How to Save MGM and Las Vegas Sands

It's pretty clear that gaming companies have soared right over 21 at the economic blackjack table. A prolonged boom period where debt was cheap and the influx of travelers seemed neverending encouraged the casino industry to gamble on huge expansion projects. Today, those projects have led MGM Mirage (NYSE:MGM), Las Vegas Sands (NYSE:LVS), and the rest to toe the line between survival and bankruptcy.

But as a Las Vegas resident, I see glimmers of hope around the edges. Gambling is a pastime that people have enjoyed for thousands of years, and many of those that don't enjoy games of chance are attracted to the gaming supercenters for the fine dining, world-class shopping, and great shows that many casinos now offer. In other words, I don't expect demand to disappear.

That said, something needs to be done about the sorry state of the gaming companies.

The debt problem
I'm sure I won't shock anyone by saying that the gaming companies' massive debt loads are the primary problems. Let's take a quick look at just how bad the balance sheet picture looks:

Source: Capital IQ, a division of Standard & Poor's. EBITDA = earnings before interest, taxes, depreciation, and amortization.

With few exceptions, the numbers in the table above would make most bankers shudder. To put it simply, if MGM's or Las Vegas Sands' balance sheet were a game of Jenga, you would not want it to be your turn.

But I want to see whether we can let the debt guide us to a solution.

The LBO solution
Gaming companies were far from the only ones gorging themselves on cheap debt during the credit boom. Private equity funds at firms like JPMorgan Chase (NYSE:JPM) and Goldman Sachs (NYSE:GS) were taking advantage of the free-flowing credit to carry out massive leveraged buyouts using little of their own equity to complete the deals.

For those not familiar with a leveraged buyout (LBO), the basic theory is that rather than using relatively expensive equity capital to buy out a company, you use just a little bit of equity and a whole boatload of cheaper debt.

You then use the cash flow from the acquired company to meet the interest obligations and pay down the principal on the debt. Rinse and repeat for a few years and -- barring a world-shaking credit crisis -- you'll end up owning a cash-flowing company with only a small up-front investment.

So what does this have to do with the casino industry? It's simple. Instead of continuing to take on additional debt and put their companies at risk, management in the gaming sector should start thinking about their companies as massive leveraged buyouts, and use the cash flow generated by the casinos to pay down their debt.

Through this process, not only would earnings per share increase, but so would the financial stability of the companies -- both of which would make the respective stocks more attractive.

Let's put some numbers to this theory
You're skeptical, I understand. Gaming companies are about growth, growth, and more growth, so the idea of shutting off that growth spigot after current projects are complete sounds insane. But bear with me. Let's use Wynn as an example.

Wynn Resorts carries around $4.8 billion in debt, and we'll say -- for sake of simplicity -- that it pays roughly 5% interest on that debt. In 2008, Wynn's properties generated more than $500 million in cash flow from operations, while the company spent $1.3 billion on capital expenditures. But what's interesting is that -- according to Wynn's SEC filings -- that capital spending was "related primarily to the construction of Encore at Wynn Las Vegas and Encore at Wynn Macau."

Let's go ahead and assume that around $100 million of the capital spending was for maintenance and upkeep of Wynn's current properties. What happens next year if Wynn shuts off the construction spigot and puts the $400 million or so of free cash flow into debt repayment?

The $4.8 billion in debt suddenly becomes $4.4 billion, and the decline in the debt load brings down interest payments by about $20 million. That extra $20 million gets taxed and becomes an additional $0.12 in earnings per share -- which would be a 10% increase on the EPS over the past 12 months.

Repeat this procedure year in and year out over the next five years or more, and through no trickery or sleight of hand, the company could substantially increase profits and decrease balance sheet risk.

Sounds great, so what's the holdup?
Your guess is as good as mine, but I would suggest that pride might be high on the list of impediments. The folks behind the gaming behemoths -- Sheldon Adelson, Kirk Kerkorian, Steve Wynn -- are all very talented developers, but they have egos as big as their bank accounts. Throttling back on growth probably sounds about as appealing to them as a mouth full of root canals.

But I have to admit that stranger things have happened, so I'll cross my fingers and watch for the impossible. And hey, Sheldon, Kirk, Steve -- if you guys are reading this, feel free to drop me a line, and we can get together and talk about this over a cup of coffee.

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