MGM: OPTIONS YES, AN OPTION? NOT YET

MGM will report its Q4 earnings in a couple of weeks and the shorts are having a field day. The short thesis is that the fundamentals are horrible, numbers are coming down, and the company will either bust a covenant or be forced to raise highly dilutive equity. Citibank recently slapped a sell rating and a $2.50 price target on the stock (why not just call it a zero?) and, like a pot calling a kettle black, Bank of America/Merrill reiterated an underperform rating. Clearly, we have a consensus call here folks.

Now for an “out of the box” call. MGM has more credit remedies than people think. Some of these may come out of the Q4 conference call. With a short interest probably higher than the 33% reported on 1/12/09, this stock has squeeze written all over it. I’m not sure the catalyst will be fundamental, unless they’ve cut costs more than expected. Rather, it is likely to be related to liquidity/covenants/balance sheet. Here are some possible remedies:

1. Bond buy backs – MGM should be buying its heavily discounted bonds back with borrowings off their credit facility or from proceeds of asset sales. The only reason they wouldn’t be is because they want to maintain their very strong relationship with their banks which brings me to #2.

2. Renegotiation with banks – MGM actually has some leverage in the negotiations because of the threat of bond buy backs which devalue the bank debt, and the fact that banks do not want to own casino assets. MGM has a very good relationship with its banks. These factors could lead to a lifting of the leverage covenant to get MGM through 2009.

3. Asset sales – MGM should be taking whatever they can for their significant but non-cash producing land portfolio. Any land sale would be a positive.

4. Hotel/casino sale – Rumors of the death of The Mirage sale are greatly exaggerated.

5. Government help – Don’t laugh. CityCenter is a huge job creator and the Senate Majority leader Harry Reid just happens to represent Nevada. As we wrote about last week, there is already a provision in the stimulus plan to defer taxes on the gains from bond buy backs. The provision was crafted by Harry Reid and the other senator from Nevada, John Ensign. Stay tuned, this may not be all.

6. CityCenter financing – Obviously, this would be huge.

7. Shareholder help – Whether it’s Kerkorian, Dubai World, or others, credit relief could come from unlikely sources.

We are not making a call on improving fundamentals. We were negative on MGM’s prospects for all of 2008. It’s not a call on the long-term value of MGM either. It is a call that there are credit remedies MGM can pursue to get through 2009 and buy some time for a more favorable credit environment. Interestingly, on their Q4 conference call PENN management indicated that the banks were becoming more flexible recently and relations with the industry were quite good.

Bearishness is unprecedented in this sector and in this stock. The negatives are generally known but the positives may not be.

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