MGM Resorts International (NYSE:MGM) management is in the midst of a battle that could be a defining moment in the company's history. While a group of activist investors seek to change the path the company takes going forward, current shareholders could decide the company's fate in its upcoming board elections. .
The two sides are battling over whether or not MGM should convert some of its casino and resort properties to a real estate investment trust, or REIT. Voting on board membership ends on May 28. Here's what is happening, and why this board battle is so important to Las Vegas investors.
The hostile takeover attempt
MGM's management has been under attack this year from an activist investor group called Land and Buildings, or L&B, which has publicly argued that MGM should spin off some of its assets into a separate REIT . The move could make MGM shares worth up to $55, according to L&B, which is almost three times as much as today's share price around $19.
In response to MGM's unwillingness to pursue a REIT structure, L&B has accused the company of withholding shareholder value and is now seeking to place four representatives from the group on the MGM board to ignite changes from the inside. There are currently 14 MGM board members including CEO James Murren and founder-turned-senior advisor Kerkor Kerkorian. L&B is seeking to have four of these board members replaced by L&B representatives in the coming board membership elections this month.
MGM's board fights back
Even though L&B owns less than half a percent of the company's total shares outstanding, the activist group is clearly ruffling some feathers in MGM's management. Current board members recently sent a letter to all shareholders to refute L&B's claims and urged shareholders not to vote any of those four representatives to the MGM board.
In the letter, MGM's board members said that L&B chose to compare MGM to other gaming companies without taking geographic footprint into account, made wrong assumptions regarding MGM's operations and costs, and even had significant calculation errors in some of its formulas. The letter ends with the board's plea to shareholders (quoted in the original all-caps format of the letter):
PROTECT YOUR INVESTMENT IN MGM AND VOTE FOR THE NOMINEES WHO HAVE BEEN AND WILL CONTINUE TO SERVE YOUR INTERESTS. YOUR VOTE IS IMPORTANT -- VOTE THE WHITE PROXY CARD TODAY!
So why would L&B want MGM to spin some assets off into a REIT structure? Well, when a company spins its land assets into a REIT, it is essentially a separate company that owns the land and then rents the space and facilities back to the parent company. This is primarily appealing because REITs don't pay income tax like regular companies do, meaning more of the company's earnings can be passed to shareholder; in fact, REITs are required to pay 90% of their income to shareholders. Furthermore, investors of a company that converts to a REIT could receive a special one-time dividend payout from the conversion that could boost returns significantly.
The pros and cons of REITs
So we can see why L&B wants MGM to go through the conversion. Even L&B's relatively small position still equates to roughly 1.6 million shares, so its members could collect a huge short-term payoff in the event of a REIT conversion. Furthermore, dividend- and income-focused investors would appreciate the high payouts they receive from the REIT.
Additionally, such a conversion can help ease the debt burden of more highly leveraged companies since the sale of the properties can provide cash to pay down long term debt. This could be great for MGM as it will soon be the most heavily leveraged company among its peers due to significant leveraging for new projects both in China and the U.S. Northeast coming online in 2016 and 2017.
However, there are long-term risks involved. Rising interest rates from the Federal Reserve that affect mortgages, an economic downturn that depresses rent prices in Las Vegas or other areas MGM operates, and MGM's ability to upgrade existing properties when investors are demanding such high-cash dividends could be tricky issues.
There is also the risk of what happens at the end of the lease. Usually REIT leases last 15 or so years, at which point MGM would have to renegotiate its leases since it wouldn't actually own the properties in which it operates. Since a REIT probably wants to get the highest possible rent, that could lead to more issues like rising rent prices, even to the point of bidding out to other gaming and resort companies to use the space.
There does seem to be short-term upside here from an REIT conversion. Morgan Stanley agreed that, while the L&B's case may have been a little high at 180% share price upside from a conversion, there is certainly growth potential in the MGM REIT option. The analysts predicted a potential upside of about 25% on MGM's current stock price if it goes through with the conversion.
However, while there is short term potential, there is significant long term risk to MGM's core business with this type of conversion. Short-term-focused hedge funds like Land and Buildings don't need to care about those long term aspects as they probably will have moved on well before long term shareholders. Therefore, this REIT conversion should not be considered a Foolish long-term best bet.
Bradley Seth McNew owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. The Motley Fool is short Caesars Entertainment. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.