MGM Macau is likely to see continued improvement under Grant Bowie but net IPO proceeds to MGM are still unlikely to reach the suggested $500m.





While MGM Macau is unlikely to ever produce the type of numbers we see at WYNN, we do believe that they can continue to fix the sins of the past and materially improve results at the property.  So what went wrong?


When MGM entered Macau, there was no shortage of hubris.  They embraced the build it and they will come approach.  With MGM’s gaming expertise and brand name, and Pansy’s knowledge of the market, it was a slam dunk, right?  Well, Pansy is not a casino operator and has no experience as a property manager, and MGM did not have a track record of operating successfully outside the US.  MGM brand recognition was indeed high, in the mid 90% range.  Unfortunately, it was the movie studio that was well recognized.  Not many people in Asia knew MGM as a great casino brand.  Oops.


Here are/were some of the problems:

  • Bad layout that appealed to a US player but not an Asian player
    • Fixed
  • No marketing or sales function at the property
    • Now they have a marketing team in place
  • Surrounded by construction
    • Ceased, now that Encore and One Central are open
  • Confusing logo
    • Recently rebranded to MGM Macau instead of MGM GRAND MACAU
  • Had no business plan and strategy
    • We’ll see whether improved performance is a result of market strength and/or Grant Bowie’s strategy
  • Too many FTE’s
    • Cut 1,000 FTE’s from August 2009-March 2010
  • Too much bureaucracy with the 50/50 structure
    • Still an issue
    • Investors will penalize the IPO multiple
  • Too conservative with whom they dealt and lent money
    • Becoming more aggressive in the way they manage their business but only extend credit to players with assets outside of China
    • Increasingly extending credit to junkets

There is no question MGM is benefiting from the incredible strength of the market.  Unfortunately, market share continues to languish after a push forward late last year.  However, margins are expanding and the increasing use of junket and direct play credit should boost share going forward. 




MGM Macau generated only $150 million in EBITDA in 2009.  However, with Grant Bowie’s changes and the strength of the market, we are projecting $240 million for 2010 and $279 million for 2011.  We think it is fair to base the IPO valuation on a range of $250-300 million.  Based on that level of EBITDA, we calculate the net cash proceeds to MGM of only $178-380 million after factoring in expected joint venture debt and the repayment of MGM’s intercompany receivable (~$100MM), which will get repaid before divvying up the IPO proceeds.   We assume 20-30% of joint venture is sold through the IPO. 




Some may argue for a higher multiple range but we think investors will severely punish the IPO valuation for the joint venture structure and a lack of control.  The valuation may be enhanced somewhat by a credible and well-articulated Cotai strategy but investors are unlikely to ascribe significant value to that part of the story given the huge amount of Cotai supply coming online and MGM’s dismal development track record. 


Based on our research and analysis we believe it is unlikely MGM generates the $500 million in net cash proceeds it is expecting.

Austerity's Rift: Europe vs USA

Position: Short France (EWQ)


Heading into the G20 this weekend there’s a noticeable rift between Europe and the USA vis-à-vis the issuance of austerity measures to address government budget deficits: many European countries are wearing the proverbial “accountability pants” to address fiscal imbalances while the Obama administration has yet to critically address the government’s excess spending and future obligations. Maybe that’s why Peter Orszag (Obama’s budget director) is leaving.


Yesterday, in an emergency budget speech, UK Chancellor of the Exchequer George Osborne outlined initial go-forward spending cuts and tax-generating measures (in a formula of roughly 80/20) to shave down the country’s budget deficit. Here are the main tenants of the budget:

  • 25% cut in the budgets of government departments starting April 2011 through 2015 (a spending review is expected for released in October)
  • Tax on banks with liabilities greater than £20 Billion (the tax is expected to generate approx. £2 Billion annually)
  • Increase to the Value Added Tax (VAT) from 17.5% to 20% starting January 2011
  • Increase in capital gains tax for higher tax bracket earners, to 28%. No change (18%) for low to middle income earner
  • A 2 year wage freeze for all but the lowest paid among Britain’s 6 million public servants and a 3 year freeze on benefits paid to parents for rearing children
  • Cuts to the housing benefit and disability allowance
  • Decrease in corporate taxes, staggered over 4 years from 28% to 24%

