Pricing Wynn Is Very Tricky

| About: Wynn Resorts, (WYNN)

Summary

I take a multiple-based valuation approach with Wynn.

I price each revenue region on its own because the company operates in two different parts of the world.

The different variations of this method are good at approximating what Wynn's value is "at the very least."

The whole gamut of valuation techniques available to investors will yield results far varying in magnitude. This wide range reflects the ample risks and potential rewards that the stock offers to investors.

Only proceed with an investment in Wynn if you understand exceptionally well the issues surrounding the stock.

Wynn Resorts, Limited (NASDAQ: WYNN) is a hard company to price. This is because it has operations in different and unrelated parts of the world, under entirely distinct governments (namely Macau and the US). On top of that, the company is in the midst of the consequences of Stephen Wynn's scandal. All these circumstances together make it a tricky valuation.

Tricky valuation

I thought that an excellent way to evaluate WYNN was to analyze its casinos one by one and price them. Now, although this looks good in theory, in practice it wasn't viable. You see, it's reasonable to evaluate WYNN based on a growth method, where you pay multiples based on growth percentages.

Typically, these growth percentages have to be over a three to five year period for the method to reach reasonable conclusions. However, here was where I ran into a problem. Which figures should we use?

If I merely value WYNN based on its total earnings, then I'd be missing many nuances on the valuation model. For example, I could quickly see that for 2017, the attributable earnings to WYNN were roughly $747 million, with a 5-year CAGR of 0.65% (i.e., no growth). Based on multiples, you'd at best assign WYNN a market PE ratio of 25.37 and come up with a price tag of $18.95 billion.

Now, since you're getting 1.34 (calculated by the stock's beta) times more risk in WYNN's shares than in the rest of the market, then we need to adjust for that. A quick way of doing this is easily calculated by proportionally assigning a corresponding PE of 18.93 (25.37*1/1.34 = 18.93). With this multiple, we can now calculate WYNN's fair value to be $14.14 billion.

To put that into perspective, the current market capitalization for WYNN is $19.79 billion. That means that through this valuation approach, the company's stock is overvalued by roughly 29%. Although usually, this method provides a good back of the envelope approximation, when I find such disparities I quickly ask myself what am I missing.

Image result for pondering

Even if I were to use the CAPE ratio as the markets price to earnings multiple, I'd come up a lower valuation than its current market capitalization. The current CAPE ratio stands at 33.13 (extremely high by historical standards), and the proportional multiple assigned to WYNN based on its beta would be 24.72. With this figure, I can calculate the resulting fair value of WYNN to be $18.47 billion. This valuation still would indicate that the company is overvalued by 7%.

Although the last price tag for WYNN is more in line with the company's current market cap, it would signal that there shouldn't be that much room for the upside at current levels. In particular, after you consider the fact that the market is currently trading at extremely high premiums. After such periods, a simple mean reversal could result in disaster for investors in high beta and top PE stocks. Hence there's much risk in a WYNN.

Different revenue regions

Nevertheless, I think the central aspect here is that it's not fair to add up earnings from Las Vegas to profits from Macau and assume they're equal. In reality, Las Vegas is a regulated and much more developed gaming market in the US where high competition exists. On the other hand, Macau is under the rule of China and subject to other types of risks. We're talking about two entirely different cultures and markets. Because of this, we should value each segment separately, and see how those valuations add up.

The company reports its results in many ways. For example, the business records by casino, by region (Macau and Las Vegas) and by type of revenue (like rooms, beverages, entertainment, and casino). Because of the reasons I previously explained, I'm going to use their figures by region. I think that it would be fair to treat Macau and Las Vegas as two segments, instead of adding one additional level granularity and evaluating by casino. The Macau Palace is still in its infant growth stage, and it's unreasonable to value it on its own because it'd require extremely high multiples (higher growth demands a higher premium).

Because of this, I'll proceed as detailed above. First, I'll need the US and China's CAPE (good proxy for Macau) ratios. These figures stand at and 33.13 and 17.89 respectively. Since WYNN has a related publicly traded company in the Chinese stock market, I can use that beta for its Macau operations. In other words, I'll be using 1.33 and 1.19 as betas for the US and Macau respectively.

Source: See links above and author's elaboration.

Then, it's straightforward to merely perform the appropriate calculations given the method I explained above. First I'll calculate the Las Vegas beta-adjusted multiple, and then do the same with Macau. From WYNN's reports, we can approximately calculate the net income attributable to each region.

Source: WYNN's investor relations (see link above) and author's elaboration.

Although I present you with the figures for the last three years, we only need last's years figure to perform our valuation. We have to multiply the attributable net income from each region by its corresponding proportional PE multiple and add both results.

Source: WYNN's investor relations (see link above) and author's elaboration.

As you can see, through this method I arrive at a total valuation of WYNN of $13.20 billion. This figure would imply an overvaluation in the shares of roughly 33%. This number is even higher than the one I obtained through my first approach.

Source: WYNN's investor relations (see link above) and author's elaboration.

I summarize for you these three valuations in the following chart:

Source: Author's elaboration.

All of these approaches would indicate that WYNN doesn't have much upside from this point forward. The only way for further price appreciation in the shares would be due to multiple expansion, which at this point seems unlikely because current market conditions are already extremely optimistic.

Important caveat

However, I must add a huge caveat to these valuations. They're only one method. I applied multiple other techniques to evaluate WYNN, and I came up with an extensive range of possible approximations to fair value. This situation usually doesn't happen in my experience. As I said in my opening statement, this company is very tricky to price.

There are multiple catalysts for the upside and downside. Its operations in Macau should continue to grow, but its license hasn't been renewed so far, and it'll end by 2022. In Vegas, WYNN has a reliable operation, but the most significant chunk of revenues for WYNN originates from Macau. Also, these two markets are entirely different for the reasons I previously explained. Moreover, Stephen's scandal and the apparent proxy fight in WYNN's board of directors add for additional instability to the shares. Plus, on another note, Japan's gambling market might contend with Macau in the future, and WYNN might see its results negatively affected if that happens.

Nevertheless, it would be unfair to ignore the enormous potential WYNN has in Macau. The problem is, if I evaluate this company based on that potential growth (which is as high as a CAGR of 60%), I can come up with fair values of up to $45 billion. These valuations would imply a price per share of $400 and a potential upside of more than 100%.

Source: Diagram of a decision tree.

In my opinion, the full range of potential valuations for WYNN reflects accurately the high level of uncertainty and risk that surrounds the company. The seemingly cheap shares hold a high level of risk with a possibility of high rewards if management pulls ahead successfully.

This situation is because in any valuation you need to make assumptions, and those axioms are the basis for your valuation model. In WYNN you have to make simply way too many assumptions (positive and negative). The resulting decision tree from these assumptions is enormous, and therefore the potential range of fair values is vast.

Conclusion

My recommendation is that you should only proceed with an investment in WYNN's shares if you have an excellent understanding of every factor. Moreover, you need to evaluate that many of the potential uncertainties surrounding the stock will play out in favor of the company.

Going through these multiple valuation scenarios would be tedious and out of the scope of this article. Nevertheless, I think that the valuations presented here are a sound approximation to what the company should be worth "at the very least," given current market conditions.

I'm interested in reading your take regarding your personal valuation of the company's shares in the comments below (please indicate your method if possible). Thank you for reading and good luck in your investments.

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.