Ana səhifə

Laura Fischer had hardly believed her luck

Yüklə 0.75 Mb.
ölçüsü0.75 Mb.
  1   2   3   4   5   6   7   8



Laura Fischer had hardly believed her luck. It was late February, 2004, and a recent promotion to lead research analyst for the Lodging and Gaming industry had given her the opportunity to make her first site visit—to Las Vegas and a deluxe suite at the Bellagio. Within two weeks her firm would formally initiate coverage of Bellagio’s parent, MGM Mirage (MGM), so as was customary she and her research team had familiarized themselves with the target company’s products before issuing a final report. A site visit had served two purposes. First, it provided an opportunity to better understand the company’s business model from the perspective of the consumer. Second, the visit provided what was once described to Laura as a “reasonableness check” of the major assumptions that formulate projections. By actually visiting Las Vegas, Laura assessed firsthand the quality of MGM’s existing properties. The company’s profits were at record levels, its facilities advertised as four and five star, and its casinos billed as consistently full. These drivers of value had been verified firsthand. For Laura this trip also had served a third purpose. It had been just plain fun.

The trip had been a whirlwind two days filled with tours of the city, explorations of each of MGM’s properties, and a meeting with MGM’s vice president of Investor Relations. Las Vegas and MGM had quite an allure—the dazzling display of lights, the endless rows of gaming tables and slot machines, pools, spas and nightclubs, the dancing fountain of the Bellagio, and the volcanic eruption at the Mirage. Beyond the glitz Laura observed firsthand that there was also substantial substance to MGM’s resorts, and as a portfolio they were very well diversified. MGM’s premier property, Bellagio, was as fine a hotel as Laura had ever seen. It deserved its ranking as one of the top hotels in the world, and to the clientele of Bellagio spending handsomely for five-star service seemed of little concern. At the Mirage and MGM Grand, she was equally impressed with the tropical and Hollywood themes and with their managements’ attention to detail. Both seemed to do just as effectively what was similarly accomplished at Bellagio, albeit on a much smaller scale. The Treasure Island and Monte Carlo while older and showing their ages clearly served a different segment of the market, but both were equally as crowded. On the lower end of the hotel scale, the Boardwalk appeared to efficiently capture the most frugal casino patrons. Although the amenities offered were common from one property to the next, to Laura each was uniquely impressive, and it was evident each had significant return potential. Wall Street apparently agreed because MGM’s stock had made an impressive run (see Exhibit 1), with most market commentators holding a consensus that this appreciation would continue.

MGM Mirage
MGM Mirage was one of the world’s largest and most successful gaming companies. It had significant interests in 14 gaming properties, half of which were located on the world’s top gambling destination, the Las Vegas strip. The company’s remaining resorts were found in other parts of Nevada, Mississippi, Michigan, Atlantic City, and Australia (see Exhibit 2). While its properties spanned the world, the prospects for MGM were unequivocally characterized as dependent on the prospects of the city of Las Vegas: three-quarters of its available rooms and about two-thirds of its casino operations were located within a three-mile radius in that city.
Las Vegas had as colorful a past as any U.S. city. Surrounded on all sides by desert, its proximity to both a sizable body of water and to the booming area of Southern California had helped establish the city. Legalized gambling in the state of Nevada gave the city its push in the 1930s, but not until the 1960s had gaming operations begun to lose the stigma of being associated with organized crime and corruption. This transformation was often credited to Howard Hughes, the billionaire recluse whose corporations bought and built many of its hotels and casinos. Corporations had a distinct advantage over smaller investor consortiums of the day given the relative ease at which they accessed capital and made large acquisitions. The profitability and growth potential of the industry had made it all the more attractive. By the 1970s, gambling had become a “legitimate” business, and companies like MGM Mirage had thrived.
MGM had defined its strategy as “creating resorts of memorable character, treating employees well, and providing superior service for guests.” This strategy has been a proven success as the company had made a remarkable growth path. Revenue had increased each year, from a low of $6.95 per share in 1995 to $27.32 in 2003. This consistent increase had come despite the dual negative effects of the economic recession of the early 2000s and the drop in leisure travel after September 11, 2001. Growth historically came from a combination of improvements to existing properties and new development. A potential downside to this growth, however, came in the form of increasing financial leverage. By 2004, the company had carried over $5.5 billion of debt versus a market cap of just over $6 billion.
Like most gaming companies MGM had derived most of its revenues from casino operations. For the year ending in 2003, casino revenues exceeded $2 billion and comprised 48 percent of total revenues (see Exhibit 3). To put this in perspective, casino revenues were measured as the amount won by a casino across its various gaming activities. A “hold” rate of 10 percent, typical in the industry, implied over $20 billion wagered in MGM’s 14 casinos. Other significant revenue sources for the company were not trivial: room occupancy (19 percent), food and beverage sales (18 percent), and entertainment and retail (15 percent). Given its heavy reliance on casino revenues like most companies in the industry, MGM had spent millions on complimentary rooms, food, or other enticements to attract casino patrons. Reflective of the highly competitive Las Vegas market, in 2003 these amounts had exceeded 20 percent of MGM’s casino revenues, the fifth consecutive year of percentage increases.
Not surprisingly, the fortunes of the gaming industry, and therefore MGM, were closely tied to the economy. This was by no means restricted to the U.S. economy as many of the largest and most profitable casino patrons (i.e., “whales”) were actively courted from the Pacific Rim. Competition for whales was fierce, as their play accounted for a sizeable percentage of casino revenues. As the economy continued to expand, industry experts had expected corresponding increases in disposable income to bring travelers to Las Vegas in droves. Corporate business meetings contributed to growth as Las Vegas was among the most popular choices for business conventions.
According to an S&P industry survey, entertaining customers and gaining loyalty was among the most important trends in the industry. Because the basic casino product, slots and table games, was fairly homogeneous, the firms with which MGM competed tended to differentiate themselves by using non-gaming amenities. Key competitors included the Mandalay Bay Resort Group, Harrah’s Entertainment and Caesar’s (see Exhibit 4). The amenities offered across these companies ranged from different hotel “themes,” dining options, live entertainment, pools, spas, and even museums. While these amenities may have had an impact on customer choice regarding which property to choose, make no mistake that the principal lure of Las Vegas in general, and MGM in particular, remained the opportunity to gamble.

