MGM: One Too Many Ants At An Otherwise Nice Picnic

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About: MGM Resorts International (MGM), Includes: CZR
by: Howard Jay Klein
Summary

We're getting antsy about MGM's voracious appetite for expansion to be bigger than its financial stomach.

Its old Vegas asset base parallels that of Caesars. Is it undervalued?

MGM Springfield and its recent $850 million buy of Empire City Racing raises questions about management's strategic vision.

“There is only one boss. The customer. He can fire everybody in the company from the chairman down simply by spending his money elsewhere…” Sam Walton

In many articles on MGM Resorts International (NYSE:MGM) we have expressed both enthusiasm and head scratching. We guided high when we saw a clear bull case coming. We also expressed concern when we questioned the proclivity of management to raise its hand and call out "Me! Me!” at every possible expansionary move to cross the news. Its “Me! Me!” strategy seems at odds with an otherwise bullish case to be made for the stock.

Most recently, on Dec. 17, we raised the question as to whether the company’s ambitions had overstretched its financial and management realities. On that day the stock was trading at $26.87.

MGM’s price at writing is sitting at $26.50. Its 52-week range is $21.62 to $37.13, much closer to its low than its 12-month high. With a market cap of $14.22 billion and a P/E ratio (ttm) of 32.73 against an EPS (ttm) of $0.81, we are setting the yellow caution light blinking despite some positive guidance on the stock coming from many in the analyst community. We’re not disputing some of the drivers cited for a more bullish outlook than we now present. As they say, everyone cooks with water, but not all chefs get the same result.

Chart Data by YCharts

As we have always noted, there is much to like about MGM that would prove that, like its strip co-giant, Caesars Entertainment Corp (NASDAQ:CZR), its Las Vegas asset base could be undervalued. Currently Carl Icahn’s moves on CZR suggest their fortress Vegas paradigm is indeed undervalued and poorly managed, as we have noted. The same Icahn logic can apply to MGM. CZR properties control about 21,000 rooms on the strip, while it's 28,000 for MGM, rounded off. Both portfolios comprise around one-third of the total available rooms on the strip. MGM management in general is better but it needs something of a wake up call in our industry-centric view.

If you buy into the more optimistic outlook that some have for improved organic growth for the Vegas market in 2019-2020, you can make the case that MGM has upside. The convention calendar this year looks better than it did in 2018. Visitation connected to convention arrivals is estimated by the Las Vegas Convention and Visitors Authority to reach 2.4 million, a 4% year over year rise. The total airlift of flights available will be up 2.3%, up 14% from 2018. While this is no guarantee that there will be fannies for all those seats, its still an indication that airlines who closely watch these visitation trends are more bullish on the destination.

Add to that the consensus expectation by economists that consumer spending will rise around 2.5% in 2019, buoyed by tax refunds and continued job growth presumably contributed to the MGM bull case, and we are looking for about 40 million to 40.5 million total in visitation to Las Vegas this year. It's flat, but projected convention spending and average RevPar will be higher, according to company estimates. Occupancy will be in the 90s. Table game wins will be flat, according to our sources on the ground, with baccarat taking a hit but slots compensating with an anticipated growth of around 4%.

While a healthy economy can vary in the degree to which it shows up by region, it is safe to assume that if you buy the economists' take, US regional casinos will likewise benefit from most of the same macro factors.

This base case for MGM EBITDA for 2019 is bullish, but not off the wall. It is based on 2018 MGM revenue, operating costs and anticipated cost-cutting yielding an increase of $200 million in EBITDA for 2019.

Our Estimated EBITDA: MGM US

(Based on MGM 2018 results – our projection)

Las Vegas Strip Same Store: $1.85bn
MGM National Harbor 200m
Borgata AC 190m
Detroit 185m
Mississppi 147m
Total US $2.354bn

Note: MGM Springfield is not included since it did not open until late August of 2018. We will review it separately from a strategic viewpoint only later in this article.

If the economy holds positive through 2020, as most economists are now forecasting, we can see MGM EBITDA moving to over $2.4bn.

We have not included MGM China in the above, but put it boldly in the plus column both as to growth potential and future prospects in Macau’s mass and premium mass sectors. We have also not factored in the prospects for MGM to be one of the successful bidders for one of the three Japan Integration Resorts (IR) licenses to be issued before the end of this year. We will review with those prospects in later articles.

MGM US

Our concern here is the general direction of MGM’s performance on the strip and US regionals only. Many of the bull cases MGM you’ll read from standard sources are built off the conviction for a strong Vegas rebound in 2019 and an economy that will likewise support their regional casinos as well.

