Marcial: Is MGM Mirage a Sucker's Bet?

During its heyday in 2007, gaming giant MGM Mirage (MGM) traded as high as 100 a share, reflecting the booming business at its 10 casino resorts in Las Vegas and eight others in Mississippi, Michigan, and Macao. But the financial crisis and economic recession last year halted the good times and hammered the stock, which, by Sept. 15, 2009, had tumbled to 13.37. (The shares have recovered somewhat from a 52-week low of 1.81 reached on Mar. 6.)

Does the stock's steep decline signal a great buying opportunity? Don't bet on it. Some industry experts warn that gaming activity in Las Vegas and Macao continues to shrivel. Apart from the big hit to the casino industry from the recession, the gaming business also will be hurt by increasing competition as many pending projects in Las Vegas are completed, some analysts say.

"Investors willing to pay 12 a share for MGM stock either believe in a very strong recovery in cash flow in Las Vegas or are willing to pay a multiple near the high end of MGM's historic valuation range," notes Robert A. LaFleur, gaming analyst at Susquehanna Financial Group. These investors, he says, "appear to be willing to overlook the still-lackluster fundamentals and [high] valuation levels that we have only seen in the 2006-2007 bubble years and back in 2005 during the industry's last mergers-and-acquisition boom."

The analyst points out that MGM's assets seem "richly valued," even with a generous valuation of the company's Project CityCenter, MGM's most ambitious plan for a multibillion-dollar development of a large casino-hotel complex. Project CityCenter includes boutique hotels and residential units on 67 acres of land adjacent to MGM's Bellagio Hotel in Las Vegas. Part of the project is scheduled to open by Dec. 16.

"our best short idea" LaFleur rates MGM's stock "negative," which is equivalent to a sell. "It remains our best short idea," he says, predicting the stock will tumble to 4 a share in 12 months. He notes that MGM's valuation has ballooned to 13.5 times his 2009 EBITDA (earnings before interest, taxes, depreciation, and amortization) estimate of $1.29 billion and 12.1 times his 2010 EBITDA forecast of $1.42 billion.

LaFleur says that a look at MGM's fundamentals and its road map for recovery don't seem to provide enough "juice" to justify the high valuation levels. Even when based on analysts' 2011 EBITDA consensus projections, "there has been no material change on projections [for the next 12 months] to justify such rapid multiple expansion," the analyst says.

"These shares should be avoided for now," says analyst Dominic B. Silva of independent investment research outfit Value Line (VALU). The trend in the declining gaming activity in Las Vegas and Macao, he notes, is exacerbated by indications that bookings for conventions are continuing to slow. Value Line gives its lowest rating, 5, on the stock's timeliness and a 4 on safety.

On the bright side, MGM has strengthened its balance sheet. Liquidity at MGM has "somewhat improved," says analyst Esther Y. Kwon of Standard & Poor's, noting the company recently raised $2.65 billion in additional debt and equity and secured a long-term amendment to its credit facility.

slashing operating costs Kwon expects MGM to lose 41¢ a share in 2009 and 55¢ in 2010, vs. a loss of $3.06 a share in 2008. Her 12-month target price is 9 a share, based on a 2010 EBITDA forecast that she says is below her estimates for MGM's peers, including Las Vegas Sands (LVS), Boyd Gaming (BYD), and Wynn Resorts (WYNN). She is among the 11 analysts who rate MGM a hold. Only three analysts recommend buying the stock, while seven rate it a sell.

MGM's biggest shareholder is activist investor Kirk Kerkorian, whose Tracinda owns a 54% stake as of December 2008. The second-biggest holder is T. Rowe Price (TROW), with 6.1%, followed by Dubai World Group, with 5.9%.

Management continues to assure analysts that the business environment in Las Vegas is stabilizing and the company has slashed operating costs significantly. But many analysts, including David Bain of investment firm Sterne Agee & Leach, are far from convinced.

"While we would normally be excited about this type of leverage and potential market recovery, the addition of CityCenter and other upcoming supply [casinos] targeting a similar demographic of MGM's current Strip customer base will likely cause average room rates to decline further—even under a scenario of market stabilization." says Bain.

With its shares trading at 12.2 times his 2010 EBITDA forecasts and 11.5 times his 2011 EBITDA estimate, says Bain, MGM "is the most expensive operator in our comparable [gaming] universe, while it also carries the most risks." Bain's 12-month price target: 5.31 a share.

With the economic recovery taking its first halting steps and competition in key gaming markets fierce, now may not be the time to lay down money on MGM Mirage.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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