MGM: MGM Mirage is Building It, But Will the Gamblers Come?
This article is a reprint of my March 5, 2008 RealMoney column
Although MGM Mirage operates casinos across the
After a few years of limited new development in
The situation reminds me of late 1998, when the Asian financial crisis and a slew of new
According to the latest 10K, the investments are paying off. “For instance, between 2003 and 2006 we invested a significant amount of capital at MGM Grand Las Vegas…. That resort earned $290 million of operating income in 2007, a dramatic increase from the $127 million earned in 2002. Similarly, we transformed The Mirage…. The Mirage earned $108 million of operating income in 2003; in 2007, The Mirage earned $173 million of operating income.”
Perhaps it is because I just read Warren Buffett’s letter to Berkshire Hathaway (BRK) shareholders, but I thought I should check whether this improvement in operating income was actually a good return on the investments being made. Buffett evaluated two of his business on the basis of pre-tax operating income divided by the total capital required to run the business.
Unfortunately, MGM has a bunch of non-operating items to contend with, and I didn’t like the way the database I use broke out the data. So I decided to use cash flow from operating activities as a proxy for operating income (in this case, after-tax.)
Source: Zack’s Research Wizard, compiled by William A. Trent
I don’t think Buffett would be impressed. In 1997, average net operating assets (NOA) for the year were $1,055 million, while cash flow from operations was $184 – a cash return on NOA approaching 18%. By 2007, average NOA were $16.6 billion and cash flow from operations was $994 million – a cash return on NOA of just 6%.
While it’s true that the current NOA includes substantial investments in long-term projects that aren’t yet contributing to operating cash flow, the trend was heading down even before these got underway. Even if the projects do boost returns on invested capital to prior levels, it will be some time before that happens. CityCenter is not expected to open until November 2009, the other
At an enterprise value of 3.8 times 2007 revenue and 21 times 2007 income from continuing operations, MGM looks about as fully valued as one can imagine. The acquisition of Harrah’s, which recently closed after a year-long process, valued that company at 2.6 times 2007 revenue, and 17 times 2007 operating income. And that deal was launched at the height of the private equity boom. It seems wishful thinking to expect a similar valuation in today’s environment.
So I am not optimistic that the 1998 thesis will pan out this time. But while I would sell any existing long position and sit on the sidelines (at least until CityCenter opens), I don’t have the guts to short this name. Kirk Kerkorian’s Tracinda Corporation has the resources to continue funding the developments and possibly to take on a larger ownership stake. Bringing on joint venture partners to co-finance the project has also become a key strategy, with deep-pocketed Dubai World being more than capable of taking up any slack. In fact, taking on Dubai World as a joint venture partner on CityCenter resulted in a $1 billion gain on the investments made to date.
Disclosures: William Trent has no positions in the companies mentioned
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