Although we think Eldorado Resorts’ domestic casinos could enjoy a mid-single-digit revenue gain from being added to Caesars’ 55 million-member loyalty program once the deal is completed in the first half of 2020, we see only a handful of Eldorado’s 26 facilities overlapping with MGM Resorts’ (MGM) Mississippi and Atlantic City properties. We estimate these regional properties amount to 10% and 11% of total 2019 EBITDA and sales for MGM, respectively, and could see an annual revenue impact of around 1% in 2021-28. As a result, we don’t plan to change our $38 fair value estimate for no-moat MGM, and we continue to find the shares attractive.
Our analysis shows that Eldorado’s Baton Rouge, Greenville, and Lula casinos are within a 2-hour drive of one of MGM’s two Mississippi facilities. In total, we calculate that these three Eldorado facilities can produce around $200 million in revenue this year and see around a mid-single-digit percentage lift to sales with the integration of Caesars’ loyalty program, based on past results from Caesars’ integrations. We believe that around half of that increase might come at the expense of these MGM properties, equating to roughly a 1% annual sales impact to these casinos.
The other MGM property we believe could be affected is the Borgata facility in Atlantic City, given that Eldorado has acquired Tropicana. We calculate that Tropicana generates around $300 million in revenue this year and expect the same mid-single-digit percentage sales lift from leveraging Caesars’ loyalty program, which again stands to have around a 1% impact on average to MGM’s Borgata annual sales in 2021-28.
We don’t expect any notable impact to MGM’s Las Vegas Strip properties (45% and 50% of estimated 2019 revenue and EBITDA, respectively), given that Eldorado’s three Nevada locations are in Reno and at a relatively lower price point.
Looking East for Growth
We think MGM Resorts is positioned to maintain its leading presence in the lower-growth, lower-barrier Las Vegas region while participating in the attractive long-term growth opportunity of Macau. MGM Resorts has expanded its room share in Macau to 8% from 3% with its Cotai property, which opened in February 2018. The offset to this expanded room presence is the continued long-term shift away from VIP and gaming revenue toward nongaming and mass play in the industry. We expect MGM to be awarded a gaming license in a Japanese urban market with a resort opening in the middle of the next decade.
We see solid Macau visitation over the next 10 years, aided by key infrastructure projects that alleviate Macau’s congested traffic (Pac On Ferry Terminal expansion and Hong Kong Bridge in 2018, light-rail transit in 2019, and reclaimed land in 2020-25), which will expand the region’s constrained carrying capacity, driving higher visitation and spending levels. Our forecast for annual mid-single-digit visitation growth over the next decade is supported by China outbound travel that we expect will average high-single-digit annual growth over the next 10 years. Additionally, we expect upcoming developments that add attractions and improve Macau’s accessibility will improve the destination’s brand, supporting our constructive long-term view on Macau. As MGM holds one of only six gaming licenses, it stands to benefit from this growth. That said, the Macau market is highly regulated, and as a result, the pace and timing of growth are at the discretion of the government.
In Las Vegas, MGM’s nine casinos account for about one fourth of total Las Vegas Strip rooms. Las Vegas doesn’t offer the long-term growth potential or regulatory barriers of Macau; thus, we do not believe the region contributes a moat to MGM. However, there have been very minimal industry supply additions this decade, which should support solid industry Strip occupancy around 90% through 2019.
Too Much Exposure to Vegas for a Moat
We believe MGM Resorts has no economic moat, given its outsize exposure to Las Vegas (49% of estimated 2019 EBITDA) and U.S. regional markets (24%), where regulatory barriers are lower, leading to competitive markets that result in returns on invested capital below the company’s weighted average cost of capital. However, we believe MGM’s execution and strong integrated resort experience in Las Vegas will aid it in receiving a gaming concession in Japan, a market we expect will generate economic profit worthy of a narrow moat. We also award the Macau gaming industry a narrow moat due to its high regulatory and land barriers, and MGM currently holds one of only six gaming licenses in the region. However, its exposure to Macau (19% of estimated 2019 EBITDA) and Japan (22% of EBITDA in 2026, the year we model an MGM resort to open) is too low to warrant a narrow moat for the company as a whole.
Although we do not think the firm’s Las Vegas exposure benefits from a moat, supply and demand have improved from past decades. After 79% and 24% room supply growth in Las Vegas during the 1990s and the first decade of this millennium, respectively, room supply has not increased through 2018. However, there are two large integrated resorts scheduled to open in 2020 (Resorts World) and 2022 (The Drew), which combined stand to add a mid-single-digit percentage to total Vegas room supply.
