MGM is severely under spending on maintenance capex. The good news is they can probably keep it up [down] through 2011.
We’ve always thought that maintenance capex in the casino industry needed to be 5-7% of revenues. It’s not the perfect measure but it’s good enough. Companies have either spent this much or under reported true maintenance. To its credit, MGM has historically spent in the 5-9% which means they are a) honest in their reporting and b) properly maintaining their properties. Certainly, given the company’s exposure to the competitive LV Strip and its market positioning at the upper end of the spectrum, they do need to spend more.
The following chart shows MGM’s historical maintenance spend as a % of revenues and as a % of PP&E. Clearly, capex is way below normal levels on both metrics.
MGM plans on spending $200 million on maintenance capex this year and next year, representing about 3% of revenues. They can probably get away with it since they had fresh product heading into the downturn. MGM spent 9% of revenues on maintenance capex in both 2007 and 2008. However, they will have to play catch up in 2012 and therein lies the problem. Normalized capex will eat into its free cash flow. In 2011, we project MGM will generate $225 million in free cash flow but only $75 million if we normalize maintenance. That translates into a paltry 2% free cash flow yield on the current stock price. Note that for this analysis we are using a modified free cash flow measure that includes hypothetical JV distributions and income tax benefits. True free cash flow will undoubtedly be negative next year.