Value Investors Club / MGM Resort (MGM )

Description

SUMMARY THESIS: MGM has 50-70% upside and is highly asymmetric

(1) Undemanding Valuation: MGM “consolidated” is currently trading in the 1st percentile of EV/EBITDA cheapness using data over the past 5 years and the 16th percentile using data going back to 2005 (i.e. including observations during the financial crisis). The implied valuation of the US assets in MGM International is ~6x EV/EBITDA – it’s never been that cheap;
(2) Current EBITDA multiple is inflated because of Enterprise Value vs. EBITDA mismatch (i.e. it's even cheaper than the 'headline' multiple suggests): EBITDA and cash flow are ‘guaranteed’ to increase in the coming 12/24 months => MGM has spent ~US$5 billion of capex on three growth projects over the past ~3-4 years which have either just opened (& started generating cash flow) or will do so in the coming months. As such current Enterprise Value includes the capex (through net debt) but EBITDA does not include any benefit of the capex that’s been spent. This mismatch is material as $5 billion of capex is ~1/3 of MGM’s market cap and run rate EBITDA is at least 15% higher than LTM (this estimate is conservative as shown in more detail below);
(3) MGM will return material capital to shareholders in the coming years: MGM has outlined a capital return plan of $2.3-3.3 billion of dividends and buybacks over the period 2018-2020. This equates to ~15-20% of the current market cap;
(4) MGM has significant real estate value that can be monetised which would increase capital return potential: it is high probability MGM will sell real estate holdings to its captive REIT MGM Growth Properties (MGP). These sales will enhance MGM’s ability to return capital to shareholders (any sales would be incremental to the capital return outlined in (3) above). The sale of MGM’s Springfield property (very high probability in late 2019/early 2020) represents ~4% of MGM’s market cap of incremental capital return. There are further real estate assets equating to >35% of MGM’s market value that can be monetised in the same way***. Such real estate sales would increase the total potential capital return to almost 60% of the current market value without meaningfully diminishing MGM’s earnings power (i.e. MGM would be selling cash flow streams the market is currently valuing at 6x for more than twice that value);
(5) Potential buyout candidate: MGM’s cash flow is inflecting and the public market valuation looks disconnected from underlying fundamentals. The business has relatively stable and predictable cash flows and as such can withstand more leverage in the private market than it currently sustains in the public market. If MGM’s market valuation does not reflect its cash flow generation and fundamental value it’s a prime candidate to be taken private;
(6) Other optionality: there is other optionality in the stock that’s currently being valued at zero. For example (i) MGM will benefit from the recent repeal of the prohibition on sports betting; and (ii) Japan (likely 2nd largest gaming market behind Macau and larger than Las Vegas) is currently looking to legalise gaming & MGM is well placed to win a licence

In summary MGM stock is pricing in a very bad outcome based on the current valuation despite guaranteed growth from sunk capital, material near term capital returns and upside optionality via either M&A or fundamental step-changes.

*** Note: these sales are also positive for MGP as under my assumptions it is acquiring assets at lower valuation multiples than where it currently trades. As such, these acquisitions are accretive to MGP.

BACKGROUND

This summary will be deliberately brief as I suspect most are familiar with MGM’s stable of assets. There are two points I would like to make though:

(i) MGM’s United States assets are heavily skewed to Las Vegas. MGM is the largest LV operator by a significant margin and has properties at all price points on the spectrum from budget (Circus Circus) to premium (Bellagio)
(ii) MGM’s corporate structure has three listed equities:
- (1) MGM Resorts International (NYSE: MGM): (i) operator of all US operations; (ii) owner of some of MGM’s best / most valuable real estate (Bellagio, MGM Grand); (iii) owner of real estate with development potential (Circus Circus) and newly opened properties (MGM Springfield); and (iv) owner of joint venture and other interests (CityCentre, Las Vegas Arena, etc.);
- (2) MGM Growth Properties (NYSE: MGP) (73% owned by MGM): publicly traded REIT that owns MGM’s other real estate and leases it back to MGM pursuant to a triple net lease;
- (3) MGM China (HK: 2282) (56% owned by MGM): owner of two casinos in Macau. MGM Macau which has been operational since 2007 and MGM Cotai which cost US$3.4 billion to build and opened in Feb’18

(1) THESIS POINT #1: UNDEMANDING VALUATION

There are three ways to look at valuation:
- (i) Implied valuation of MGM stub based on valuation for listed subsidiaries;
- (ii) Fully/Partially Consolidated Earnings Multiples
- (iii) Sum Of The Parts

