In a return to my roots as a turnaround investor, I'm recommending MGM Resorts (MGM) as my ninth pick for my Top 10 list for 2013. For those who aren't familiar with my writing, I'm trying to outperform for a fourth consecutive time following 2012's Top 10 list, in which 10 out of 10 picks have beaten (by double or more) the S&P 500. (Click here to review the record.)
MGM Stock Poised to Soar to $20 and Beyond
MGM peaked at $100 per share in 2007 before getting crushed by an overleveraged balance sheet during the credit crisis. While this $11 stock won't get back to $100 anytime soon, it has cleared the "high risk" zone and is an excellent way to play a recovering economy in 2013.
Before I tell you why MGM the stock will reach $20 in the next couple of years, here's what you need to know about MGM the business. In contrast to Las Vegas Sands (LVS) and Wynn (WYNN) -- both of which are compelling stocks in their own right -- MGM is more of a pure play on Las Vegas, from which it derives about two-thirds of its revenue. MGM dominates the Strip, with properties such as Bellagio, Mandalay Bay, The Mirage, New York-New York, and MGM Grand, among others. MGM also has a fast-growing and undervalued asset in its 51% ownership of MGM Macau, and it is in the process of developing a 2,500-room hotel across the street from Wynn on the Cotai Strip (also in Macau).
The stock market says MGM stock is worth $5.3 billion. Revenue will be about $9.2 billion this year, with a GAAP loss of $0.45 expected. Debt is about $13 billion. Here are the catalysts that will unlock value to $20 per share and beyond:
1. Vegas is coming back. Some 20 years ago, I remember pundits saying Disneyland was on the decline, in part because of competition from other theme parks. They also said "Rugrats" and Nickolodeon had captured the fancy of children, and that kids didn't care all that much about Mickey Mouse. It was all a bunch of hooey, just like the nonsense from pundits who say Vegas has already seen its best days. Don't believe it. The number of visitors to the Strip continues to set records. There is nothing like Vegas -- nothing. Sure, revenue per visitor has declined, but that's more about a tough economy than about Vegas, the destination. As the economy continues to strengthen, you'll see income per visitor ratchet higher, benefiting MGM disproportionally because of its highly leveraged operating structure.
2. The company is performing a debt overhaul. MGM has been paying interest rates as high as 13% on its debt and is in the process of replacing it with notes that cost 6.5% and below. It just refinanced about one-third of its debt, which will result in $145 million in interest savings next year, all of which drops to the bottom line. Expect MGM to do a lot more by way of reducing its interest expense burden in the coming years. By the way, the nominal debt at MGM of about $13 billion -- while high -- is far from an extreme. And the problem has not been nominal debt as much as high interest rates, a problem that's in the process of being fixed.
3. Free cash flow is masked by GAAP earnings. An aggressive expansion of property in the years leading up to the credit crisis has created an asymmetry between depreciation and capex. As a result, owner's earnings are much higher than GAAP earnings because depreciation is about double the rate of capex -- depreciation is running about $943 million per year, while capex will be about $450 million in 2013.
4. The company is experiencing expansion. While there are expansion possibilities in the eastern U.S. (Massachusetts and Maryland, for example), Macau offers the richest vein of top-line growth. The addition of the Cotai development, for which MGM has already secured financing, is a potential game-changer. While investors may not want to wait four more years to see it happen, my guess is that the wait will be worth it. While the ingredients are in place for a rebound in the stock to $20, perhaps as high as $30, a successful development in Cotai is necessary to drive the stock appreciably higher than $30.
In terms of valuation, for now I'm using a multiple of sales of between one and 1.25 times sales (implies $20 per share). That is much less than its peers, such as Wynn, which trades at about two times sales. A multiple of sales is useful when analyzing an operating model like this, with numerous moving parts, such as the imbalance between depreciation and capex.
If you've ever wanted to attend a value investing conference and didn't want to travel, here's the next best thing. I'll be discussing my thesis regarding NCR Corp. (NCR) in detail at ValueConferences.com on Jan. 9. There's a reason why I made NCR my one and only double pick for my Top 10 list for 2013. As I will discuss at the conference, NCR is uniquely positioned in the rapidly growing mobile transaction space, and the stock is worth a lot more than its current quote of $25 per share.