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The May 5 proxy statement outlines issues related to the company's pending merger with fellow gaming company MGM Grand (NYSE: MGG).
First a bit of background. In March, MGM, which is majority-controlled by billionaire investor Kirk Kerkorian, offered to buy the luxury hotel and casino operator for $6.4 billion in cash and assumed debt. The purchase price works out to $21 per share, 24% higher than MGM's original offer of $17 per share, and almost double the level Mirage traded at before the MGM offer.
Mirage accepted the bid after consulting with investment banking firm Goldman Sach's (NYSE: GS), its financial advisor, and hunting around for potential buyers willing to top Kerkorian's $21 per share offer. There weren't any takers and Goldman said the bid was fair, so Mirage went with MGM.
What did Goldman determine? After analyzing Mirage, the gaming industry, and a litany of recent mergers between gaming companies, Goldman outlined a range of theoretical values for Mirage. Goldman said Mirage was worth something between $16.70 per share and $29.19 per share, and had a theoretical enterprise value ranging from $5.4 billion to $8.2 billion.
In other words, Goldman came up with a spread of values that reasoned Mirage could be worth as little as $16.70 per share or as much as almost twice that. Talk about narrowing it down.
But Goldman's results aren't at all unusual. That's the kind of spread investment bankers often come up with when trying to fix a value for a company's shares. Why the enormous range? Because determining a company's intrinsic value -- in many cases -- is one-part measurement and about three-parts guesswork.
Mirage's values were based on a discounted cash flow analysis, a method that determines the value of an equity by discounting the future stream of cash flows at a certain rate, called the discount rate. The discount rate basically represents the risk associated with those future cash flows. After all, no one knows for sure what kind of cash Mirage will generate from its casinos in the future, so the discounted cash flow represents an educated guess. As such, it makes sense to apply a range of values rather than to pick just one.
According to the Mirage filing, Goldman applied discount rates ranging from 7% to 11% with a base of 9%. Again these are pretty typical rates. The enormous spread tells investors how much guesswork is involved in predicting future cash flows. An investor can come up with any valuation he wants depending upon the discount rate he applies, but how much sense does it make to just keep applying different rates until you come up with an exact value you like?
Better to do what Goldman did -- provide a range of values, even if it's an enormous range. At least that way investors are getting a realistic assessment of how little we know about the future cash streams of most companies, and therefore the present value of many stocks.
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