One of the notable instances of lack of imagination we see as the gaming industry remains hostage to the coronavirus is the ongoing snoozing of bankers through opportunities to do mega-deals unlocking massive shareholder value on the cheap. Last week’s crushing of the market related to Fed gloom and fears of a second virus wave have created an even more perfect storm for a private equity pounce. Forget the Apollo Global $30 billion Caesars 2008 disaster. True, the deal was made in the teeth of the great financial collapse, but no matter, clearly Apollo and its partner Texas Pacific Group made a drunken sailor deal overpaying wildly for Caesars, as it was then poorly managed.
We live in a different world now, with macro risk on probably even greater than that which faced Apollo and TPG. Yet, Blackstone Group Inc. (BX) and private equity guys in general face a far more pregnant opportunity in Las Vegas now. Gaming stocks have been bludgeoned along with the entire consumer discretionary sector. Despite some recent recovery and a few downside knee-jerks in between, the stocks still remain very cheap. Among them is MGM Resorts International (MGM). The stock plummeted on March 13 to $7.75 amidst pandemic panic phase one.
While BX and others still appear to see Vegas entries as realty plays, the bigger, far more appetizing picture is the dominant theme of the business today: betting on more consolidation. It is a trend that cannot be slowed or stopped in its tracks even by a rampant virus holding the business prisoner at least another year or so. It springs from the reality that too many large casino operators are concentrated in the same states. Recognizing that an entirely new paradigm has formed, US regional operators have merged or offloaded their realty to REITs.
Among those was Caesars Entertainment Inc. (CZR), which created the VICI Properties Inc. (OTC:VICI) REIT as a refuge in its post-bankruptcy re- engineering. In the aftermath, CZR shares went into the dumper, where Carl Icahn sat waiting to scoop up the debris and, when it’s all over, perhaps pick up a billion in the process. He’s going to get an $8.50 cash component for his stock, and the rest is rich brown gravy in shares post virus.
Uncle Carl found a former boon companion in Eldorado Resorts Inc.’s (ERI) CEO Tom Reeg, who was the only CZR suitor among many to step up to the table and lay down the benjamins, in this case $17.3 billion a lot in new debt. The ERI/CZR deal is in the final stages of securing state-by-state regulatory approval. The deal is expected to close, barring a black swan or two, by the end of this month or early July. It will create a 60-property behemoth of US regional gaming with over 60 million Total Rewards members.
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So both in Vegas as well as across the US, gaming, once host to over 14 independent regional operators, now has Boyd Gaming Corp. (BYD) and Penn National Gaming Inc. (PENN) joining the newly merged ERI controlling nearly $13 billion in revenue. MGM, sans Macau, adds another $9 billion in US business. Without Vegas/Asia giants Wynn Resorts (WYNN) and Las Vegas Sands (LVS), the three regionals now control nearly 50% of the pre-virus estimated commercial US casino volume of $40 billion. MGM will make it four. (Another $30 billion pre-virus comes from native American casinos and the remaining handful of small commercial regionals.)
So, the once 14 are now four. And the appetites of those four to merge or sell have never been sharper, as their duplicative locations throughout the nation raise the ongoing cost of marketing and operations. Pre-virus, the total US gaming pie grew steadily in low, but respectable, single digits. Consolidation has now fattened the slice sizes to four and made the entire pie far more digestible. The merger deals we’ve seen have largely been accretive to earnings across the board as synergies kick in.
This powerful wind has been blowing across gaming for nearly seven years. So yes, the REIT expansions tell one story: unlocking realty value. But it misses the far bigger one: consolidation bringing lower costs and stronger earnings profiles to fewer operators. This will present an even more dramatic shift in valuations once the CZR/ERI deal closes.
Stipulation: With all due consideration, investment bankers’ compensation for their appraisal of opportunities earn rather a bit more than we do happily sharing our views with SA readers. So bear that in mind as you mull my guidance on a Strong Buy for MGM Resorts International in this article. I use very few pearls of their conventional wisdom. I’m building the same house using a different set of tools.
The prime usual private equity suspect should be Blackstone Group Inc., which made its gaming bones as it were, acquiring the Las Vegas Cosmopolitan in 2014. The 3,000-room property was a dying animal post the 2007/08 financial crisis and consequent collateral damage on Vegas revenues. Blackstone invested from the bargain bin and re-positioned the casino hotel, installed good management and, as recently as last April, was considering unloading it. The WSJ then valued it at $4 billion. BX had bought it for $1.7 billion. Events since have kept it hostage in BX’s portfolio along with its other Vegas realty.