Our focus here is on two asset-allocation decisions of the company in the US Northeast. We spotlight them as ants at an otherwise nice picnic. They raise the question as to why MGM announces an ambitious cost-cutting program to increase EBITDA by $300m by 2020 and at the same time makes head-scratching expansion moves in a crowded regional space.

The northeast gaming picture: Lots of ants

MGM SPRINGFIELD: Cost $1b

Our call: It was, and is, a bad bet.

MGM Springfield a puzzling $1bn bet

MGM Springfield: A puzzling bet at the very least. Source: MGM

Based on our own internal data sets, discussions with colleagues in the region and the ground-rooting realities of filling fannies at gaming positions daily, we see the Northeast as oversupplied.

MGM’s decision in 2014 to build in western Massachusetts was at best puzzling. The question was this: Do you invest $1 billion in a location that will sit in the crosshairs between two mammoth tribal casinos in Connecticut (Mohegan Sun and Foxwoods)? They know your bullseye target will be the Hartford/New Haven market just over the border. And that market is tribal bread and butter. You should have expected them to fight back. And they have. While still in something of an administration legal delay, their objective is clear. Both tribes have partnered to build a fighting brand slot parlor to East Windsor, Conn., to protect its revenue base. Sooner or later that property will be built.

In its early presentation to Massachusetts officials in 2014, MGM forecast its Springfield property would produce $418 million in annual gaming revenue. Based on numbers from the Massachusetts Gaming Commission it appears now that MGM Springfield’s 12-month actual gaming win is headed to average around $200 million to $250 million, or around half of forecast.

Enter Encore Boston this summer. The Wynn Resorts Ltd (NASDAQ:WYNN) $1.7 billion blockbuster debuts with a property that bears the design signature of former founder and CEO Steve Wynn. It’s minutes from the core metro Boston markets. Its wing-shaped towers loom over a magnificent waterfront park. We’ve eyeballed the property with two industry colleagues. The short take from both, and a quote from one of those colleagues, who has run major properties: “This place will eat everyone’s lunch. MGM Springfield and the tribal properties in Connecticut."

In gaming, driving or flying, distance is destiny.

Metro Boston/Providence are ground-zero markets for Connecticut’s tribal properties.

Driving time from Springfield to Boston: 1 hour, 35 minutes.

Driving time from Connecticut tribal properties to Boston: 1 hour 45 minutes.

And here’s the key: Driving time from Hartford to Springfield is a nifty 30 minutes. That augers well for MGM, per se. But in the casino business, the next question is, “What do you see when you get there?” as one one of our casino veterans noted. Arriving at MGM, you see a nice downtown building sitting among other business district buildings. It a nice property. Now take the same Hartford player and drive the hour-forty-five-minute route to Encore. You’ve ridden an extra hour but what do you see on arrival? You see something easily at home among the top properties on the Vegas strip. And you didn’t have to make the five-hour-plus air trip to get there. So for an “investment” of one hour extra highway driving time, your arrival is an escape – not a downtown building plunked amid offices and apartment blocks.

A foreboding analogy: Upon the legalization of gaming in Maryland, CZR swept into downtown Baltimore with a project under the Horseshoe brand. It sits in the heart of the metro center. It was built despite the coming of MGM’s National Harbor blockbuster facing Prince George’s County, Va., and the wide swath of the Washington/Baltimore suburban market core. Ironically MGM’s National Harbor, a $1.4 billion property in a superb, beautifully executed location, has a gaming-run rate at writing of around $50 million per month. It has poached Horseshoe, which is tracking down 14.5% and gobbles up 39% of total Statewide GGR, taking smaller but regular slices off Maryland Live! and others.

So here we have MGM’s Springfield property, already underperforming before the arrival of Encore, also facing a very possible tribal slot parlor minutes away over the next two years. That smacks of bad asset allocation not easily overcome by any number of marketing ploys. I’ve been there and done that. When you have plus location and property richness, your marketing cost goes down. When you have minus location and so-so property richness, as does MGM Springfield, all the slickest marketing ideas in the world won’t overcome that bad asset-allocation decision.

Time will tell. MGM Springfield eyeshade minions can possibly find a way to cost-cut, increase marketing efficiency, and probe outer markets. We’ll reserve final judgment for after it faces the arrival of the Encore Boston property.

Meanwhile, we think it's fair to question the wisdom of investing $1 billion in a geographically small area with strong competitors to the east, the south and eventually the front door. Our takeaway: The property could be viable for sale at an attractive price to a regional operator with no northeast footprint who, with a lower cost base, might make it work.

A New York State of Mind: Empire The Empire City racing. Distance from Times Square cited by enthusiasts for deal is meaningless.

