Wynn In Play? MGM A Bad Fit, Galaxy Or LVS Better, Either Way Bullish For The Stock

Summary

• Speculation that MGM might be mulling a move on Wynn makes little sense strategically or financially.
• Las Vegas Sands, a more logical buyer, is tightly focusing efforts and resources on the developing Japan prospects.
• Galaxy bought 5.3% of Wynn: The company looks well-positioned to scoop up more; It is a good strategic fit.

Understandably, since the sudden departure of Steve Wynn right after the Wall Street Journal accusations of sexual misconduct surfaced last Jan. 26th, speculation has soared as to what lies ahead for a Wynnless Wynn (NASDAQ:WYNN). My own view, often expressed on SA, has been that the most viable and logical buyer would be Las Vegas Sands (NYSE:LVS). I believe LVS offers the best strategic, financial, operational and corporate culture fit for both companies. I continue to believe that to be the case.

However, we have had news this week that the ever diddling members of Japan’s two coalition parties have finally agreed on several critical issues at the heart of the enabling IR legislation. It would appear that we could see a final bill voted on favorably by Q3 or before with the bidding process ramping up in earnest by early 1Q19. A broad consensus of industry, legal and political sources in Japan we check with periodically on the IR initiative, continue to agree that Las Vegas Sands is by far the leading candidate for the first license award and for a site in the plum market of Osaka. Of course, this is politics and anyone who presumes to predict the erratic inner scuffling of officialdom in such cases, must honestly caution that there is always an element of astrology in these political decisions. The conjecture among experts sometimes does sound like the reading of horoscope signs. I, and many others, prefer to make educated guesses. That’s about as close to a bettable forecast as it is reasonable for anyone to expect.

We have also had the sudden, stunning development that Galaxy Entertainment Group (HKG: 0027), the Hong Kong-based giant of Macau gaming, laid just under $1bn on the barrelhead and picked up 5.3% of Wynn shares in a private sale from the former CEO. By any measure, a Galaxy Wynn deal makes immensely great sense for reasons we will lay out later in this post.(Below, The Venetian, Las Vegas IR complex)

MGM: A bad idea for a good company

So now here comes MGM. A speculation loaded article in Friday’s New York Post Feb. 6^th quotes a number of unnamed sources suggesting that MGM Resorts International has already expressed quiet interest in buying Wynn. While I have been, and continue to be bullish on MGM (My PT stands at $40), I don’t see the logic on any basis, for such a deal. (Below: The new MGM Macau Cotai)

Wynn has denied any such talks have taken place but as is common in fluid situations after major corporate upheavals, this denial will not stop the persistence of speculation fueled by what is clearly a situation pregnant for change.

This is not to say that some very hungry investment bankers can don their eyeshades, roll up their sleeves and push buttons all over their formidable algorithms and make an MGM case the market could find viable. In the financial business, you can twist and pull numbers and make any irrational case sound like gospel. In truth, the same sort of blind man’s bluff game among the bankers is what formed the basis for the acquisition of Caesars (CZR) at a huge premium by private equity operators Apollo Global and TPG Group back in 2008. That too was a bad idea executed by a good company.

By 2015, the CZR private equity deal was clearly exposed as a colossal failure, partially, but not fully, the result of the 2008 financial crisis and its aftermath on the casino industry. After lots of financial Erector set constructs aimed at protecting assets, the company finally gave up and filed for Chapter 11 in 2015 and has only recently re-emerged split into an operating company and a REIT (VICI). We have not liked the strategy or the stock at this stage and have guided away from it in prior posts.

We don’t imply here that a similar path is destiny for a possible MGM play at all. But we do believe there is a cautionary tale of shaping a banker’s narrative for an MGM/Wynn deal based on rationalized delusion, rather than a cogent logic. And I think the MGM rumors, probably resulting from chin scratching idle conjecture by some industry sources, is the origination point of the Post story, not the beginning of a deep dive into looking at a deal by MGM’s top management. Yet investors can’t ever rule anything out.