Prospects for sell-downs of the BX Hughes Center Office Park and downtown World Market Center Furniture Showroom during virus challenges appear dim. Rumors also abound, as noted by SAS colleague jensan96 that BX is also looking hard at Crown Resorts of Australia. There is little doubt that BX has become a dominant player in gaming realty, hard focused on Las Vegas. Office parks and shopping malls have been crushed by the pandemic with dour outlooks post virus.
But there may be an even bigger pot of money awaiting private equity to do the last remaining, sensible private equity deal still sitting on the gaming table: MGM Resorts International.
Gaming properties now seem like a better bet than office parks and malls. Though single-purpose buildings like casinos present challenges, they generate daily cash and, when properly run, can make huge pots of money for their shareholders.
MGM: Pregnant, cheap, ready to deliver
Last October, BX’s Real Estate Income Trust acquired from MGM the realty of the flagship Bellagio for $4.5 billion – one of those deals now eliciting yet another Vegas virus-related intermediate-term headache. The 95%-owned joint venture entity has leased the property back to MGM with a hefty $245 million 30-year rental with two 10 years’ options beyond.
MGM’s flagship Bellagio, its realty now 95% owned by BX in addition to the Cosmopolitan down the strip.
Once upon a time, casinos were plopped wherever political hacks were desperate to do some tax farming. Gaming operators have now abandoned the waiting game. Right now, 40 US states have legal casinos. They abound in Europe, Asia and are beginning to peek behind the curtain in South America. So gaming operators can now pick and choose from existing jurisdictions and chase new ones at their leisure.
The way casinos get developed and built bears little resemblance today compared with twenty years ago. Then they had little choice when perhaps no more than 6 states were legal. Now there is a veritable buffet table of possibilities across the entire nation. This always high-burning capex industry finally began recognizing change was needed to keep stockholders happy with dividends and strategies aimed at accelerated growth. Hence the move to REITs.
Anatomy of a deal begging to be done
We are living in a new, virus-logged world where standard stock valuation metrics bear less and less relation to ongoing realities every day for the foreseeable future. Nor does it take a Cassandra to envision what this world will look like post-virus: bigger companies with fewer moving parts and fatter market shares. Also, companies which will be the considerable beneficiaries of the continuing boom in legal sports betting, and further down, online gaming. And lastly, a long hard slog back to respectable revenue flows as consumers await the green light vaccinations expected no earlier than late this year to near mid-2021.
It seems fruitless to forecast data like forward earnings growth, accumulated virus losses, betas and EV/EBITDA ratios when the companies are essentially powerless to eject the 600 lb gorilla in the room: the virus. It is that scourge that calls all the shots now on valuations. The few data points that still command our attention are liquidity, market cap, post-virus recovery cycle and prospects for transactions in a consolidating sector.
MGM has it all
MGM National Harbor, a post-virus money machine in Maryland – Source: MGM archives
The present combined market cap of MGM and its REIT MGM Growth Properties (MGP) is $12.9 billion. That includes its interest in MGM China. The combined share price of the two companies is $47.43. In plain English, free of currently irrelevant data points, if you own them, you have bought a ton of great assets in the bargain basement. Ironically, the market now says MGM the operating company is worth $19.30 per share and the realty REIT is worth $28.13. At their six-month, pre-virus high, the stocks traded at $34.54 for MGM and $34.11 for MGP, totaling $68.65, or more than a 30% discount. Bank of America has a $15 PT on MGM. We disagree and don’t see how any PT can be projected against the gorilla’s presence until it is caged by the arrival of a vaccine.
A buyer like BX could turn the “discount” into the premium to shareholders and buy both companies for what the market valued them at pre-virus. So, in effect, there is no premium needed in the deal above an already overvalued price as was the case with the CZR private equity deal. The virus has created the bargain bin. So post virus, the entire upside is to be created by a steady return to normalized operations. A private equity owner can hold and collect dividends or exit with a very handsome profit. With MGM there is no liquidity issue in the foreseeable worst-case duration of the pandemic.