In his speech Osborne stressed that he is “not going to hide the hard choices from the British people”. Obviously managing growth while cutting spending will be a great challenge for the newly elected Cameron government. UK growth is currently estimated by the Treasury for +1.2% this year and +2.3% next year. Interestingly, the emphasis to lower corporate taxes is in direct response to the government’s fear that an unfavorable tax environment would drive corporations out of the UK.  


Noteworthy, following the budget announcement, Germany and France expressed their support for a bank tax. While we don’t expect any concrete policy to come from the G20 this weekend in Toronto, we do expect the talks to surround the UK’s fiscal tightening and the growing rift between Europe’s “action” and Washington’s “inaction” in shoring up budget imbalances. 


As Keith has affectionately stated: a country can kick the can of debt down the road for only so long.  Maybe America will take a hint from the Europeans.


Matthew Hedrick

FOMC Update: Professional Politics

Sadly, in what is becoming a proactively predictable statement of conflicted US Federal Reserve monetary policy, Ben Bernanke opted to pander to the easy money policy that has amplified both the volatility of markets and the cyclicality of price inflation/deflation since he took his lead from Alan Greenspan.


Our advice this morning was to respect the cost of capital. Promising a risk free rate of return of ZERO percent to both domestic and foreign investors will not inspire investment. We live in an interconnected world where capital seeks yield. Ask the Brazilians and Chinese what they think about that…


Whatever you do, don’t ask Ben Bernanke and his troubadour of the willfully blind at the Federal Reserve for an economic forecast. If he didn’t see economic growth and inflation in the last 12 months he’s definitely not going to see it now. Like a broken clock, he’ll eventually get it right – the double dip we are forecasting for both the US economy and US housing will be here come Q4. By then, Bernanke will be formally cutting his economic forecasts.


As a reminder, Bernanke’s forecasts on US economic growth are about as far out in the stratosphere of nod as we have seen in some time. That said, given his outlook, he should have the Fed Funds Rate at least 100 basis points higher than where it stands today (he is looking for upwards of 4% GDP growth in the US in 2011). So it’s time he either raises rates in line with his forecast or just takes a chainsaw to his forecasts.


Wait – he can’t cut his forecasts because lowering the GDP estimate will make the US deficit/GDP calculation look worse than Greece’s come 2011. Better hope for another “great depression” that “no one could see coming”, then cut forecasts after the fact I guess…


In today’s statement he went as far as to say that the “labor market is improving gradually.” I couldn’t make that up if I tried. If he’s forecasting these kind of economic growth numbers, I guess he needs to provide a narrative to support the forecasts – this is called confirmation bias (bad).


Looking at the latest monthly US unemployment report and round of May housing numbers, Mr. Macro Market has already provided the only economic forecast that should matter to Americans. As any good risk manager who has managed real capital in his or her life would say, it’s on the tape.


Maybe he’s not serious about forecasting. Maybe he just is who he is – a good natured academic trying his best to be a professional politician.



FOMC Update: Professional Politics - 1

NKE: Thoughts Ahead of the Print

Look for a big beat and a shift in EBIT guidance to be sales+GM to sales+SG&A leverage. It's important to understand the underlying rationale as to why. If people don't get it and the stock trades down, then opportunity knocks for those not involved.



A few considerations heading into Nike this evening.


First off, I’m at $1.17 vs. the Street at $1.05.


2) The big beat should be on revenue. I’ve got ‘em growing 11.4% -- vs. the Street at 8.9%.