(1)(A) Historical Data: Implied valuation of MGM stub based on valuation for listed subsidiaries

The MGM stub currently trades at ~6x EV/EBITDA
- This is as cheap as it has ever been (see charts & tables below)
- 6x is a significant discount to both WYNN and LVS Stub valuation (both of which also have listed Macau entities). WYNN and LVS Las Vegas assets trade at an implied value of >15x EV/EBITDA
- 6x is a discount to US regional casino operators. Las Vegas strip operations are generally thought to be more valuable than regional assets
A quick explanation of methodology
- StubCo Enterprise Value is calculated as MGM market value (equity value) plus MMG HoldCo net debt (i.e. excluding net debt at MGP and MGM China) less market value of MGM’s stakes in MGP and MGM China
- StubCo EBITDA is calculated as EBITDA generated at MGM HoldCo (i.e. excluding EBITDA from MGP and MGM China)

(1)(B) Historical data: Fully/Partially Consolidated Earnings Multiples

MGM currently trades at 10.6x 2018E EBITDA (Bloomberg consensus estimates). Bloomberg estimates are presented on a fully consolidated basis
- This represents the 1st percentile of observations over the past 5 years and the 16th percentile back to 2005 (as far back as Bloomberg has the data)
The median FY1 EV/EBITDA multiple is 11.7x over the last 5 years and 11.6x back to 2005 as far back as Bloomberg has the data
- The trading range over the past 5 years has been relatively tight => 1 standard deviation is 0.6x
- The trading range going back to 2005 is wider due to the volatility during the financial crisis

(1)(C) MGM is trading at an undemanding valuation ASSUMING NO GROWTH. *** THIS IS A CRITICAL POINT ***

LTM EBITDA is $2.7 billion (fully consolidated). Assuming a valuation range of 11.1-12.3x EV/EBITDA which is the median multiple over the past 5 years +/- 1 standard deviation derives an enterprise valuation of $30-34 billion and an equity value broadly in line with the current MGM share price. The result is not significantly different (modestly better) if one uses proportional consolidation rather than full consolidation.

However, as shown in Thesis point #2 below LTM EBITDA is not representative of run-rate EBITDA, which is at least 15% higher. This excludes any organic growth (which increases EBITDA further).

THESIS POINT #2: ‘GUARANTEED’ EBITDA GROWTH FROM COMPLETED CAPITAL PROJECTS

MGM will complete three large capex projects during 2018. The cash has largely been spent on these projects (i.e. it’s in EV through net debt) but EBITDA has not yet commenced. This mismatch corrects in the coming 12-24 months (mostly in the next 12 months)
- (i) Cotai (Macau): New casino in Macau. US$3.4 billion capex project that was completed in Feb’18. MGM expects this facility will generate US$400-500 million once it’s fully ramped up. Sell-side estimates for 2019 EBITDA vary greatly (based on assumed ramp-up speed). The range is ~$200m to ~$450m with an average of >$300m. I have ~$279m in the analysis shown above
- (ii) MGM Springfield: New casino in Massachusetts. US$960 million capex project that is scheduled to open in Aug’18. EBITDA for this project will likely be ~US$100m. Sell-side estimates for 2019 are ~$90-110m
  - Note: it is very likely the real estate will be sold to MGP once this asset is stabilised. This is generally ~12 months after opening. More detail on that discussed in Thesis point #4 below
- (iii) Monte Carlo: extensive renovation of the Monte Carlo casino in Las Vegas involving a hotel & casino upgrade and the building of a new 5,200 seat theatre. The cost of the project is $550 million. There are two impacts a project like this has: (1) EBITDA suffers during the renovation; and (2) EBITDA increases post renovation (e.g. the rooms have been up-scaled so ADR will increase + the new theatre will deliver new income). Average EBITDA for 2014-16 (full years before the renovation) was ~US$80m. LTM is US$36m. At a minimum EBITDA gets back to what it was previously (+~$45m vs. LTM) but realistically it will be better. I assume ~$90 million in 2019, increasing to $110 million in 2020 (note: $110m is only a ~5% ROIC on capex spend, which is likely conservative)
Using historical multiples in this way should be a conservative approach for at least 2 reasons:
- (i) we are applying an FY1 valuation multiple to LTM EBITDA (FY1 multiples are generally lower than LTM);
- (ii) historical multiples are under a different tax regime => from a fundamental perspective EBITDA multiples (which are before tax multiples) should adjust upward to capture the NPV benefit of the tax change;
For completeness MGM announced in May that it had repurchased 10m shares for ~US$310 million post quarter end. The impact of this is shown in the table below

Summing it up MGM: has 20-40% upside ASSUMING NO ORGANIC GROWTH

Aggregating the analysis above justifies a share price of $34-39/share without assuming any organic growth
- It’s worth reiterating that the estimates for both MGM Cotai and Monte Carlo are very conservative in this analysis. Per above:
  - Monte Carlo likely stabilises at ~US$110m or greater (the analysis above assumes ~$90m)
  - MGM Cotai likely stabilises at ~US$400m or greater (the analysis above assumes ~$279m)

Organic Growth Potential + FCF Generation?

