By Howard Jay Klein
"He that fights and runs away, May turn and fight another day; But he that is in battle slain, will never rise to fight again…." Tacitus
Tomorrow MGM (NYSE:MGM) is scheduled to release its Q4 2015 earnings call. Analyst consensus expects the company to earn 8c, with an increase to 12c for Q1 2016. We're smelling a possible beat because the citywide late fall numbers in Vegas were up. We'll see. However, that number won't be the headline of this earnings conference call.
Shareholders and potential shareholders of MGM will focus most intense interest on whether CEO Jim Murren announces it's all systems go on its proposed REIT IPO: MGM Growth Properties Inc. Or bowing to the ugly market and economic realities of the moment, he decides to postpone it for a more salubrious time to debut, heeding the wisdom of Tacitus, brilliant Roman senator and historian (b. 56AD, d117AD) quoted above.
Two weeks into this month, not a single company with operating revenue has gone public, including such retail consumer giants as Albertson's Markets at the mass level and Neiman Marcus at the luxury tier. Clearly, their confidence in the consumer going forward in an economy with a forecast 2.7% GDP for the year has sobered their outlook.
And the nearly $1.7 trillion of losses already sustained by stock markets since the Dow plunged isn't very pretty either. It's too early to call the end of a much-needed correction on bloated values long supported by cheap money from the Fed. A recovery could come very soon or we may see the beginning of a long, tough bear market in which gallons of blood will be shed before it's all over. On top of that, we learn that the amount of debt carried by people over 50, the prime customer engine for Las Vegas, has soared, spectrum, debt among millennials, currently centered in student loans, has shrunk because young people are spending less and deciding to use more discretionary dollars to extinguish their debt burdens. Will they disappear from the Vegas scene if a recession hits?
How a possible recession will slake consumers' Las Vegas gaming appetites is hard to forecast, but a quick look at strip gaming revenues from the 2008/09 recession bears consideration:
Las Vegas Strip - Gaming revenues only
However, during this same period, non-gaming revenue went from $13.7 billion in 2009 to $16.7 billion in 2015. The gaming decline, given the economic collapse, was relatively modest. The rise in non-gaming was faster, largely fueled by conventions, tourists and the growing partying of millennials - all groups likely to be hit by belt tightening if a recession hits. In fact, non-gaming revenue is far more likely to be battered if we face a recession now because the average price points in the town have risen to levels that seem less supportable in a bad economy.
As REITs in gaming go, MGM's proposal is the best of breed. We're not fans of gaming REITs in general, but we think the MGM Growth Properties, Inc.'s (GLPI) model is far superior, for example, to the Gaming & Leisure Properties, Inc., issue - a standard REIT. Its 52-week trading range has gone between $24.21 to $38.30. It's currently trading at around $24 near its low. MGM, the parent, will control 70% of the IPO stock, elect 3 board members and share managements. All that is to the good in that both entities will share a single destiny up or down. The skin in the game by the parent here is a big plus.
Yet it does not alter some basic realities:
1. It is an offloading of $4 billion in debt to MGP shareholders who need to be true believers in the capacity of the REIT property portfolio to meet triple net lease obligations, if - we repeat, if - we're headed into a serious recession. The properties are: Mandalay Bay, New York New York, Luxor, Monte Carlo, Excalibur, MGM Grand Detroit, Beau Rivage and Gold Strike in Mississippi. We believe these properties are the least recession-proof of the entire MGM portfolio. Their core target demo hits at the heart of those visitors most likely to be price sensitive if a recession hits.
More telling here are the properties MGM did not include in the proposed REIT: Bellagio, MGM Grand, Circus Circus, MGM China, its 50% stake in Borgata Atlantic City and its City Center development. These are the properties more likely to sustain their revenue profiles because their demos are more resilient. Examples: Bellagio at the upper end and Circus Circus in the low end. Borgata remains strong in a weak AC market, MGM China will be expanding in Macau at a time we believe the current downdraft there will have eased. The company's two newest developments, MGM Springfield and MGM National Harbor, have yet to be assigned a corporate home. The betting among Vegas cynics is that the problematical Springfield will be dumped into the REIT and the really super National Harbor project kept close to daddy's corporate vest.
2. The current market turmoil diminishes MGM's pricing power on the IPO. The valuation of the assets in the portfolio going forward needs to be scrutinized carefully under a recession scenario. The arrows at the moment don't seem to be pointing north. And if MGM sees the perception of that valuation sinking too low, it is more than less likely to pull the IPO for the moment and wait to fight another day. However, if it does elect to go ahead on the theory that no matter what the precise valuation, the IPO remains a valid course to unlock shareholder value. And whether the stock debuts a few dollars lower or not really won't matter to true believers.
3. MGM has said its objective is to get its leverage at or below 5X - a very worthy objective, and a particularly good story for MGM shares going forward. The stock has taken a beating from mid-year last year to its most recent fall into the $18 range. We had been fans of the company, originally targeting a $35 price, largely because we liked the asset base, the potential of the National Harbor property and the company's diverse non-gaming entertainment offerings. However, our view of a going forward vision and the company's strategic responses were disappointing and we lowered our targets down to $25 and at best, a hold.