3) They might choose to spend some of the upside on the SG&A line, but I’m inclined to think that they show more than one might think. Keep in mind 2 things…

   a) This is their 4Q, and they don’t have as much leeway to push/pull rev and costs between quarters.

   b) The prior year, Nike laid off 7% of its workforce. Morale was awful. The people that made the cut are pumped to be part of the starting lineup. Above all incentives, people at this company are paid based on hitting pre-tax income targets. They NEED to get paid this year.


4) Even though trendline futures should accelerate 300-500bps, Don Blair is likely to be cautious with guidance – like he is every quarter without fail.  My sense is that the company will stand by its ‘high single digit revenue growth and mid-teens EPS growth’ model for the year, though the constituents may change. Why?

   a) The co will have to acknowledge that 1H revenue will be strong – as futures will dictate so. But it will not give any color on 2H.

   b) In that regard, as NKE anniversaries FX benefit on GM and World Cup spend on SG&A, the margin equation will likely shift from being a GM story in 1H to being an SG&A leverage story in 2H.

   c) Tack on the perceived uncertainty about the Yuan (even though Nike’s revenue organization is nearly as big as its sourcing organization in China – ie a Yuan revalue is a near wash), and I don’t think that this guidance will make people step on the accelerator to buy the stock due to a potential ownership rotation – even with a big print.


If the multiple compresses despite better earnings, this is a great shot for those who thought they missed this name on the first ride up.

Softlines Production in China: A Deeper Look

Here's a look at share trends over time for producers of US apparel and Footwear. Don't get caught in the web of extrapolated changes in the Yuan across Softlines retail.


Without a doubt, the question I’ve been peppered with the most this week has been what the dispersion is of apparel and footwear production by country – especially China. Not a surprise given the revaluation of the Yuan.


Here’s some eye candy showing the obvious…that about 36% of apparel that we wear is made in China, but closer to 76% of footwear.  Facts are facts, but I think that these numbers can be misleading. First off, why did China’s apparel share triple over 8 years? Partially bc an archaic quota system was removed that opened up apparel trade between the US and non-WTO countries. But also because the currency arb allowed it to occur. If a strengthening Yuan makes production cost-prohibitive, then several things will happen – 1) China will likely lower its VAT tax to offer some form of relief to exporters, and 2) other Asian and Latin American countries are likely to gain share vis/vis undercutting China on price.


This is not to say that there will not be transitional pains…but simply that we cannot look at Macro changes like this in a vacuum.


Softlines Production in China: A Deeper Look - Apparel Import Table


Softlines Production in China: A Deeper Look - Footwear Imports


New Home Sales Collapse - Not Surprising


We've been a broken record for a while on the coming collapse of housing activity following the April 30 expiration of the government's tax credit-induced false reality. This morning, new home sales data finally reflects what purchase applications have been telling us for the last seven weeks. New home sales came in at 300k, down 40% month over month from last month's 504k seasonally adjusted annualized rate. April (the prior month) was actually downwardly revised to 446k from 504k, so pegging this month's number of the revised number looks a tad better - down 33%. Inventory was basically flat at 213k vs 211k last month (though last month was revised up to 214k, suggesting a nominal inventory decline.


This was the lowest sales level since 1963, the year record-keeping began. Not a positive sign for the housing market.










Purchase Applications Suggest More Pain to Come


MBA mortgage purchase applications dropped another 1.2% this week sequentially. This brings the tally to six of the last seven weeks that purchase applications have fallen sequentially. For reference, to put things in context, purchase applications are down 70% from the highs in 2005/2006 and are levels not seen since 1. Taking the YTD 2010 applications, which includes the tax credit stimulus, applications are at levels not seen since 1 (including the stimulus!).




The stage is now set for a much weaker-than-usual summer housing environment. Housing-sensitive stocks could be at risk heading into the 2H10 and 2011 time frame.


We have an extensive report coming out on this topic on Friday, which Josh Steiner will summarize on a conference call at 11am on Friday for subscribers of his Financials research. Email if you are interested in learning more about his product and the call.


Joshua Steiner, CFA


Allison Kaptur

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