MGM Resorts ( NYSE: MGM ) has quietly made a very big bet on the future of the Strip Las Vegas, and it could determine the long-term performance of the stock. Not only did MGM recently agree to acquire the half of CityCenter it did not own for $ 2.125 billion, it also agreed to sell CityCenter real estate for $ 3.89 billion to managed funds. by Blackstone ( NYSE: BX ) .
The decision to acquire a key asset and monetize its real estate seems smart at first glance, but it adds more leverage to MGM's business. What if Las Vegas doesn't recover from the pande sooncrumb, MGM will feel it.
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The popularity of REITs in Las Vegas
Over the past decade, it has become very popular to sell real estate from casinos to a Real Estate Investment Trust ( FPI) , either controlled by the company or by a third party. Penn National started the trend by creating Gaming and Leisure Properties in 2013. Caesars used the Vici Properties REIT to organize the merger with Eldorado Resorts. MGM itself entered the arena with MGM Growth Properties ( NYSE: MGP ) in 2015.
Today, most real estate on the Las Vegas Strip is owned by one of these three REITs, along with a few more owners of dispersed assets. The agreements have brought billions of dollars to casino companies but not without risk.
The Casino Business Model Reinvented
Previously, casino companies would spend billions of dollars to build a casino, take out debt to fund the project, and then operate and own the casino and earth. As long as the business could cover operations and interest payments, it was a viable but expensive business model to start.
Today, casino companies can sell the real estate of their projects for almost the same cost as building the casino, which essentially leaves them with new casino operations.. free. MGM has done it in Washington, D.C., Massachusetts, and now with CityCenter. The compromise is a long-term agreement to lease the property to the REIT for a monthly payment.
It sounds good, but now companies no longer have their own real estate to fall back on during tough times. During the financial crisis, for example, MGM sold Treasure Island (including real estate) to help finance its own operations during the crisis. In the past year, he sold real estate properties in Bellagio, MGM Grand, Mandalay Bay and now CityCenter for $ 12.7 billion. Real estate can be a very valuable safety net when times are tough.
From an operational standpoint, the sale of real estate can give these companies more operating leverage, which means that operating revenues rise or fall faster whatincome. It 's great when income goes up, but presents risks if income goes down.
The Risk of MGM's REIT Movements
Over the past 15 years, we have seen two major disruptions in the gambling industry in the United States. The first took place from 2008 to 2010, when the financial crisis caused huge cuts in consumer and business spending, and the second was the COVID-19 pandemic. In both cases, MGM had to sell assets and debts just to get through the crisis.
Now that MGM has sold the vast majority of its real estate, it no longer has the same safety net in difficult times. But it didn't reduce debt to offset higher operational risk, as you can see below. This is partly due to the fact that MGM consolidates the debt of MGM Growth Properties. But the company used most of the cash qu 'she got REITs to finance growth rather than paying down debt.
MGM Income (TTM) given by YCharts
This strategy could pay off for investors if income increases in the coming years as the additional leverage will translate into by higher returns. But there is also an additional risk in a crisis. And we have seen that crises in Las Vegas occur more often than we would like, which is why MGM 's bet on the city is risque for investors.