MGM Continues to See Recovery in Its U.S. and Macao Regions, With Sports Betting Leading the Way
MGM Continues to See Recovery in Its U.S. and Macao Regions, With Sports Betting Leading the Way
Senior Equity Analyst
Analyst Note| by Dan WasiolekUpdated Apr 28, 2021
While MGM’s domestic and Macao business continues to recover toward our expectations, we are more constructive on its BetMGM joint venture, which reported sports betting and iGaming first-quarter sales annualized at $652 million (4% of our 2021 no-moat MGM sales forecast, accounting for its 50% ownership), up 266% versus 2020. As a result, we plan to increase our $33 fair value estimate by around $3 per share. We believe investors are more than pricing in MGM’s demand recovery and sports/iGaming opportunity and that they should wait for a larger margin of safety.
MGM’s Las Vegas sales recovered to 38% of prepandemic levels in the first quarter versus 34% last quarter, helped by increased vaccinations and reduced restrictions. And the region’s rebound has continued, with April occupancy lifting to 73% from 46% overall in the first quarter. We still expect Vegas sales to fully recover by 2023. Meanwhile, regional revenue rebounded to 88% of 2019 levels versus 66% last quarter. Here, we still see a nearly full return to 2019 sales levels in 2022. Overseas, MGM’s Macao revenue reached 40% of prepandemic marks, up from 15.6% last quarter. Encouragingly, March visitation to the region increased 40% from January/February, and demand recovery has reportedly continued into April. We think MGM’s Macao revenue can fully recover by 2022.
BetMGM’s strong growth is driven by more states legalizing sports and online wagering and share gains. Our near-term U.S. sales forecasts already account for the robust activity, as we expect MGM’s overall domestic sales to return to over 70% and 90% of 2019 levels in 2021 and 2022, respectively, ahead of consensus’ (Visible Alpha) 67% and 89% estimate. That said, we are likely to raise our 2024-30 MGM total U.S. sales forecast about 1 percentage point to over 3% annually on average to account for higher sports betting and iGaming play reaching a larger population than previously expected.
Business Strategy and Outlook| by Dan WasiolekUpdated Apr 29, 2021
Although COVID-19 stands to have a material impact on near-term leisure and travel demand, we think no-moat MGM Resorts' healthy liquidity profile will see it through this turmoil and that it remains positioned for the attractive long-term growth opportunities in Macau (22% of prepandemic 2019 EBITDAR), U.S. sports betting, and Japan (accounting for an estimated 11% of 2027 EBITDAR, the first year of likely operation).
We see solid Macau industry visitation over the next 10 years, as key infrastructure projects that stand to alleviate Macau's congested traffic (Pac On terminal expansion and Hong Kong Bridge in 2018, light-rail transit at the end of 2019, and reclaimed land in 2020-25) come on line, which will expand the region's constrained carrying capacity and add attractions, thereby driving higher visitation and spending levels. While near-tem Macau gaming demand continues to be materially affected by COVID-19, our forecast for annual mid-single-digit visitation growth over the next decade is supported by Chinese outbound travel, which we expect will average high-single-digit annual growth over the next 10 years. As MGM holds one of only six gaming licenses, it stands to benefit from this growth. Further, MGM Resorts has expanded its room share in Macau to 8% from 3% with its Cotai property, which opened in February 2018. 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 the U.S. (78% of prepandemic 2019 EBITDA), MGM’s casinos are positioned to benefit from an estimated $6.2 billion sports betting market by 2024, generating around a mid-single-digit percentage of the company's total sales that year. That said, the U.S. 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. Still, there has been very minimal industry supply additions this decade that should support solid industry Strip occupancy, which stood at around 90% in prepandemic 2019.
We expect MGM to be awarded one of only two urban gaming licenses in Japan, with a resort opening in 2027, generating attractive teens-level ROICs.
Economic Moat| by Dan WasiolekUpdated Apr 29, 2021
We see MGM Resorts as having no moat due to its outsize exposure in Las Vegas (49% of prepandemic 2019 EBITDAR) and U.S. regional markets (29%) 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. That said, 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. Also, we 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 (22% of 2019 EBITDAR) and Japan (11% of EBITDAR in 2027, 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 and U.S. exposure benefits from a moat, it is encouraging that current 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 2019. That said, there are plans for two large resorts to open in 2021 (Genting World Resort with 3,000 rooms) and 2022 (Witkoff Drew with around 4,000 rooms) that combined will increase existing supply by a mid-single-digit percentage. Still, we believe that demand will be able to match these supply additions, as historically room expansion and visitation in the region have been correlated, as travelers are enticed to see new attractions, and the football stadium starting to host games in 2021.
Additionally, we are constructive on the opportunity of U.S. sports wagering, as we expect the current 20-plus states and District of Columbia that have legalized betting to expand toward 40 states by 2024, leading to a $6.2 billion sales market that year. We expect all of MGM's domestic properties to participate in this opportunity.
Although we do not view MGM as having a moat, it is still encouraging that its solid execution of operating some of the world’s best-integrated resorts has assisted in its approvals for new casinos in Maryland (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 2027.
