If you are an MGM Resorts International shareholder (MGM), current CEO Jim Murren's decision to build the $9.5 billion City Center resort has been a complete disaster. Even worse, the idea that the project will eventually yield any kind of positive return on invested capital in the near future is at best far fetched. Let's do the analysis to see why.
The CityCenter is a project on the south side of the Las Vegas Strip and is comprised of the Aria Resort and Casino, the Vdara Hotel & Spa, the Mandarin Hotel & Luxury Residence complex, and Crystals Shopping, Dining, and Entertainment mall.
Based on MGM's 2011 Annual Report filed 2/29/2012, MGM resorts currently carries the MGM CityCenter property on the balance sheet at a value of approximately $9.5 billion. The $9.5 billion is broken down in the following manner:
- Equity: $6.6 billion
- Long-Term Debt: $2.5 billion
- Current Liabilities: $.4 billion
The CityCenter is a 50/50 partnership between MGM Resorts and Dubai World. As such, we can calculate MGM's equity and debt exposure to the project at approximately $4.75 billion. The $4.75 billion is made up of approximately $3.3 billion of equity value and $1.45 billion of debt.
In evaluating the financial merit of the CityCenter project, let's look at the operating results over the past few years. Also, keep in mind the CityCenter is a large development at the south end of the Las Vegas strip and does have synergy with MGM's other properties like the Bellagio, MGM Grand, and Mandalay Bay, so there is intrinsic value reflected in it, which is not carried on the balance sheet. Still, a project's value is ultimately determined by the financial results so here are the last three years of operating results.
These results show revenue at the project declining by some $250 million in the last year. The operating loss is still over $200 million with a net loss of over $500 million. If we are going to be very generous and use adjusted EBITDA, EBITDA, and operating income as a worthwhile metric for valuation, we can use the following figures: (the first is provided to us by Bobby Baldwin, MGM's Chief Design and Construction officer, at the most recent MGM earnings call):
MGM reported CityCenter generated $236 million of adjusted EBITDA for 2011. The adjusted EBITDA number is vastly different from the EBITDA figure in the annual report (a loss of 56 million), and the operating loss number as well. Still, we can use the numbers to take a look at the different ways to value the CityCenter project.
First, let's evaluate CityCenter using equity value and operating income. The operating results show a loss in 2011 of over $200 million and a net loss of over $500 million. If we take the MGM 50% share of the $6.6 billion equity value, we use $3.3 billion as our metric. An easy calculation to use is taking 10% of the total equity value to get a yield of $330 million for operating income (many expensive companies trade at 20X operating income, and inexpensive companies at below 5X operating income).
If we say MGM generates $330 million of operating income, and discount that income using the whole number 1 as your discount rate (usually it is at 5-15%), it would take 10 years for MGM resorts to just return the equity value to even. Right now, CityCenter operates with large losses, as we have seen.
Next, if we evaluate CityCenter using EBITDA and adjusted EBITDA, we use the EV/EBITDA ratio to come up with the following scenarios:
EV/ Adjusted EBITDA=9,500/236=40.25X, which is very expensive. If we flip this upside down, we get a return on total capital of a little under 2.5%. Extending the example even further, let's say the CityCenter project shows significant improvement and Adjusted EBITDA jumps to $1 billion per year. The EV/Adjusted EBITDA calculation would become 9,500/1,000=9.5X, and flipping the ratio upside down, our return on total capital becomes 1/.095=10.52%
Again, it would still take almost 10 years just to get a break even return on the total enterprise value if EBITDA were to come in at 1 billion dollars per year. Total revenue for the entire project is currently a little over $1 billion. The reality right now is it is not even close. In fact, total EBITDA for the project is a loss of $56 million, which would render the property worthless. Clearly, the CityCenter complex is not generating enough income to value the equity at $6.6 billion.
Past Write Downs
MGM already wrote down the value of the CityCenter project in June of 2010 by $1.12 billion, and it wrote it down again in September of 2010 by $191 million. In addition, in 2009 it was reduced by $956 million as well. One should expect management will be under constant pressure over the next few years to evaluate the carrying value of the project against the cash flows to determine if the value should be lowered again. I am suggesting it will have to take another large charge in the future if operating results do not dramatically improve.
Other Issues Regarding CityCenter
MGM faces a litany of other problems because of the problems which still exist at CityCenter. First, there are numerous shareholder lawsuits regarding material misstatement of financial reporting and breach of fiduciary obligations. There is a major lawsuit with MGM and the general contractor on the project, Perini. In addition, MGM announced they are discontinuing another major part of the project, the Harmon Condominium complex, due to structural defects.
A Little Bit of Debt
MGM resorts currently has total debt obligations of $13.6 billion. $10,017 billion of the debt comes with an average fixed rate of 8.1%, with $6.4 billion maturing between 2013 and 2016. $3.7 billion of the debt is variable rate and averages 6.5%, with $3.4 billion maturing in 2014.
Heavily Exposed to Las Vegas
MGM has a heavy concentration of its hotel rooms in the State of Nevada. Out of a total of 48,295 rooms, over 44,000 are located in the Silver State. MGM has very little exposure in China as they only own 582 hotel rooms in Macau. MGM has a little more presence in China with gaming tables, as out of a total of 1724 games, 427, or approximately 25%, are in Asia.
Recent Earnings Report
In the most recent earnings report, MGM reported a net gain of $3.24 billion, or $5.62 per share. Of the $3.24 billion, $3.114 billion was attributable to net income from MGM Resorts International. The International division acquired an additional 1% of total capital stock in MGM China and MGM Resorts became a 51% owner of MGM China. When MGM China had an IPO in 2011, MGM Resorts recorded a gain of $3.5 billion. However, total income from operations for 2011, excluding the IPO gain, was $820 million, and $670 came from domestic operations.
CityCenter represents a large drag on the business because of the amount of capital invested in the project relative to the rest of the company. MGM Resorts has great properties up and down the Las Vegas Strip which generate the bulk of the operating income for shareholders, but none of it comes from CityCenter.
Shareholders Should be Demanding Answers from the Board and CEO
The CEO and Board of Directors of any company are in charge of capital allocation and should invest in projects that have high returns on capital. For example, Las Vegas Sands built a casino in Macau, which paid for itself in one year of operations. By contrast, MGM Shareholders might not get their money back from all the capital spent on the CityCenter for another 10 years. All of these problems with the project highlight the question of whether the CEO and board of directors objectively evaluated the risks to shareholders of building a $10 billion project. One of the first rules of risk management is to not risk the entire company on one project, and you have to question whether anyone on the current board learned that basic risk management consideration.