Most recently, Merrill has issued a buy recommendation based on a better Macau picture. However, the shares have continued to move south, trading at $18 at this writing. There is something of a mixed signals effect on the Merrill recommendation and those of others.
On the one hand, they see MGM's low Macau exposure as a plus - true. Yet on the other hand, they like the somewhat firmer picture in Macau as a plus as well. Where's the logic here? I don't see it. Do you?
Right now, MGM's total debt stands at $12.8 billion; manageable yet edging close to worrisome. The IPO would indeed remove pressure from this number and that's to the good. However, the question then becomes, what would public shareholders be getting in exchange for their financing of MGM's total debt? In other words, what's the value equation the potential IPO shareholders get when they become, de facto, MGM's bankers? They become landlords of good casino properties but not great ones, casinos that may - repeat may - get disproportionately hit if we fall into a recession. That's the question that most needs answering by management tomorrow.
4. If there is a recession, investors in gaming have better options. Las Vegas Sands (NYSE:LVS) and Wynn (NASDAQ:WYNN) will benefit (along with MGM) from a Macau recovery. However, both these operators are strongly committed to dividends and in a sloppy market still offer good yields plus an ongoing upside, with considerably lower exposure to Las Vegas - should a recession hit. We've forecast a Wynn spike before the earnings call and it's up 15%.
5. Will the current market slide create a new normal in valuations that could crush expectations for an MGM REIT? No one can forecast that now.
And we're certain company bankers and number crunchers have already run dozens of scenarios through their computers and if they announce they're moving ahead undaunted with their IPO, it's certain the pricing will reflect that reality. CEO Murren is a creature of the stock market, and it's clear initial pricing would have already taken the measure of all the aforementioned factors.
If it postpones the IPO, would it help or rattle the stock?
On basics as we've noted, the MGM REIT design is the best we've seen as a genuine effort to unlock shareholder value. Unlike other REITs we've watched, it's not merely a disguised birthday party for insiders. We also believe that an IPO now would not be as well priced for new investors as it might have been last October when it was announced but not yet priced. Recognizing this, management may opt to price the shares lower than originally anticipated. That will make the issue a clear, self-evident bargain to attract enthusiastic buyers.
If that happens and the combined trade of the parent and the REIT totals a realistic value equation based on an earnings profile going forward, we see a nice pop in MGM shares based on these factors:
1. The diversity and resilience of the MGM core portfolio, despite a recession potentially damaging revenue.
2. The strong entry of the National Harbor property.
3. The execution of the planned deleveraging.
4. The success of its pay for parking strategy in spring.
If MGM does elect to postpone the IPO, here are the bullets it can dodge:
1. If the launch of its pay for parking strategy in April gets off to a rocky start, it has time to adjust its policies by creating a comprehensive comping system that will blunt any negative impacts on drive-in business.
2. Improving Macau numbers will add to perceived value of its expansion in that market by the end of this year.
3. There is little risk of outliers or predators moving on the stock if it doesn't t proceed. It'll have the time to re-evaluate options, consider alternate strategies, or merely keep its design intact, wait until the economic and market climate shows signs of resuming reasonable growth and merely issue the IPO later in the year than originally anticipated. Easy peasy. And it won't have to drop the price of the IPO shares to meet lowered expectations and could in fact, re-value the REIT portfolio upward based on improved Q1 operating results. Current consensus is for earnings of 12c, up from 8c expected for Q4 2015.
Unlike other gaming REITs, MGM Growth Properties, Inc. will be a captive entity of the parent. The company's success in creating shareholder value will then be perceived as the combined trading price of the parent and the REIT and the market's acceptance of that as a strong value equation. If it seems that management has fair-dealed shareholders in that pricing, then going ahead will make sense.
However, if management has decided that given the current market turbulence, it opts to wait it out for a time that could offer a firmer price on the REIT shares based on ongoing performance, we believe the market will recognize this and reward the parent with an upside going into mid-year.
As we've stated in many SA articles, we like the MGM asset base and believe the management is okay. We're less enthused about its edifice complex, but believe too that its new Maryland and Macau properties will become hefty contributors to 2016, 2017 EBITDA as well as helping to transform leverage into EBITDA. We're less sanguine about its Springfield, Massachusetts development and the revenue stream its ambitious 20,000-seat arena complex can produce. But overall, we think the trump card in the MGM deck remains its dominant room inventory in Las Vegas.
Our call: If the IPO is postponed, it's no loss; perhaps a bump to the shares. If it goes forward at a price that makes sense combined with its current trade, we think it passes the common sense test as well.
About the author:
Howard Jay Klein is a 25+ year veteran c-level executive of the casino industry. He now conducts a consulting practice in that sector. He is the author of Mastering the Art of Casino Management and the publisher of The House Edge, premium site on Seeing Alpha.
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.