MGM & MGP’s total combined long-term debt: $14.6 billion MGM
$4.6 billion MGP = total $19.2 billion against cash on hand as follows:
MGM: $6.02 billion
MGP: $1.77 billion
Total: $13.46 billion
This translates to a combined $25.60 per share in cash against a combined purchase price of $68.65. So far, so good.
MGM already owns 57% of MGP, so you are buying the deal at 43 cents on the dollar, in theory. The combined companies hold an estimated $45.7 billion in assets. So BX could, in theory, either unload its 57% for cash or hold it as a nice portfolio of dividend-paying assets. You are acquiring MGM China Ltd. worth US$5 billion post virus at the very least (two Macau properties), which you can own with no anti-trust implications if you are a private equity investor like BX or sell Macau and use the proceeds toward sale price. BX has a market cap of $65.7 billion with $2.5 billion in cash, and the last dividend paid was $1.56 per share. The stock was trading at $56.60 as of this writing. AUM: $571 billion, assets $34 billion. MGM is undoubtedly the pole-position bidder for the Osaka Japan integrated resort.
The project is a partnership between MGM and Japan’s consumer finance giant, Orix Corporation. The project is estimated to bear at least a $10 billion development cost. BX can provide a significant measure of financial power to MGM’s part of the deal, positioned to increase its equity part of the project if it so wishes downstream. MGM’s 2019 EBITDA was $2.7 billion (pre-virus). Even though it may take up to 2 years forward post-virus to achieve that level, it still presents an eloquent deal case for private equity to own a major gaming company, its realty, earning power and rosy future in Asia at a considerable discount. Of course, when a private equity investor like BX or BX itself bids, we can’t predict in these unchartered waters who or what entity could jump in with an opposing bid. Either way, it’s a nice place to be for an MGM shareholder.
MGM at the Cotai Macau, either a hold or sell at a nifty profit going forward for private equity investors – Source: MGM archives
The result on any basis: Investors do very well, far better than they would as MGM holders awaiting the post-virus recovery.
Private Equity exit strategy
That a company like BX already has the affinity and skill set to evaluate Las Vegas and gaming properties is without question. That it can embrace MGM’s new management team and give it the kind of post-virus financial support it will need likewise fits the acquisition theory. What it gets is the biggest Vegas room footprint among all peers, a regional network of properties heavy in the northeast, from New York to NJ to Maryland.
(Our theory best assumes MGM can unload its Springfield Mass property to tribal owners and get out whole rather than try to compete with the Wynn property in Boston and the tribal fighting brand slot parlor envisioned for northern Connecticut.) That sale on a dollar-for-dollar basis can yield near $1 billion to be used as proceeds toward the deal. Or, it may decide to sell some of the weaker MGM regionals and use the cash toward the purchase as well. In theory, it can wind up with remaining the Big Foot of Las Vegas for relatively bargain prices as well as a mighty presence in Asia in the out years.
BX or another private equity player can then hold MGM/MGP for around 3 years until the aftermath of the virus damage is fully repaired by an arrival at a 2019 revenue and EBITDA base or better. By that time, decisions can either have been made to sell off Macau, Massachusetts and even possibly exit the 57% of MGP in a public offering or hold tight and watch the asset values appreciate far above its purchase price – plus dividends.
When MGM rebuilds its base, runs its entire cost-cutting program launched in 2018 to its completion, adding a projected $300 million in EBITDA, and gets a price spike when Japan announces its award of the Osaka license, BX/private equity waves bye-bye with a huge upside plus 3 years of annual dividends and fees. Room rates will languish in discount land even as Vegas opens. But the post-virus RevPAR will soar back to normal range with the biggest inventory in Las Vegas.
Whether BX steps up to the plate or another private equity operator, or even an activist fund, MGM at its current trade represents outstanding value despite the virus contagion threat. We suspect there will be a deal sometime going forward as long as the stock languishes at its currently cheap valuation. Investors are well-advised to get in now before those big hungry eyes spot this gem.
Note: I have not always been bullish on MGM. In fact, during the prior regime, I had considerable concerns about its long-term strategies, which I considered muddied. But I always believed the company’s Vegas asset base was a powerhouse. And I applauded the elevation of interim CEO Bill Hornbuckle, a solid gaming buy, as successor to Jim Murren. The financial engineering designed by Murren brought a mixed bag of goodies and baddies to the balance sheet. I believe under the new reign it becomes a far more attractive buy at its price.
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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.