While we do not attach moats to Las Vegas integrated resorts, we do believe the Japan and Macau gaming industries have moat qualities driven by a favorable demand and supply 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. Although the framework of a license might include around 30% gaming and corporate tax rates and the requirement to work with partners, the attractive supply and demand dynamics will generate ROICs in the teens, in our opinion, thereby supporting narrow-moat qualities.
The Macau gaming industry also has an advantageous supply and demand setup. With regard to supply, 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 these 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 also think it is likely that there will not 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 and 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 phase 2 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 7% over the next five years, compared with the company’s 9% cost of capital.
Fair Value and Profit Drivers| by Dan WasiolekUpdated Apr 29, 2021
After reviewing MGM's first-quarter results, we have increased our MGM fair value estimate to $36 per share from $33, largely due to increasing our long-term sports betting and iGaming revenue forecast. Our fair value estimate implies an enterprise value/EBITDAR multiple of 7 times our 2023 estimate, a year when we estimate travel and lesiure demand to reach pre-COVID-19 demand.
The pandemic outbreak drove MGM's total 2020 revenue lower by 60%. We still expect industry gaming revenue in Macau to return to 2019 sales levels by 2022, as we expect pent-up demand to drive traffic. We continue to expect MGM China sales to average mid-single-digit percentage growth during 2022-30. Given the growth we see from growing mass gambling and nongaming activity, we project Macao EBITDA margins to remain fairly steady at 27% in 2030 from 25% in 2019, despite higher expected license-renewal fees beginning in 2022.
MGM's domestic revenue dropped 55% in 2020, and we expect a rebound of 62% increase in 2021. Over the next 10 years we forecast a 7% annual lift to MGM's domestic revenue (versus 6% prior), aided by its T-Mobile arena, professional sports, U.S. sports wagering, and recent renovations.
We estimate the company to have a 33% ownership interest in a Japanese gaming resort opening in 2027, which generates $11.4 billion in sales with development costs of $10 billion, and EBITDAR margins averaging 22% in 2027-30. We portend its Japanese facility will generate 11% of total company EBITDAR in 2027.
We assume a 9% cost of equity, in line with the rate of return we expect investors to demand of a diversified equity portfolio.
Risk and Uncertainty| by Dan WasiolekUpdated Apr 29, 2021
We maintain our high uncertainty risk rating. Risks surrounding the timing of widely distributed vaccines remain, which could delay our forecast recovery in demand.
A risk is a downturn in travel and leisure demand, driven by either macroeconomic/geopolitical factors, through government regulation, or an airborne illness like the coronavirus. In 2009, U.S. gaming revenue on the Vegas Strip declined 19%, and VIP rolling chip volume in Macau faced a double-digit decrease in the first half of 2009 amid the credit crisis and a steep decline in the Chinese stock market. Also, Macau showed weakness as a result of anticorruption activities in China during 2014-16, as well as renewed concerns about slowing economic growth and currency devaluation. More recently, industry VIP gaming revenue dropped a high-teens percentage in 2019, due to uncertainty from trade tariff discussions between the U.S. and China. In 2020, the Macau and U.S. gaming markets were materially affected by the coronavirus, driving MGM's total revenue will down 60%.
Another risk is a trade war between the U.S. and China, which could influence the renewal process surrounding the Macau gaming licenses up for renewal in 2022.
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 2027. Further, the framework of a license in Japan is still undetermined and could negatively impact the profitability and intrinsic value of the company.
Finally, MGM faces environmental, social, and governance risks like gambling addiction, which could stoke government restrictions and affect demand. Also, its resorts operate at all hours and days of the year, using energy and supplies, which if not properly managed could cause some people to lose interest in visiting. Additionally, it has customer data, which it must be careful to protect, so not to cause distrust.
Capital Allocation| by Dan WasiolekUpdated Apr 29, 2021
We see MGM’s balance sheet as improved but still weak, its investment strategy as fair, and shareholder distribution as appropriate, resulting in a Standard capital allocation rating.
MGM’s balance sheet risk has improved, with net debt/EBITDA averaging 3.7 times during the prepandemic years of 2017-19 versus the 8.7 times averaged in 2014-16. Still, we consider its balance sheet weak, despite MGM’s medium revenue cyclicality and operating leverage, as we expect net debt/EBITDA to average 3 times during 2022-24. And although less than 25% of its debt is set to mature in the next three years, overall net debt represents over 25% of the company’s enterprise value at our existing fair value estimate.
We hold a fair view of MGM’s investment strategy. On one hand, we like the company’s focus on gaining a gaming license in Japan, as we think the region offers an opportunity to generate economic profit, and we would welcome any investment to grow its Macao presence, although this would require approval from the government. In the more competitive U.S. markets, MGM is making appropriate investment into sports betting and iGaming markets, as well as ongoing investment to keep its physical assets relevant. But we think such investments are needed to keep pace with peers and don’t stand to generate economic profit. That said, MGM has developed a track record of execution, as it removed meaningful cost out of the model and has transitioned to more of an asset-light model even before the pandemic, which has helped its ability to reinvest back into its business.
MGM’s shareholder distribution is appropriate, as we see the company’s focus prudently remaining on improving its balance sheet position and reinvesting into its business to remain competitive. Dividends and share repurchases have been measured, which we expect to continue during the next 10 years.