We have learned in the past few months that famed investor John Paulson has purchased a significant number of shares in MGM. Paulson has a very impressive track record. In what some have called the greatest trade ever, he famously shorted the housing market at a time when many people were still buying SUVs with their home equity lines. It is clear that Paulson is a forward thinking investor. His ability to see what is coming in the future has allowed him to reap amazing profits. With this in mind, it is interesting to consider what a forward thinking investor like Paulson might be seeing in MGM.
It's clear that Paulson sees a significant amount of inflation coming in the future. You can surmise this from the investments he has made in gold and other hard assets. In times of inflation, debtors benefit. Debt provides leverage, and the cost to pay back dollars which lose value over time benefits borrowers. Many investors believe that with the policies coming from Washington, the dollar is going to buy less tomorrow than it will today. (The declining dollar also makes foreign tourists a lot more likely to vacation in Las Vegas, and this could benefit MGM in the future.)
As the dollar declines, Las Vegas rebounds, revenues grow, property values increase, etc., suddenly the debt MGM has can look not only very manageable, but even beneficial as this leverage could come to increase shareholder profits. MGM has many options available to manage the debt, and has successfully managed it during this recession. MGM has a long list of top tier properties they could always sell, especially as values rebound. It is important to realize that while MGM has a significant amount of debt, they have incredibly valuable properties to offset this debt. As revenues rebound, MGM can repay debt and their credit ratings can rise. When their credit ratings improve, they will be able to refinance bonds at much lower rates potentially saving millions of dollars in interest expenses.
You have to wonder why an investor like Paulson would choose to invest so heavily in MGM instead of LVS or WYNN. The capital structure for MGM and these competitors are very different. MGM's capital structure has significant debt. LVS and WYNN have a capital structure with significant equity and little debt. In order to evaluate these companies more accurately in the face of their different capital structures, it makes sense to compare their revenues and enterprise values. MGM has an enterprise value of about $17 billion and has annual revenues of about $6 billion, LVS has an enterprise value of about $32 billion and it has annual revenues of about $5.5 billion, WYNN has an enterprise value of about $14 billion and annual revenues of about $3.5 billion. Based on these numbers, MGM is a far better value, especially if the economy and Las Vegas continues to rebound. LVS and WYNN do not have the interest expenses that MGM has and because of that, they are able to achieve profits much more rapidly than MGM can. When you see that MGM has an enterprise value that is about half of LVS and yet their annual revenues are very similar, it shows there is plenty of room for MGM's share price to increase. I realize LVS has significant growth opportunities in Asia, but based on current revenues, MGM appears to be a better value. The markets are clearly rewarding companies with a capital structure based on little or no debt, but that may change in time.
Recently some encouraging data and info has supported the thought that MGM and Las Vegas in general have bottomed out. For example, Las Vegas gaming revenues jumped up 21.1% in August which is usually a weak month for gaming. Also, MGM's CEO recently said that City Center is profitable now, and has been profitable all quarter. He also said he sees a "very solid" October. You can read more about this here.
Another factor that could help take MGM shares up is the large number of shares shorted. I think the short trade in MGM is very crowded and that could lead to a short squeeze. The irony here is that Paulson made one of the greatest short trades of all time, and now Paulson is heavily invested in one of the most heavily shorted stocks, MGM. Shorting the housing market amidst a real estate boom appeared very questionable at the time, just as it appears questionable to some for Paulson to be buying shares in MGM during a significant recession.
According to the most recent reports, Paulson has made nearly a half billion dollar bet on MGM. I would not bet against Paulson, Vegas, or MGM. At less than $11 per share, MGM has significant upside potential in a recovering and possibly inflationary economy.
Disclosure: Long MGM