The reason? By our calculations, the break-up value of Wynn could reach somewhere between $255 and $260 per share. At writing, Wynn was trading at $178.74, under pressure, as is the entire market in general, over the ever louder beating of the trade war drums between the US and China. Yet, while we expect Wynn shares to recover as the macro din diminishes, there is still in our view plenty of room for a buyer to step up to the plate. Galaxy paid $175 a share. It was a savvy buy. Realistically with the stock now sitting slightly above that number, a buyer could easily swoop in offering $185 to $190 a share. That would be happy days for Wynn holders, especially the 9% still held by Wynn’s ex-wife, Elaine.

Why MGM/Wynn is a bad fit

If MGM bought Wynn it would only deepen its asset base in Las Vegas, a market where it already could be somewhat overcommitted despite the company’s good performance there. Adding the two Wynn hotels and its two pipeline properties in a market where they already command the dominant room and entertainment capacity makes zero sense. While non-gaming revenue grows, pure LV gaming is flat to down. And with both the Wynn as well as the huge Genting project pipeline underway, we could see the beginnings of a flattening of non-gaming growth as well. The LV market could move from fully served to possibly the beginning of being a bit overserved and more sensitive to possible economic headwinds that could shave future earnings.

Meanwhile, we see MGM’s market share growing in Macau due to its second property at Cotai. We likewise think it will be a solid competitor for one of the three Japan licenses. It is beginning to resemble a hungry guest at a buffet whose eyes widen and plates get heavier, passing up no treat on the groaning board. Strategically, it just makes better corporate sense for MGM to begin ingesting what it has already piled up on its plate lest it get an attack of indigestion triggered by debt among other problems. That’s what happened at CZR.

MGM also has its Springfield Massachusetts property under construction facing a fighting brand challenge from a tribal slot casino slated for building on the Massachusetts and Connecticut borders. Moreover, MGM’s National Harbor property in Maryland, which we long ago saw as a blockbuster, has indeed produced great early numbers. Its run rate on casino win is around $50 million a month and rising. Its non-gaming revenue stream is likewise strong. Yet, based on our own visits to the property and reports from professionals and customers in the area, the property still has shakedown cruise operating problems in parking logistics, floor traffic, restaurant management and other below par operational systems that need and will undoubtedly get fixed in due time.

This sheds light on a dilemma: namely, when does a portfolio become so big that it is unwieldy, and its capacity to deliver a solid customer experience is impaired? That’s part of why Caesars tanked as we mentioned. It is a danger now for a MGM with eyes bigger than its stomach. And to some extent, it’s a matter of corporate culture.

MGM, which is by any measure, is an outstanding corporate citizen in its jurisdictions, doesn’t have in our view, the customer service culture sophistication, training and ability to create the property chemistry of a Wynn. That is one of the prime characteristics that define some casino operations from others. Wynn and LVS, are both companies that are products born in the ambitions of founding entrepreneurs. They are men with a clear, non-robotic grasp of how to build, market, service and develop customers for iconic casino hotels. They are in short, sui generis, among along with the Sam Boyds, Bill Harrahs and Jay Sarnos (Caesars Palace 1966) in the history and innovative boldness in the industry’s history.

MGM is well run, also led by a founding entrepreneur in Kirk Kerkorian. But he focused entirely on finance. He was not actively involved in developing a corporate culture at the street level that worked its way through the system over a period of years from the executive level, to the customer-facing employees on the casino floor, rooms, restaurants, hotel and entertainment outlets. MGM has been in the hands of CEO James J. Murren since the departure of another great, the late J. Terrence Lanni in 2008. A financial executive, Murren had his share of early stumbles, but more recently, has proven a fine steward of his asset base, heading a competent, professional management team.

By contrast, the essence of Steve Wynn resides in the walls of his properties and in the bloodlines of his executive team and bench now headed by Matt Maddox. These are all Wynn people, blooded and I mean blooded, if you measure relentless pounding away by the boss. Wynn personally, and famously temperamental, weighed in regularly on operational issues, and decisions on casino configuration, restaurants, entertainment, finance and most of all, an uncanny, hard to come by grasp of customer knowledge that all can’t be learned from focus groups.