Empire City racing. Dealmakers cited "distance from Times Square is 12 minutes" as a huge location plus. It's meaningless. The guts of the metro NY market's casino business comes out of the outer boroughs and suburbs. Source: Ricky Flores and Peter Carr/The Journal News

Las month, MGM closed an $850 million deal to acquire the Empire City Racino in Yonkers, NY, located in southernmost Westchester county, in the heart of the massive No. 1 U.S. metro area with a population of 18 million. The property sprang out of a legacy harness racing track that has 5,200 video lottery terminals. MGM hopes it can get the New York legislature to approve live gaming slots and tables. Meanwhile, its eye is focused on the 97 acres of property owned by the facility that appears headed for major expansion if and when state officials give the nod. We checked with our local contacts in the gaming/legal arena and most called it: “a possibility, but probably a long shot at this point and the foreseeable next two years at least.”

Meanwhile, taken as it is, Empire City is a nice racino property, and well located, but is facing immense competition, like Springfield, in an area that is essentially oversupplied. Firstly, just 45 minutes by car to the southeast lies giant Genting’s Resorts World racino, which is undergoing massive expansion with amenities and rooms in spitting distance from the JFK airport. Resorts World’s 5,000 video lottery terminals (VLTs) generate close to $950 million in revenue annually.

Also competing head to head for New York metro business are the two aforementioned Connecticut tribal properties, around two hours away. And more recently there's been Genting’s Resorts World Monticello, in the Catskills New York resort area, about 90 miles from metro core and less than a two-hour drive from its center. That property, as well as three other upstate resorts authorized by the legislature, have been hurting for business.

Atlantic City as a competitor, regardless of its halved revenue base, remains an active pursuer of the metro New York gambler. It's around a two-and-a-half-hour drive from the core and since 1978 has literally feasted on New York as one of its two bread-and-butter markets (Philadephia is the other). Beyond that it should also be noted that Las Vegas Sands (NYSE:LVS) in Bethlehem, Penn., also sees metro New York as a marketing target offering live casino gaming. LVS saw the writing on the wall and last year sold the property to an Alabama tribal group. Even the Sugarhouse casino property, positioned in northern Philadelphia, advertises its sports-betting availability in metro New York media (60 miles away). As long as New York State legislators dawdle about sports-betting legalization, both Philadelphia and Atlantic City consider the metro area key marketing targets.

The takeaway

In our view betting $850 million for openers on the Empire City potential, amid an ocean of competitors coming at a property from all directions, is a questionable asset allocation bet. New York State’s legislature is markedly one of the slowest and erratic in the nation. Bear in mind that, if the state does take such action, it will also apply to Resorts World in metro New York.

Together, the MGM moves in Springfield and metro New York, even as part of a larger Northeast strategy, do not seem to us as smart asset allocation of $2 billion total.

Position this against the two great bets MGM made. First, last year it bought the 50% it did not own of the AC Borgata, the market leader there. The property is about holding its own despite the macro decline in Atlantic City. It is also facing stiffened competition from a reimagined Taj Mahal, where Hard Rock International has put $500 million in renovations on the line, betting on a revival there. It will take time. It's early stages, but aiming at the same demo, there will be some slowing-down of Borgata growth. The $900 million MGM paid for half the property was a reasonably good bet that the top-shelf property would continue to do well.

And secondly, MGM’s National Harbor will continue to produce outstanding results because it possesses all the elements of success that its bad bet deals do not: great location, superb execution of a first-class Vegas Strip-level property, centered in a huge population base with a large upscale segment for non-gaming revenue in meetings, expos and conventions.

Our conclusion

Regardless of the fact that MGM has spun off much of its realty to its REIT, MGM Growth Properties Inc. (NYSE:MGP), it must still meet those rent obligations and operating costs laden down with a heavy corporate overhead. We like its pledge to increase EBITDA by $300 million in cost-cutting programs by 2020. We like much of its Vegas footprint as clearly having fortress performance characteristics unless there is a recession, of course. We like their two-property footprint in Macau, especially because their new Cotai hotel is off to a positive start despite concerns about China’s macroeconomic woes. And we do see MGM as among the leading aspirants for a Japan license by the end of this year. All great and bullish. But as noted here, we see other moves as head-scratching, and that is unsettling against its long-term debt of over $15 billion.

This implies to us something beyond the numbers. Carl Icahn’s move on CZR indicates that the very savvy casino investor thinks that company’s fortress Vegas portfolio and regional network is undervalued. Assuming Vegas does rebound strongly this year and next, and that US regionals hold their own in a good consumer market, you could make that case. We can’t in the light of other factors on MGM – specifically the two investments in a very saturated Northeast.

On this basis we see MGM as a hold at best – not a buy. The balance between its best bull case against its bear case is just to narrow from our industry-centric point of view.

We will revisit the stock before the end of the second quarter for another look. We think the single tailwind that counts will be good news from Japan. We don’t see any breakaway in the stock until then.

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.