"No wind serves him who addresses his voyage to no certain port…"
Michel de Montaigne
Over a year ago I, among others, took MGM (NYSE:MGM) to task for what was seen as a company with a great asset base and no clear strategy to assure shareholders as to its long-term direction. It was highly leveraged, its operating results unimpressive; what it needed above all was giving greater clarity to the market as to who it was, what it was, and where it was going. Activist shareholders started getting more vocal about the perceived lassitude of management in unlocking shareholder value.
As a result MGM shares wallowed in the high teens to the low twenties, with investors skittish about its high leverage and uncertainties at the time as to how it was going to approach the core issue of delivering a performance and sense of direction going forward.
But then the company got its act together and addressed its issues head on, one by one, in a series of moves that moved the stock north to where it now sits at $28.60 (pre-market post Q4 and full 2016 earnings release this morning).
We'll bypass Q4 results which showed adjusted EPS of $0.11, a miss from an analyst expectation of 17c though revenue was up 17% and full 2016 results showed a strong margin performance. The shares are trading down at this writing largely due to the normal knee jerk street reaction to an earnings miss in a single quarter, which in this case represents nothing more than a snapshot against the full 2016 performance of the company which is a solidly produced portrait of an excellent turnaround on all fronts. Investors should bear in mind that the Q4 earnings miss is probably a lot of algorithm button pushing rather than a rational take on a solid annual performance.
MGM got its act together
In a steady series of moves from late last spring, MGM:
1. Announced the implementation of what it called its Profit Growth Plan, essentially a euphemism for cost cutting programs across the board to improve operating margins by producing an accretive $300 to $400 million in EBITDA over time. For this year the plan contributed $30 million.
2. Unlocked shareholder value by forming a parent controlled REIT called MGM Growth Properties (NYSE:MGP) into which it moved a sensible mix of its property asset base. The IPO was oversubscribed and relieved considerable pressure on the company to act.
3. Sold its interest in the Shops at Crystal property, acquired the 50% of the highly successful Borgata in Atlantic City it did not own from Boyd Gaming (NYSE:BYD) in transactions that produced a $401 million gain on the AC deal and a $450 million distribution on the Crystal sale. In addition the company sold its Circus Circus Reno property.
4. Opened its new T-Mobile Arena and expanded its retail reach with the outdoor Park pedestrian browsing space at Monte Carlo.
5. Most of all, it opened on December 8th, its much touted MGM integrated resort at National Harbor Maryland (Metro Washington, Baltimore), which as we'd noted, looked to us like a home run. And a four bagger it has thus far proven to be, contributing $53 million in 2016 revenue in just 23 days.
6. The pipeline. MGM has delayed its Macau Cotai property opening to sometime between late Q2 and Q3 this year assuring it will enter that steadily recovering market at a strategically superior time than what would have been the case at the moment. It has also delayed its Springfield. Massachusetts project in the light of continuing complications from access highway problems to controversy over the plans of nearby Connecticut tribal casinos to open a partnered fighting brand property just over the border to defend its Hartford, New Haven market. This project remains somewhat problematic and is certain, when completed and opened, to find itself quickly shifted into the MGP portfolio for its REIT investors to worry about.
Beyond all the short-term nervous Nellie reactions, let's look at the company's annual performance for clues to its really strong performance and rationale why we remain committed to our target of $35 to $40 on the shares despite the Q4 earnings miss.
Hard numbers, hard facts
From an investor who looks at companies through a wide-angle lens focused more on where it appears to be heading rather than where it was, here's MGM's most important annualized 2016 numbers vs. 2015:
2016: $4.936bn vs. $4.842bn yoy from 2015. Adjusted for hold percentages and an essentially flat number yoy on the strip, this represents a solid performance. (Note: Flagship upper end of the market property Bellagio posted record gaming, non-gaming revenues since its opening.)
2016: $2.023bn vs. $1.876bn in 2015, going against an unusually robust convention comps for Q4 2015.
Food & Beverage
2016: $1.639bn vs. $1.575b for 2015, an indicator of more outlets, more covers, higher average covers.
2016: $517m vs. $539m. The slight decline was clearly related to the 2015 Mayweather/ Pacquiao fight bonanza which showed up in every service line category that year.
2016: $200m vs. $201m for 2015. Overall retail on the strip was flat though total visitation to Vegas was up to 42 million.