Laura’s Preliminary Analysis
Laura’s prepared her final report after a series of meetings with her associates. Before those meetings, however, she had designs on completing a preliminary assessment of MGM using a set of standard relations and trends found in the company’s historical accounting data (see Exhibits 5, 6 and 7). After her initial reading of MGM’s annual report, Laura had been concerned that the present 3 percent growth in revenues did not support the company’s current valuation. So she had constructed a set of proforma financial statements from which to form expectations of earnings and cash flows. These projections approximated an “implied” growth rate for the company. Specifically, one evaluative technique used by Laura’s firm was to work backwards, using traded prices to approximate certain growth and cost of capital assumptions as implied by the market. In this manner a security was evaluated relative to the assumptions needed to generate an observed price, rather than directly estimating a unique price. A preliminary assessment of overvaluation or undervaluation was then inferred based on the aggressiveness of the assumptions needed to generate observed price.

On her flight back to New York, Laura had generated a preliminary set of proforma financial statements using the following assumptions:

Account assumptions

  • Sales for each of the five revenue segments (this includes promotional allowances), grew at their respective two-year compounded annual growth rate.

  • Cost of sales varied at the two-year average of each expense amount over its respective sales.

  • General and administrative expenses and corporate expense were based on the two-year average of expense to total net sales.

  • Net receivables grew at the two-year average turnover. For this calculation, only casino revenues were used in the computation of turnover. Likewise, the provision for uncollectibles was assumed to vary directly with casino revenues using its two-year historical average.

  • All current taxes due or owed were received or paid in 2004. Going forward estimated tax payments were expected to equal current tax expense.

  • The acquisition and disposition of properties seemed to be routine. In 2004, she expected an approximate charge of 10 million dollars for restructuring costs. Beyond 2004 restructuring charges were assumed to be zero.

  • Laura knew deferred tax assets relate to a combination of bad debt expense, pre-opening charges, net operating loss carry-forwards, and other operating accruals. She expected the balance to remain constant. Deferred tax liabilities related primarily to property, plant, and equipment. The liability account was expected to remain at its historical two-year average of deferred tax to net property, plant, and equipment.

  • The provision for taxes was determined using the two-year average effective tax rate.

  • Inventory, accounts payable, accrued liabilities and prepaids were expected to change based on their turnovers averaged over the last two years. Turnovers were based on cost of goods sold, estimated purchases, sales, and general and administrative expenses, respectively. Other long-term liabilities grew at $15 million per year. All other current assets and liabilities were assumed constant.

  • For property accounts, Laura assumed gross property was based on two-year average turnovers; capital expenditures were the changes in this account. Depreciation expense was assumed to follow the prior two years’ relation of expense to gross property, plant, and equipment. No liquidations were assumed.

  • Accrued interest payable grew at the observed two-year compounded annual growth rate of the account.

  • Finally, MGM was assumed to pay no dividends, did not issue shares, and retained its current debt level. Because debt was assumed constant, interest expense was fairly constant and was computed using a rate calculated as the 2003 reported interest expense to average 2003 long-term debt. Any free cash flow generated by the company was retained and expected to earn the risk-free rate.

Growth and cost of capital assumptions

  • Unlevered free cash flows and/or net income before interest would grow at 5 percent per year during 2009 to 2013. Economists’ predicted industry growth during that time period. A constant growth annuity in perpetuity is assumed after 2013.

  • Weighted average cost of capital was estimated using the 12/31/03 debt-equity mix. The cost of equity was estimated under CAPM. MGM’s current beta was 1.10.

Laura’s Subsequent Analysis

Upon her return Laura immediately worked to modify her analysis. Her changes were based on a careful review of, (i) events that occurred since the financial statements were issued, (ii) MGM’s Management Discussion and Analysis from the most recent 10-K (Exhibit 8), and (iii) the notes to the financial statements (Exhibit 9). With her model completed she drafted her report.
Exhibit 1
MGM Mirage Stock Price Performance

Exhibit 2

Properties Owned and Managed

Number of

Est. Casino


Name and Location



Sq. Footage







Las Vegas Strip, Nevada







MGM Grand Las Vegas






The Mirage






Treasure Island






New York-New York






Monte Carlo (50% owned)

















Primm, Nevada






Buffalo Bill’s Resort & Casino





Primm Valley Resort & Casino





Whiskey Pete’s Hotel & Casino





Primm Center





Detroit, Michigan

MGM Grand Detroit






Biloxi, Mississippi

Beau Rivage






Atlantic City, New Jersey

Borgata (50% owned)






Darwin, Australia

MGM Grand Australia






Grand Total





  1   2   3   4   5   6   7   8

Verilənlər bazası müəlliflik hüququ ilə müdafiə olunur © 2016
rəhbərliyinə müraciət