain’s (L:ENT) 50% for $11b was rejected. We believe this is not the end and have strong conviction that a major change in equity on the unit will happen this year. Either MGM will up its offer, or make one to acquire Entain entirely. It could take the approach taken by Caesars Entertainment (CZR) when it bought the UK’s William Hill legacy bookmaker, kept the US unit and sold off the international business. MGM’s MO is telling. It begins partnerships, keeps them during growth cycles and then buys out partners. This was the case with its 50/50 deal with Boyd Gaming (BYD) on the Atlantic City leader, the Borgata. That property still holds #1 position in AC.

Above: MGM’s online business has moved into the top five platforms in the space and is due to become profitable by the end of this year.

New York Prospects: The State Legislature has now approved three casinos in the metro NY area. Some of the presumptive bidders have advanced absurd proposals, such as converting the top floor of the famed Saks Fifth Avenue luxury department store into a casino. Possibilities in the boroughs outside of Manhattan are more realistic, among them, MGM’s Empire City racino in Yonkers, just over the city line. Right now it is limited to video lottery slot terminals. The new approvals will permit full scale casino games including tables. As a current licensee of the state, we put MGM in a pole position to snare one of the three licenses. This will happen this year. If it does, MGM shares will spike on the news.

All in all, what we see here is a coherent strategy of MGM aimed at becoming a world level brand of destination casino resorts. Its steady reduction of long term debt, its strong cash position of $5.3b (mrq- translates to $13.78 in cash per share) plus access to credit ahead and strong gaming oriented management outlook puts the stock at its current price at a very attractive entry level.

Its ROI (TTM) is 18.44% vs. the industry at -1.07% largely linked to Macau, debt and softer revenue streams.

We are at the early stage of the post-Covid era. Las Vegas has already shown a phenomenal bounce, US regionals are more than holding their own in an uncertain economy, and we are seeing green shoots in Macau. Management’s forward decisions seem to have prepared the company to embrace a positive change in macro sector outlook, despite the threat of recession and ongoing inflation. Clearly whether we have a soft landing this year, recession-fueled spending collapse or neither, MGM’s financial strength coupled with a management with a proven skill set in gaming are clear indicators that the stock has run room ahead.

Price history: MGM is telling

Way back in 2007, MGM, hard on the heels of a skyrocketing Macau market, opened its first casino. The stock zoomed to over $72 a share almost entirely on that prospect. It did not begin to deteriorate until 2009 when Vegas revenues tanked in the light of the financial crisis.

• At writing: $41.30
• Recent low: $29.90 last September.
• 52 week range: $26.41-$49.00
• P/E (TTM): 13.63. In our view of prospects and management focus ahead, undervalued.
• EPS (TTM): $3.03
• Market cap: $15.8b
• Revenue (TTM): $12.5b.

Does not as yet fully bake in what will be improved revenue performance from MGM China and event. Convention heavy 2023 in Las Vegas. Also catalysts could be BetMGM nearing positive EBITDA or a transaction involving its gaining 100% of the unit. Also a positive bid for New York. The flip side of course are the what ifs here: recession hitting both Vegas and US regional business, decline in sales growth for sports betting, a sudden halt in Macau recovery. That puts us into the margin of safety range.

We looked at the stock from a Discounted Cash Flow basis put out by several sources. Alpha Spread’s formula comes to $46 a share, or 11% undervalued. In a best case scenario, that is, assuming all catalysts are positive and its strategy, Alpha Spread puts the best case DCF value at $144.41. Our own calculations assume the following: Vegas performance to slow but continue positive in single digit growth in gaming revenue, non-gaming. Macau recovery to be sustained beyond Chinese New Year with no re-imposition of Covid travel bans. (On Feb. 8th, in another move by Beijing to ease travel restrictions, group travel bans will be lifted finally. This will be a huge boost to Macau arrivals and mass segment revenues).

IAC Inc. (IAC): Last September, the very savvy Barry Diller’s ecommerce giant added to its position in MGM bringing its holding up to 16.5%. In August of 2020, IAC opened its position in MGM with a 12% stake valued at $1b, or ~$13 a share or a $35 a share profit. Were its objective in the buy been that of an in-and-out activist shot taker, Diller’s company could have walked away a big winner at MGM’s current price.

Instead, they added to the position, price averaging to a degree. To us this spells several possibilities. First, they have concluded as we have, that there is considerably more value in MGM than what is reflected in its current price. Given the positive tailwinds forming, they see much more upside and increased their position. Two, the 16.5% foretells their focus on BetMGM, a business they clearly understand given their own palette of brands. The prospect that at ~$2b in 2023 revenue, in a sector overcrowded, with low margins, MGM is top tier online operator dominated by FanDuel (DUEL) and DraftKings (DKNG) no easy task.

Or three, they can foresee MGM acquiring the 50% of BetMGM not yet held, spinning off the unit into an IPO when it turns profitable and becoming a major holder of that stock going forward. Whatever their objective, this much is clear: When someone as smart as Diller stays the course when profits are a walk away, it translates to a green light for investors.

Analyst average consensus for 2023 earnings indicate a move into profit post Macau Covid at $0.63 a share out of revenue forecasted at $13.9b. Our own calculations put earnings at $1.27-$1.33 with revenues vaulting into $14.5b. With long term debt under control and verticals planted in every meaningful gaming venue on the globe, we are putting a PT of $58 on the stock between late 1Q23 and mid 2Q23.