MGM’s solid execution in operating some of the world’s best-integrated resorts has assisted in its approvals for new casinos in Maryland (it received the sixth and final gaming license), Massachusetts (only one of three gaming licenses awarded), Macau expansion in Cotai, and our expectation of a Japan facility opening in 2026.
We believe the Japan and Macau gaming industries have moat qualities driven by a favorable supply/demand situation. In Japan, we estimate limited gaming supply, with only two urban resort licenses being awarded. We also foresee strong demand for gaming in Japan driven by the nation’s high per capita income, density, and apparent propensity to gamble, exhibited by its existing $30 billion pachinko parlor industry. This attractive supply and demand will generate ROICs near 20%, in our opinion, supporting narrow-moat qualities.
The Macau gaming industry also has an advantageous supply/demand setup. There are only six gaming licenses in Macau, and these are not up for renewal until June 2022. We believe these concessions are likely to be renewed or extended for the existing operators, as they have invested meaningful capital and helped to positively develop the Macau economy. Given the limited land available to develop and the government’s seeming preference for controlling growth of the region, we doubt that there will be any meaningful new gaming concessions or table allocations presented at the time of renewal. Demand for Macau’s gaming market is driven by China’s increasing prosperity as well as the region’s improving infrastructure, which will enhance accessibility for visitors. As a result of this solid supply/demand relationship, we believe the Macau region holds a narrow moat.
MGM Resorts has a fair presence in the supply-controlled Macau market. The MGM Macau is located on the Macau peninsula and not on the Cotai Strip where the mix of traffic has migrated. However, MGM opened its Cotai property in February 2018, which increased its room share to 8% from 3% among the six concessionaires. MGM’s Macau room count may increase by another 700 rooms toward the end of this decade if the second phase of MGM Cotai moves forward, which would bring the total room count to 2,800.
In total, MGM’s ROICs do not offer enough quantitative support for a narrow moat rating. Although we forecast ROIC including goodwill to average 9.0% over the next five years, as compared with the company’s 8.1% cost of capital, we estimate that the vast majority of that ROIC is generated from its Macau properties, where there is some level of uncertainty one needs to factor in for that region. This leaves ROICs for MGM’s U.S. operations (the majority of its EBITDA) that are well below the cost of capital, supporting a no-moat rating.
Macau Downturn Is Biggest Risk
The principal risk to prospective shareholders is a downturn in Macau, either macroeconomic or through government regulation. Much of the company’s Macau revenue comes from VIP players, a market segment sensitive to economic, credit market, housing, and stock market conditions. VIP rolling gaming revenue in Macau declined roughly 20% in the first half of 2009 amid the credit crisis and a steep decline in the Chinese stock market, and it showed weakness during 2014-16 owing to anticorruption activities in China.
The Chinese and Macau governments control the number of gaming tables, labor for development projects, and visas for Chinese visits to Macau. The Macau gaming board has announced the requirement of junkets to disclose deposits made by investors into the junket system. Finally, mainland Chinese mass gamers often pay for goods using credit at pawnshops and then return them for gambling money; should these transactions be regulated, it would probably add pressure to mass gaming volume.
Another risk is a cyclical downturn in the U.S. The Las Vegas Strip is a destination market that is highly cyclical and dependent on business travel and personal travel expenditures. During the most recent U.S. recession, gaming revenue on the Vegas Strip declined 19%.
A delay or halt of legislation focused on bringing gaming resorts to Japan would affect our fair value estimate, which forecasts the company opening a facility in the country in 2026.
MGM faces several additional risks: uncertainty associated with its higher debt levels; the potential for increased competition from other new integrated resorts in other countries in Southeast Asia; any expansion in the number of gaming licenses in Macau; and activist pressures that could meaningfully change the current capital-allocation strategy.
MGM’s debt/EBITDA was 5.7 times at the end of 2018 versus 6.6 times in 2014. As of Dec. 31, 2018, MGM had $1.1 billion in available liquidity under its main credit facility and $1.5 billion in cash. Of the company’s $15.1 billion in debt, $10 billion is due in the next five years; we believe this will need to be partially refinanced, keeping long-term debt elevated between $11.7 billion and $16.4 billion over our 10-year forecast. Our expectation is that cash flows will rebound sharply in 2019 and beyond as capital expenditures for the Cotai, National Harbor, and Springfield projects drop off and MGM realizes cash flows from those openings. As a result, we expect MGM to generate $8.3 billion in free cash flow over the next five years. MGM instituted a dividend in 2017, and we expect it to maintain a payout ratio around 30% over the next several years.