Organic Growth

Some high level heuristics:
- Absent a recession I think it’s reasonable to assume there will be some growth in US casinos. EBITDA growth over the past 5 years has averaged >10%;
- The Macau gaming market continues to grow at double digits;
- The estimates above are conservative for both Monte Carlo and MGM Cotai (for the reasons described)
The analysis below assumes ~$152m of organic EBITDA growth from LTM to 2019E (~6% growth in total or ~3% CAGR). I think absent an economic shock this should be a conservative estimate
Organic growth adds ~$3-4/share to MGM's value as shown in the table above

FCF Generation

Based on my estimates MGM should generate ~$4/share of FCF over the period to YE2019

Aggregating everything: Organic Growth adds a further >25% for a total of ~50-70% Upside (as shown in the table below)

WHAT IS THE CURRENT MARKET VALUATION IMPLYING?

Inverting the problem => what is the implied multiple of LTM EBITDA + “guaranteed growth” EBITDA (i.e. as described above)?
- EV/EBITDA: 10.1x => 11th percentile of all observations and below any observation in the past 5 years (shown in the table above)
- As a reference point Consensus EBITDA estimates shown below => the LTM + “Guaranteed” EBITDA is below the lowest analyst estimate for 2019/2020

USING MARK TO MARKET SUM OF THE PARTS AS A CROSS CHECK

(i) MGM Growth Properties: $6 billion (current market valuation of MGM 73% stake)
(ii) MGM China: $5 billion (current market valuation of MGM 56% stake)
(iii) MGM Stub: $16-20 billion (Las Vegas strip assets at 9-11x EV/EBITDA; Regional Casinos at 7-9x EV/EBITDA)
(iv) MGM Stub Net Debt: $7 billion (excludes net debt at MGM subsidiaries)
SOTP Valuation: $35-43/share

THESIS POINT #3: MGM WILL RETURN CAPITAL TO SHAREHOLDERS

Management has been explicit about its intention to return capital to shareholders. The basic premise is that once the large capital projects (referenced above) are complete shareholders should receive the direct benefit of increasing free cash flow through dividends and buybacks
At the investor day in May 2018 MGM articulated estimated free cash flow generation of $4.5-5.0 billion for the period 2018-2020, of which 50-65% (or $2.3-3.3 billion) would be returned in the form of dividends and share buybacks. This represents ~15-20% of the current market capitalisation
Important Note: this does not assume any sales of MGM’s real estate assets. I believe with high confidence that MGM will sell MGM Springfield to MGP in 2019 or 2020. It is also possible that other real estate assets could be monetised. See Thesis Point #4 for more details

