05/18/09 09:41AM EDT

The impetus for this note was the MGM secondary pitch, "if you put a 10x multiple on 2012 EBITDA and discount it back, the stock is worth at least $15".  The last time one could credibly argue that a Las Vegas operator was worth close to 10x was in 2006-2008, when a casino company could float bonds at 6.5-7%.  Those days are long gone and probably aren't coming back anytime soon, even with LIBOR at 1%.  Neither should the multiples, although history has shown that there is a delay between higher cost of capital and lower multiples.  A more appropriate comparison is probably the late 1990s when the major market operators traded at 7-8x forward EV/EBITDA.

The following chart details the relationship between cost of capital (bond yields) and trailing EV/EBITDA for gaming operators.  The multiples are an average of regional and major market operators so they are not meant to apply to individual stocks.  Rather, we are simply illustrating the causal relationship of cost of capital to valuation.

10X EV/EBITDA? YEAH RIGHT - gaming multiples vs cost of capital 

There are two takeaways from the analysis.  First and not surprisingly, higher cost of capital leads to lower EV/EBITDA multiples.  This can be seen in the chart and in analyzing the regressions.  Second and more illuminating, the strongest relationship occurs with a lag of 18 months, meaning rising cost of capital does not immediately get fully reflected in the valuation.  The R square on the 18 month lag was 0.62, which is very high.  This second point does not bode well for gaming stocks.  Despite very high bond yields, EV/EBITDA multiples remain above historical levels.  If history and current yields hold, current multiples may not be sustainable.

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