Bill Lerner of Union Gaming Group
November 1, 2010
Bill Lerner
The Case for Stability
For
a window on the challenges confronting Las Vegas just look at the roller
coaster the share price of MGM Resorts International has been riding. In the
last year, the big cap with the greatest exposure to the Strip has seen its
price (NYSE: MGM) dip below $9 and soar past $16. The shares jumped 15 percent
at one point last month, briefly topping $13, on news of a terrific August for
Strip gambling revenues (up 21 percent year over year on the highest volume of
baccarat play in state history, $1.9 billion). Casino Journal Editor James
Rutherford caught up with equities expert Bill Lerner to talk about this in the
context of the Strip’s shifting fortunes and Wall Street’s love-hate
relationship with gaming.
Confidence
in gaming stocks as a whole has been low for a while. What’s it going to take
for investors to get behind the industry again?
Lerner: These stocks have
actually done quite well year-to-date, or over the last 12 months or so, and
that is a function, I think, of these companies surviving, and the equity
markets recognizing the likelihood that most of them actually will survive.
Whether it’s because they’ve amended their debt by pushing out maturities or
they’re paying for more favorable covenants on their debt or buying back debt
in the open markets at a discount to help their liquidity scenarios, and that
goes for exchange offerings on their
debt, too.
What’s
next after survival?
Lerner: What gets these
stocks to go higher from here is really now fully focused on recovery. If you
look at Vegas, actually if you look at any regional casino market, these have
become quite cyclical. In the past there had been a perception that casino
gaming in the U.S. wasn’t cyclical. But because these are cyclical names you’re
going to see the stocks trade that way. And people won’t buy these stocks or
award a premium valuation until there is evidence of a recovery. We got a
little glimpse of that with August numbers for Nevada, and the stocks,
especially MGM, had a nice move. But people really need to see a recovery. And
that goes for the regional operators too.
MGM a few weeks back was able to pull off a fairly large secondary
offering in a tough market. How do you view that?
Lerner: I think MGM was
going to be opportunistic here, and that’s probably what that was. The stock
had started to run on the back of strong August numbers, and we suspected that
an equity offering could be in the pipeline at that point. And by doing so
they’re really helping themselves from a liquidity perspective beyond their
comfort for 2012, in my view. To the extent that free cash flow doesn’t recover
with a broader recovery. So a little bit of an insurance capital
raise.
Are investors looking to MGM, and to CityCenter, as bellwethers of a
Las Vegas recovery?
Lerner: CityCenter has
lost money, and now it’s starting to break even. The economy, of course, has
been a challenge. And all of this has been a function of timing. (Well, and
others have criticized the budget.) So there’s this unfortunate sour view that
we often hear when it comes to CityCenter. Otherwise, is MGM a bellwether of
the Strip? Absolutely. The only public equity casino operator with the largest
exposure to Vegas. Harrah’s would follow, but they have no public equity at the
moment.
Union
Gaming Group does not buy in to the prevailing pessimism.
Lerner:These are
volatile stocks in volatile times, so you might characterize it that way. But
for the most part I think the unwind of the bankruptcy trading has played out.
… Yes, some of these companies have diluted themselves with equity offerings,
they have more debt than perhaps in the past, in some cases; but they’ve cut
costs, and I think these cuts are sustainable through a recovery. So we
probably don’t need a full revenue recovery in order to see these stocks move
materially higher. Especially because the cost reductions should start to show
up in the cash flow story. So the stage is set to generate material cash flow
growth. And that could be a couple of dollars in the room rate, that can do the
trick, all other things being equal.
Your
prognosis then for the Strip’s long-awaited recovery?
Lerner: We are
cautiously optimistic. That’s probably how I would characterize it. We’re
seeing a lot of signs of stabilization, if not the markings of an early
recovery. It’s seeing the air lift in some cases, auto traffic, it’s convention
bookings, delegate conversions — all these things are happening at stable to
higher rates. And there are other segments of the business that feel OK. Room
revenues are down less than room supply growth; that’s a healthy positive story
to tell. Positive gaming revenues through the majority of the last year have
been because of baccarat growth, but if you strip that out, the declines in
revenues are very, very modest now. So I think it’s almost indisputable, if not
indisputable, that we’ve stabilized. We’re not catching a falling knife here.
The market has stabilized.
In terms
of key indicators, what do you project?
Lerner: Mid-single-digit
at most in visitation growth for 2011. And I think we could see that translate
nicely to earnings. In other words, if that translates to low- to
mid-single-digit gaming revenue growth, maybe it’s high single-digit or low
double-digit cash flow growth for these companies.
How does
Cosmopolitan’s added supply affect this?
Lerner: I’m not concerned
about The Cosmopolitan’s 2,000 Phase 1 rooms shaking that story up whatsoever.
The companies that operate here have much better balance sheets than they did a
year or two years ago. So we’re in better shape than we were. And as an equity
analyst that sets up really well for these stocks to capture a recovery.
Especially if you believe that inflation is in the pipeline, these stocks
should do particularly well capturing a recovery disproportionately.
Good
news for the competition. But how does Cosmopolitan fare, given the
timing?
Lerner:
It’s a beautiful place. I like the physical plant. Obviously the location. The
viability? If you take a look at
the new projects over the last few years, whether they’ve been expansions or
new builds, from Palazzo and Encore all the way through CityCenter, the return
profile hasn’t been there. So I’m not sure why that would change in an
environment where there’s a lot more supply that Cosmopolitan is bolting on to.
But beyond that I know that they
did a deal with Marriott [to market the hotel through Marriott’s data base],
which is a positive thing. I know they swapped the physical plant around so the
casino is downstairs instead of on the mezzanine level. So the walk-in traffic
story will be very good. But they’re going to have to get a pretty notable room
rate to justify a $4 billion property. I say “justify,” but it’s owned by a
bank, and I don’t know how they necessarily view return hurdles and those
things. I suspect for it to be an acceptable return for them the room rate
story is going to have to make sense, and the gaming story is going to have to
be meaningful. And that’s going to be difficult unless they’re willing to
accept high-end play. And it doesn’t seem like the bank is interested in
developing that kind of gaming. So the formula is going to be a little tricky.
Bill Lerner is an analyst with Las Vegas-based Union Gaming Group, an independent
financial research and advisory firm he co-founded in 2009 to focus on the
gaming industry worldwide. He spent 13 years on Wall Street in sell-side
research prior to forming UGG, most recently as managing director and senior
Gaming & Lodging analyst at Deutsche Bank Securities. He has been
recognized by Institutional Investor as part of its “All American Research
Team” and Wall Street Journal’s “Best of the Street”.
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