2016: $533 vs. $506 includes income streams from diverse activities and ancillary services.
This shows a net $265m revenue increase attributable to the addition of Borgata and National Harbor revenues offsetting a flat number for the Las Vegas Strip. MGM Detroit and MGM's Gold Strike in Mississippi both showed increased revenues.
2016: 793m vs. 752m for 2015 reflecting increased revenue support.
Same store Adjusted Property EBITDA margin: 29.6%, an increase of 336 bps.
The debt dragon
Total long-term debt stands at $13.1 bn. Without question this is one of the remaining obstacles the company needs to deal with longer term though its moves to date are slowly reducing its drag on results. However, it should always be noted that casino companies are voracious consumers of capital. They are, until a better business model shows itself writ larger than it has to date (i.e. online gaming), brick and mortar businesses. Its debt coverage ratio of 1.5 is not very reassuring to many investors, one reason we believe the stock has still not moved higher to better reflect its strongly improved operating numbers. Yet though thin, i'ts manageable, as the company's cash position and free cash flows pretty much put it in the safe zone enough for it to declare an 11c dividend payable next month. MGM's cash balance as of December 31st sits at $1.4 billion and will ramp up as free cash flows from both National Harbor and Borgata rise.
Though some analysts have questioned whether MGM should be paying even piddling dividends given its cash and debt position, neither of these pose any major threat to its continuing growth. The real threat comes from its ability to finance a possible entry into the just authorized Japanese Integrated casino resort market. MGM is on record as having said it is willing to invest up to $9 billion if licensed in Japan. Our best guess is that if it does successfully get a license there, it will need a strong, if possible, major Japanese financial partner.
The company has also been active in the lobbying effort in the State of Georgia to authorize casinos. We are encouraged that the aggressive stance management has taken over the last 11 months signals a continuing commitment to deleverage, build shareholder value, improve operating margins and meet expansion head on in markets it deems viable.
Given MGM's sharpened focus on asset allocation, margin improvements, and dominant position on the Las Vegas Strip, we like the stock to move. We think National Harbor will outperform analyst expectations considerably. (Its first full month of operation it won $48.4 million against the total Maryland market of $126 million, while the 5 other existing properties showed declines, clear evidence of cannibalization, that will continue.)
The Tracinda factor
Earlier this week Tracinda, the investment company of the late Kirk Kerkorian, which upon his death owned 16% of MGM's common, announced it had sold more shares, getting its remaining ownership down to 13.80%. This was not a new sale but the settlement of a call options deal from last June with UBS. The bank reportedly made $60 million pre-tax on the deal.
It should be borne in mind that Kerkorian's will specified an "orderly" sale of the block, which is what the trustees are doing. (One sits on the MGM board and is a strong ally of Chairman Murren.) So this was not a sale based on valuing the company up or down but something arising out of the will. It is fair to suggest that under ideal circumstances MGM would be in a cash position to set in motion a plan to acquire the residual Kerkorian interest itself and by extension, enhance shareholder value going forward.
The case for $35 is simple
I believe the shares are mispriced now, post earnings call, because the market is a) Worried about leverage, b) Uncertain about the Kerkorian interests playing out over time, c) A flattish tone to Las Vegas Strip gaming revenue, d) Concern over the ability of Macau to absorb the new Cotai property even coming at a time when it's in a steady pattern of recovery.
What the market does not sufficiently calculate in my view:
1. Improving tone to the national economy as some Trump initiatives begin to work through the system, such as tax cuts. The Las Vegas strip will be a prime beneficiary.
2. The rapid ramp up of revenue and EBITDA accretion from National Harbor and a slowly improving mini-recovery in Atlantic City where Borgata will be the biggest beneficiary.
3. A good performance by MGM Growth Properties enhanced by the prospect of more product being generated for it by MGM. Thereby rewarding MGM with ever increasing income from its MGP units.
Above all, and I value this most, the tighter, more focused, clearer long-term management strategy that has begun to pay off. This is not the MGM of a year ago. And the share price has not yet baked this premium into its price.
Authors note: My own gaming portfolio is held in a blind trust for my children and grandchildren and is run by a former industry colleague.
The reason for this is that as a consultant I deal with listed casino operators and I consider it a potential conflict of interest to own or trade their shares, past present or future.
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.