Gambling in the U.S. is making a comeback. At least that's the way it would seem with the rise in Las Vegas visitation and revenues as well as the renewed construction on casino resorts in the U.S. Northeast. However, just as we saw in the years leading up to the market crash in 2008, over-investment in new, massive projects financed by heavy debt loads can be very dangerous if visitation and gambling revenue start to decline unexpectedly.
Caesars Palace in Las Vegas. Photo: Caesars Entertainment.
Such was the case for Caesars Entertainment (CZR +0.00%). While trying (and mostly failing) at expanding, the company took on far more debt than it could manage, and after it went through years of losses following the crash of 2008, one of its main subsidiaries (Caesars Entertainment Operating Co.) recently filed for Chapter 11 bankruptcy protection. While the company thought that it could use debt to finance potential growth, the plan backfired when the market took a downward turn leaving Caesars with way too much debt supported by largely under-performing properties.
Now, MGM Resorts International (MGM +0.79%), another company that gets most of its revenue from the U.S. -- unlike Las Vegas Sands (LVS +1.84%), which is more diversified throughout Asia -- is also taking on a large debt load to finance new resorts in the U.S. and China. Which of course raises the question: Could MGM be following Caesars' catastrophic debt path?
MGM's big bet on a growing market
The U.S. economy continues to push upward, with rising consumer confidence helping spur revenue growth for companies that rely on discretionary spending, such as casino companies. MGM Resorts, the biggest player in the industry by U.S.-earned revenue, was one of the stronger bets in the casino market in 2014. MGM's relative success last year was due to the resurgence of gambling and non-gambling revenue in the U.S, during a time when competing casinos were getting beaten down by falling revenue in China.
With MGM's recent success in its domestic market, it makes sense that the company would want to continue expanding and gaining more ground on a regrowing U.S. market. But is the timing right for the amount of growth (and debt) it's taking on now? The company was continually renovating and improving its Vegas properties in 2014 to make them more appealing to visitors and to add more hotel capacity and it has two massive projects in the U.S. Northeast on tap.
A rendered view of what the National Harbor resort will look like. Image: MGM Resorts.
MGM is currently continuing constructing its newest resort in National Harbor in Maryland, and it's set to open in 2016. This 1.7-million-square-foot complex is expected to house about 4,000 slot machines. On the heels of this project, the company also got necessary licenses for a new resort in Massachusetts, and it's been reporting its plans for a Springfield, Mass., resort to start construction this year.
MGM is also still expanding in China, with a huge resort planned to be opened in Macau in 2016. The potential benefit of these new resorts is big, and Nomura Securities predicts that these new casinos combined could drive up MGM's total annual EBITDA by 56%, to over $3.5 billion, in the next three years.
Expanding at the peak?
Investors who are looking at MGM's current growth as a reason to bet on this company should also consider the cost of all of this growth and that the company is taking on very large amounts of debt. This has been done to finance the Macau and National Harbor projects, and it will likely do the same to build the Massachusetts resort. As of now, MGM's total debt stands at $12.9 billion, and is the highest in the industry (behind Caesars). This is about 30% more debt than Las Vegas Sands holds even though Las Vegas Sands also has a new resort coming to Macau that will be completed a full year earlier than MGM's resort there.
MGM's interest coverage ratio (EBIT/interest expense, showing ability to use earnings to then pay interest expense) is just 1.5, well below Las Vegas Sands at 14.5. MGM's interest coverage ratio is one of the lowest in the industry and is a red flag that such a high portion of its earnings are spent on debt expense.
Although there doesn't seem to be a liquidity risk in the near term, thanks to the new round of financing, this could be a major issue in the medium to long term. Of the $11.7 billion in debt the company had at the end of 2014, before the new round of financing, $1.3 billion of that debt matures in 2015, but MGM has said that some of the new round of debt raised at the end of 2014 will be used to pay this year's debt expense. This is essentially just pushing the problem down the road a little further, even though MGM still has debt that matures every year between now and 2023.
This system of continually taking on new debt is dangerous when the company doesn't have a very large cash cushion to work with. Even though MGM has more debt than Las Vegas Sands and will have a bigger debt interest expense to pay in the near future, MGM has only about $2.50 worth of operating cash flow per share, compared to over $6.00 of operating cash flow per share for LVS.
For these reasons, I'd be wary of MGM's current growth trajectory. If the U.S. market continues to grow, then these big new projects could prove very beneficial to MGM, but it looks oddly similar to how Caesars looked in the years leading up to the U.S. market crash of 2008 -- and we see how poorly that turned out.
