Stack the Deck

Kirk is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Every gambler knows that the secret to survivin'
Is knowin' what to throw away and knowing what to keep...

Kenny Rogers

It's rare that I get a chance to be on the same side of the table as the house when I go to a casino, in fact, it doesn't ever happen.  Today though, the next best thing might be available, good investments in casino operators. 

It isn't always so that investing in casinos is a good bet.  During the financial crisis and deep recession that followed, many casino operators suffered mightily and even went bankrupt.  These companies can be in big trouble when aggressive expansion is followed by a economic downturn.  

Two companies doing well now are Las Vegas Sands (NYSE: LVS) and Wynn Resorts (NASDAQ: WYNN)

Sands, which derives half of its revenue from China's Macau gaming area and another 28% from Singapore, just reported earnings with 70 cents of EPS on $2.76 billion in revenue, against expectations for 58 cents of EPS on $2.59 billion in revenue.  The company, in fact, reported an all-time industry record $1.07 billion adjusted property EBITDA for the quarter.  Shares traded lower however on Thursday as the company did not have, or would not give, a comprehensive update on its newest Macau property, Sands Cotai. 

Wynn is another high end leader with heavy operations in Macau, with properties there generating 67% of the company's earnings.  Over the past five years, gross margin has improved from 28.5% to 33% and seem to be on pace to reach nearly 40% by the end of the decade.  Wynn's image as a premium brand will play well if the Chinese and U.S. economies show improvement.  Wynn has also looked into online poker, which if made legal in the next few years, could fuel a large upside.

The company with the most upside however, might be one that narrowly missed bankruptcy.  Under former CEO Terry Lanni, MGM Resorts International (NYSE: MGM) was one of the companies that almost went bust after the company expanded at a breathtaking rate and incurred massive debts. 

Under Lanni, MGM undertook the spectacular CityCenter development, which at the time was the nation's largest project.  CityCenter ran into problems though, requiring MGM to bring in more partnership money and refinance the project in order for it to survive. The development is now virtually complete and appears to be well on track to add to MGM's bottom line.  The bulk of the CityCenter debt has been pushed out to 2015 through 2017.  With almost a billion dollars of free cash flow, MGM looks well on pace to be able to pay down their debts rapidly over the next decade.

MGM shares plunged from their market peak in the low $90s to below $3 on the financial collapse.  Prior to the real estate bubble prices, MGM shares traded more reasonably in the $20s to $40s.  With 60% of their revenue linked to non-gaming activities, the real estate super-cycle and collapse had a disproportionate effect on MGM. 

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Among the factors that set MGM back were room rates that declined 33% from 2007 to 2010.  Those rates have gradually rebounded and if they reach their previous high of about $240 per night, MGM earnings would explode.  A rate of about $200 appears more reasonable short-term, which is only slightly higher than the approximately $180 they are receiving right now.  Even at rates averaging $200 per night, margins would expand and considerable revenue would hit the bottom line.   

Unlike Wynn and Sands, MGM is mostly an American play. With properties such as The Bellagio, MGM Grand, Mandalay Bay, Aria, New York-New York, Monte Carlo, The Mirage and Luxor among several others, MGM dominates "The Strip" in Las Vegas.  Not to sit out China, MGM also has a presence in Macau that is growing.

Return on equity has rebounded from negative rates to approximately 50% now.  With any improvements in the economy and continued progress on improving margins as debt is paid down, MGM could make significant share price gains.

The risks for MGM include the heavy debt burden and the possibility of a double dip recession.  Should a heavy recession hit America and Las Vegas in the near-term, MGM appears strong enough to weather the storm and survive, but shares would likely suffer with profits.  Purchasing shares should likely be done in increments over time.

Having visited a number of MGM's establishments I can vouch for the quality and service that MGM provides.  The quality of the experience, combined with a very good rewards program brings patrons back to MGM properties, even if not the same ones.  Their appeal is both at the high end for "whale" guests, and at the mid-level.  With a rebound in the American economy, MGM appears poised to hit the jackpot in coming years.

Kirk Spano and clients of his Wisconsin Registered Investment Advisor Bluemound Asset Management do not own positions in any company mentioned in this article.  Neither Kirk nor Bluemound clients have made any transactions in the previous 3 days or plan any transactions in the next 3 trading days in the mentioned company's securities. Opinions subject to change at any time without notice. Follow Kirk on Twitter @GALPinvesting.


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