He’s passed that DNA onto his team. That’s why we believe that LVS, also grown out of a similar pattern from the individual vision and whims of a domineering, my way or the highway entrepreneur, represents a far better cultural fit with Wynn. Sheldon Adelson’s team meeting Steve Wynn’s team will advance on what is by any measure a tough enough chippy elbows game to begin with common in all mergers. But they would, in my opinion, stand a much better chance of blending a copacetic mindset to the challenge of a merger and therefore produce superior results for investors.

MGM is excellently now positioning itself ahead of the US Supreme Court PASPA decision, to snare leadership in the casino space for online sports betting should the court strike down the law. Focus and investment in that sector make a solid strategic goal for the company and is one key reason I am sticking with my PT of $40 on the shares by the end of the year Galaxy: Hand and glove a great fit slipped in place.

While all the decibel of chatter rose about Wynn’s resignation, Galaxy Entertainment Group Ltd. quietly stepped up to the plate and acquired 5.3% of Wynn shares in a near $1bn deal with Steve Wynn at $175 a share - a very savvy deal made at the right price at the right time. Evoking the iconic final dialogue from the 1942 classic movie Casablanca, when nightclub owner Rick turns to police inspector Renault as they walk into the foggy night, "Louie, I think this is the beginning of a beautiful friendship….” So too, the destinies of Wynn post-Steve and his Macau competitor Galaxy met and did indeed form what could be more than a friendship. Macau’s biggest corporate operator, GEG produced $11.3bn in 2017 revenues, a 20% y/y increase and $2.7bn in adjusted EBITDA.

The buy-in was immediately praised in welcoming tones from Wynn CEO Matt Maddox. We can expect GEG to get board seats and our sense is that more could be on the way. The most immediate possibility would be GEG to make an offer to Wynn’s ex-wife, Elaine Wynn, who currently has 9%. Should it buy her stake, that would give it a total of near 15% of the outstanding. That in turn could set the stage for a sound merger.

In such a transaction, Galaxy would get the superb US Wynn footprint in Las Vegas with two flagship upscale properties, plus the development projects of Paradise Park and Wynn West on the strip. Moreover, it would get the spectacular Wynn Boston development now scheduled for opening in Summer 2019. All the regulatory noise ginned up by Massachusetts gaming authorities over the personal Wynn woes would go away since Steve and his stock would be gone. There is the possibility that the uber sensitive PC minions of Massachusetts gaming regulation may insist on a brand name change to support their PC credentials with activists. Whether it evolves as the Wynn, or Encore or Galaxy makes no difference. I have visited the site and it is beyond question that it will make or beat all forecasts for revenue and profitability.

For those inclined to invest in the international gaming sector, GEG looks to us like a buy here. At last trade it was HKD$70.50 or USD$8.96 a share. Considering its Macau results, its pipeline in the Philippines (A planned US$500m property in Manila) and now its foothold in Wynn, we think the stock vs. its prospect is cheap.

Even if Galaxy sits on its 5.3% and goes no further, the possibility exists that it could make a joint run at a Japan license, bringing across the board financial, operational and Asian experience to the party. It is too early to see their proposed Manila project, or shot at Japan as being baked into the shares at its current trade.

It is worth a hard look now. Wynn will work its way north again as the market turmoil abates and it seems that if Galaxy or LVS wants to move on the company, the timing and price seem a good fit now.

Overall, we see a continuing swirl of transaction talk continuing around Wynn in the post-Steve era and overall a bullish tone to the shares if and when macro bearish headwinds on the tariff wars subside. We are nearly 2 years away from the all crucial reconcession talks with the Macau government, but in effect with the PRC. There are the ever-present rumors grinding away now that Xi Jinping will seek to punish US-owned Macau operators in retaliation. There are now 98,000 people employed in the SAR casino sector with probably another 60,000 jobs as a multiple. While nothing is ever certain, the likelihood that China will reverse course and transfer what it sees in general as a sin industry, to government ownership does not seem at this point to square with the facts.

Analyst’s 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.