It has come to our attention that MGM will only generate net proceeds of around $600 million versus our projection of $700 million. This is very disappointing and brings into question why the company would pursue this transaction. Near term liquidity will be improved but the sale doesn’t help the Q2/Q3 covenant issue. MGM will still have to undertake an expensive refinancing, possibly involving equity.

The problem, of course, is that TI has a very low cost basis, as is the case with many gaming assets. The gross purchase price of $775 million seemed fair but at $600 million, MGM is only receiving around 7.0x 2009 EBITDA. This multiple is less than our projected leverage ratio. The transaction is neither accretive to equity nor does it de-lever the company.

Assuming the rest of the portfolio is worth a premium to TI, say 8x, that doesn’t leave much equity left over.

Eye On "Re-Flation"

Last week's "Re-Flation" math is pretty straightforward to look back on. It was broad based and correlated. See the chart below.



MGM confirmed rumors that it is selling Treasure Island (TI). The purchase price is $775 million and we estimate net proceeds will be in the $700-725 million range after a decent sized tax bite. The company expects the transaction to close in Q2 2009, which is an important quarter for another reason. Absent new financing, we estimate MGM will trip the leverage covenant in its credit facility during that quarter. If it doesn’t happen in Q2, a covenant bust is virtually a mathematical certainty in Q3.

The TI sale looks like a non-event. Near term liquidity is improved but the multiple was just ok. Most importantly, the covenant situation is essentially unchanged. The chart below provides estimated quarterly leverage ratios against the maximum allowable ratio as provided in the credit agreement. This is the biggest issue facing MGM right now. Investors should expect a highly dilutive equity offering in the coming months or a sharp rise in the company’s borrowing rate should they choose to renegotiate their credit facility. Neither of these options will be good for the current equity.

It's a bust!

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SP500 Levels Into The Close...

Today’s failure to breakout through the “shark line” (SP500 867) to our immediate term target of SP500 916 is what it is for now – wrong. We try our best to call markets and how they interact, daily. This is not an excuse. This is what it is – we won’t be right 100% of the time, but we will miss 100% of the shots that we don’t take (Gretzky).

As I am writing this note, the SP500 is testing its lows of the day at 859. From that line, the balance of risk/reward is very straightforward, playing to the bullish side’s favor. Downside is -2% from here; upside is +6.5%.

BUY “Trade” = 841.11
SELL “Trade” = 915.68

“Heli-Ben” will be dropping moneys from the heavens in t-minus 24 hours. That will be bullish, on balance, for stocks.

Looking Back; Looking Ahead: Two China Charts ...

Some of the revisionist historians are getting themselves in a heat today about how bad this Chinese industrial production number was. While we agree with the facts that September-November was a period of deteriorating growth, we do not agree with the idea that January will represent another sequential deterioration.

Today, for the record, is December 15th, and markets trade on what happens tomorrow, not last month. Both China and Hong Kong closed up overnight, despite this “news.”

The more interesting chart is the second one below, simply because it’s a proactive prediction of what tomorrow (January 2009) may bring. The Chinese stimulus plan is math, and we can draw conclusions from it. We remain bullish on China and suggest that those who have missed the recent +20% and +40% moves in the Shanghai and Hang Seng indices, respectively, find room in their portfolios to buy China on down days.

Kruger’s Frau Nein

In Paul Krugman’s Op-Ed piece today in the NYTimes he teed-off on Germany, in particular framing Chancellor Merkel and her economic officials as the “biggest obstacles to a much-needed European rescue plan.” This in reference to Merkel’s meeting over the weekend in Berlin to discuss Germany’s contribution to the EU stimulus package.

Krugman’s criticism, which matches that of other European nations, relates to Germany’s inability to name their contribution in Euros that some project to be too low. Krugman took this sentiment to accuse Germany as the lone kink in the chain to setting this package in motion. In our view this is a bit shortsighted. Taking a step back, any time the European community comes together to make a group decision, consensus is never a guarantee; in fact, regional and economic differences play a huge role.

Just last week EU leaders agreed to spend €200 billion, or 1.5% of the bloc’s GDP, to bolster growth. Yet few governments have matched this target number with new spending or tax relief, prompting renewed discussion and a closer look at individual contribution on a per country basis. As an example of the disparity among EU nations on GDP basis, Germany’s Q3 GDP totaled €567 Billion versus Belgium at €83 Billion. Certainly Germany will pay a larger piece of the EU stimulus pie than Belgium, which may not directly benefit Germany in the long run.

Germany currently says its proposed package represents 1.3% of GDP. This comes at the heels of Merkel’s issuance of a €400 billion banking stimulus to guarantee loans. According to the WSJ, “a senior German official said Germany is waiting until US President-elect Barack Obama takes office and enacts his own stimulus program (to name theirs),” which if true, means the EU will have to be patient.

Germany, arguably the strongest economy in Europe and the biggest market for exports from the 27 nation EU, is sending a signal in dragging its heels—one that shows its cautious nature, but more importantly, implies that its economy may not need as much stimulus as the rest of Europe. The government looks to be buying time to run the cost/benefit numbers to determine what type of stimulus package will lead to growth both domestically and within the Union, as opposed to making a reactive decision.

In The New Reality, we want to own the patient and proactively prepared. We remains long Germany via the EWG etf. Today the EWG is outperforming most of the top 10 in this world’s country GDP tables. Slow and steady works for us.

Matthew Hedrick

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