THESIS POINT #4: ASSET SALES

I believe it is highly likely that MGM will monetise assets in the coming 12-24 months. I think this can be broken into 3 broad buckets:
- (1) High probability sales from MGM to MGP: it’s very high probability MGM sells the real estate of the newly built MGM Springfield casino to MGP once the asset’s operations are stabilised (i.e. sale and lease back transaction). This was the playbook employed with MGM National Harbour which was sold from MGM to MGP once stabilised (in Q4’17). Assuming US$100m of EBITDA, rental coverage of 1.85x (in line with the National Harbour transaction) and 12.5x EBITDA (also in line with National Harbour) this asset would generate $675m of sale proceeds
- (2) Possible sales of assets from MGM to MGP: MGM could also sell the real estate of MGM Grand and Bellagio to MGP (similar transactions to Springfield). These two assets generated $875 million of LTM EBITDA. At 1.85x coverage and 12.5x valuation this would generate $5.9 billion of sale proceeds;
- (3) Opportunistic sales: Management has also spoken openly about m monetising assets if the price was right (see below). In the past few months MGM has sold two assets
  - Grand Victoria Casino for $327.5 million (https://investors.mgmresorts.com/investors/news-releases/press-release-details/2018/MGM-Resorts-International-Announces-Sale-Of-Grand-Victoria-Casino-For-3275-Million/default.aspx)
  - Mandarin Hotel for $214 million (https://investors.mgmresorts.com/investors/news-releases/press-release-details/2018/CityCenter-Announces-Entry-Into-Definitive-Agreement-to-Sell-the-Mandarin-Oriental-Las-Vegas/default.aspx)
I would expect MGM to use these proceeds for capital returns to shareholders. Importantly these cash flows are not included in MGM’s current capital return plan (they would be incremental). Foer reference:
- (1) would equate to ~4% of MGM current market cap (increasing total capital return to 19-24%)
- (1) + (2) would equate to 41% of MGM current market cap (increasing total capital return to 52- 57%)
It's important to note that the sale transactions described above are also benefiical for MGP
- MGP currently trades at ~15x EV/2018E EBITDA and 14x EV/2019E EBITDA. As such acquiring assets at 12.5x (per above) is highly accretive for MGP.
  - Arguably, 12.5x is too low as a valuation given the valuation at which MGP trades and recent transactions between other parties (e.g. VICI has been acquiring LV strip assets at higher valuations)
- Accretive transactions such as these enhance MGP's FFO growth (primary valuation metric) which underpins (maybe even richens) MGP's valuation. MGM is a beneficiary of this as it owns 73% of MGP
MGM management has commented about potential asset sales and returning capital to shareholders

THESIS POINT #5: POTENTIAL BUYOUT CANDIDATE

MGM’s cash flow is inflecting and the public market valuation looks disconnected from underlying fundamentals. The business has relatively stable and predictable cash flows and as such can withstand more leverage in the private market than it currently sustains in the public market. If MGM’s market valuation does not reflect its cash flow generation and fundamental value it’s a prime candidate to be taken private. Historically these are the sorts of assets that have been attractive to leveraged buyers of cash flow.

THESIS POINT #6: OTHER OPTIONALITY

There is other optionality in the stock that’s currently being valued at zero. Two examples are:

(i) MGM will benefit from the recent repeal of the prohibition on sports betting. Morgan Stanley recently published a big note on this topic for anyone interested; and
(ii) Legalisation of casino gaming in Japan. Citi published a note on Japan Gaming in May 2018 and concluded it will likely be 2nd largest gaming market in the world (larger than Las Vegas but smaller than Macau). Japan's parliament is expected to legalise gaming this year and request RFPs. MGM is well placed to win a license

CONCLUSION

In summary MGM stock is pricing in a very bad outcome based on the current valuation. LTM EBITDA capitalised at historical median valuation multiples justifies modest upside to the current valuation. This means the market is currently implicitly valuing each of the following at zero:

(1) 'guaranteed' EBITDA growth from sunk capital => EBITDA started flowing in Feb'18 when Cotai opened and will continue as Springfield opens (Aug'18) and the Monte Carlo rennovation is complete (late 2018 / early 2019);
(2) Organic growth => anything other than zero (or negative) growth is upside versus the current valuation;
(3) M&A optionality => lots of historical precedent of these types of assets being acquired;
(4) Other step-change upside optionality => sports betting and Japan are just two examples
(5) Capital return => MGM are going to be large buyers of their own stock in the coming years (at what I believe are objectively low valuations);

I think the above creates very attractive asymmetry.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Ramp-up of EBITDA => opening & ramp (Springfield, Monte Carlo) and ramp (Cotai) will be important
Return of capital to shareholders => MGM bought 10m shares in Q1’18 and a further 10m in May’18. This is ~4% of total shares outstanding. MGM authorised a further US$2 billion share repurchase program in May’18 (~13% of MGM’s current market cap)
Sale of Real Estate from MGM to MGP => Bellagio, MGM Grand and Springfield are worth $6-7 billion in aggregate. A sale of this real estate to MGP combined with a capital return to MGM shareholders would be a material positive catalyst
- For context $6-7bn represents >100% of MGM’s Stub equity value and ~50-60% of MGM’s Stub Enterprise Value
Hitting Guidance => minimal fundamental impact but would be very important for market sentiment
Acquisition candidate => the current transition period sets up well for an opportunistic buyer (e.g. private equity)

2 show sort by

			2018	2019
Price:	28.16	EPS	1.34	1.76
Shares Out. (in M):	547	P/E	21.2	16.2
Market Cap (in $M):	15,730	P/FCF	8	6.5
Net Debt (in $M):	12,171	EBIT	1,781	2,204
TEV (in $M):	27,901	TEV/EBIT	17.8	14.4