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MGM Resorts International (MGM 1.97%) recently announced a plan to improve its earnings before interest, taxes, depreciation, and amortization by $300 million on an annual basis.
In this segment from Industry Focus, host Nick Sciple and Fool.com contributor Asit Sharma break down MGM's plan to achieve higher earnings, which includes an increased presence in digital gaming. They also compare MGM to competitor Caesars Entertainment (CZR +0.00%) and discuss which casino operator is the better buy.
A full transcript follows the video.
This video was recorded on Jan. 15, 2019.
Nick Sciple: Let's talk about MGM for a little bit. MGM is similar to Caesars in that it's a major U.S. operator. Them and Caesars are kind of a duopoly when it comes to the Vegas Strip. They have less regional presence than Caesars does, but their regional casinos are very powerful. For example, I've been to the Beau Rivage in Biloxi. When you go to Biloxi, Mississippi, that's the nicest casino there. I live in the D.C. area right now. At Motley Fool HQ, they have the MGM National Harbor. There ain't anything as close to D.C. as the MGM National Harbor. It's a nice casino. And, they have exposure in Dubai, with two casinos there.
Do you want to talk a little bit about MGM's REIT arm? They have MGM Growth Properties. That IPO-ed in 2016. It probably was the model behind what Caesars did with Vici and their bankruptcy proceeding. What do you think about that vehicle and what MGM might be trying to do with that in the coming years? They own a significant portion, but they're looking to sell down some of that stake.
Asit Sharma: MGM, being a little bit better off financially than Caesars, I think the real estate holding company is working out a little bit better for them. They're looking to pull that stake down to under 50% in the next three years. That should get them about $1.5 billion of cash. MGM, having this in its pocket, also has maybe more potential to develop and acquire.
But, it also has a little bit of a cash flow...I won't call it a problem, it's more of an issue that's native to these large casino operators. It has to expand its profitability. We talked in the beginning about the activist interest. One of the reasons that activists are interested in MGM is that it doesn't generate quite enough cash flow to do everything you need as a casino. What I mean is, everyone has to take their operating cash flow and then pay any shareholders for repurchase or dividends if you issue one. I don't think MGM actually issues a dividend. But, first, you have to generate positive cash flow, then you have to cover your capital expenditures, and then there's money left over. And the problem is, again, as I said earlier in the show, casino operators are continuously acquiring new properties. They're building out additional square footage into properties. They're putting new events and exhibits in. It's such a capital-intensive business that you have to have high margins. The cash flow begins with high margins. As I said, coincidence that they announced this $300 million plan to improve profitability? Or, was management feeling the heat that activists might step in?
But let's talk about that plan. $200 million out of the $300 million in savings annually in adjusted EBITDA -- again, earnings before interest, taxes, depreciation, and amortization -- $200 million will come from operating efficiencies, half of that from labor reductions, i.e., layoffs. Then, this last $100 million will come from EBITDA expansion that's tied to digital revenue growth. The company has an idea to perform a digital transformation. It's going to reallocate some of its annual capital expenditure each year to specific technology advancements. That should increase its top line and grow its market share. This is a mix of elevating guest experience through data and pricing, the digital loyalty programs that you mentioned, Nick, and then optimizing its business mix -- who it sells to, how much of it is corporate business, how much of it is leisure business.
I think this is important. I just took a brief look at the company's cash flow the first nine months of the year. This is a very typical example. MGM generated about $1.4 billion roughly in operating cash. Capital expenditures were about $1.2 billion and change. Again, very little left over there.
I'm intrigued by this idea of a digital transformation because it's not tied to high fixed costs. If you can increase that top line just through digital channels, if you can get more into the online sports betting game -- which I'll ask you to talk about, Nick -- that's free money for a casino operator, which is operating, again, off of a few things. Bringing in that total take into a house, but also acting as a hotel operator, also acting as an operator of restaurants. To me, there's some opportunity here if management can execute.
I should point out that they did a similar plan that just ended last year in which they freed up about $500 million over a few years in EBITDA. The potential is there for them to improve this.
What are your thoughts, Nick, on this digital transformation, and maybe how that relates to sports betting that can go online for MGM?
Sciple: MGM, probably of all the casino operators, has pushed the hardest to make some partnerships in the arena of sports betting. I think they've announced partnerships with every major sports league with the exception of the NFL, which hasn't partnered with anyone yet. They've really pushed hard into that arena. You pointed out management's emphasis on moving toward a more digital strategy. They entered into a market access deal with Boyd Gaming. Boyd Gaming is a regional gaming provider in the U.S. They're going to share infrastructure to promote sports betting between their two businesses. What that gives MGM is an increase in distribution without having to pay for a more physical presence.
I mentioned that their regional casinos, while they don't have as many as Caesars, they really are some crown jewel facilities. Like I said, the National Harbor is probably the closest casino to the D.C. area there. They've got one of the only casinos in the Detroit area. They have a good physical presence. And as we mentioned earlier in the show, digital looks like where you want to be for the sports market. We saw that data out of New Jersey, saying that the folks affiliated with DraftKings and FanDuel have really captured an outsized portion of the market. I really like what MGM is doing here. I like the assets that they have to leverage around this sort of thing. I like the partnerships that they've made. I think it's really a nice-looking business.
The question, just like with Caesars, is how do they navigate their debt situation? But, as you mentioned, what's attractive about this opportunity is that you can grow your business without having to grow your hard assets on the balance sheet, which I think is attractive. Any last words on MGM?
Sharma: Again, if you're choosing between the two, both of these companies have underperformed the broader market over the last year in what's been a cyclically strong era. So, just an idea, you could take positions in both. Both could be poised for an upswing -- unless we get a recession, of course, which hurts discretionary spending. Again, eager to see all the changes both companies are instituting. If they're able to increase those profit margins, investors will finally award them that higher premium that's been missing for the last few years. Again, the point of this entire show is to pinpoint the changes that are nascent in the industry. It's going to look so much different with sports betting, online betting, with these digital plays in the next few years.
I'm getting interested in them. I don't own either. Maybe after the show, I'll take a position in one or both.
Sciple: I tell you, if I had to choose between these two major U.S. operators, Caesars and MGM, I think MGM has to be the choice here. You don't have the management questions, you don't have nearly as many questions when it comes to the balance sheet. They have some value they can unlock from their REIT business. There seems to be a little bit more value there for them than what Caesars is having to deal with. I really like what they're doing in the partnership space. Definitely something to watch.
As we mentioned earlier, and I'm going to mention it as many times as I possibly can, a lot of the thesis here for growth is going to be dependent on what the states decide to do. If states take a tack where their taxes are too high, or if they constrict the ability to do business online, that can impact the thesis behind these companies. But I think it's a trend that we're going to see continue to play out. I think MGM is, of the two, the better position and the one I'd be more comfortable putting new cash into today.
