A giant stirs on the Strip

Jun 19, 2001 10:41 AM

Mandalay Resort Group is trading at $26 and change these days, a couple of dollars off its 52-week high. It should be more like $50, according to President and Chief Financial Officer Glenn Schaeffer.

Now you’d be hard-pressed to find a gaming boss anywhere who likes the way Wall Street treats his stock. But Schaeffer predicts Mandalay will be growing free cash flow per share at double-digit rates, better than twice the rate of the overall economy. He says the company’s stock price should reflect that.

It was a strident message of corporate well-being that Schaeffer delivered Friday at the company’s annual shareholders meeting at Mandalay Bay on the Las Vegas Strip. The implication was clear: It’s time to reassess how gaming stocks are valued, and in light of that, the future of smart investment analysis rightfully belongs to the prognosticators of cash flow, not net income. This is true, Schaeffer said, especially in the resort industry, where the general mandate is "build or perish" and depreciation and amortization become significant non-cash expenses under current accounting rules. Happily for casino operators, those rules change next year, freeing them from having to expense amortizations through acquisitions.

"We use a variety of valuation matrices that figure in both earnings and cash flow multiples. We tend not to rely on any single one," says analyst Brian Egger of Credit Suisse First Boston. "We do try to think with free cash flow as a valuation tool. So I’d agree with that."

In fiscal 2001, Mandalay reported net income of $119.7 million, or $1.50 per diluted share. Currently, the stock is trading at about 17 times EPS for the last 12 months. That’s slightly better than MGM Mirage (16 times) but behind the company’s two other large-cap competitors, Park Place Entertainment (22 times) and Harrah’s Entertainment (22 times), both of which enjoy more geographically diverse portfolios.

At the 10-times cash flow multiple Schaeffer advocates for Mandalay, the stock should be valued at around $48.40 per share. Mandalay ended fiscal 2001 with about 75.5 million shares outstanding and, by its own accounting, $363 million in cash flow after all bills, interest and taxes were paid.

"We’ve been talking about free cash flow for the last two years as an essential valuation tool for gaming companies," says Merrill Lynch investment analyst David Anders. "I would concur that casinos are powerful cash generators. The question is, how you use it. People need to believe that it’s going to go into high-return projects."

But that’s not what’s been happening, as Anders sees it. Instead, the last round of super-resort construction in Las Vegas - Bellagio, the Venetian, the Aladdin and Mandalay Bay - is generating returns he says are "arguably" less than the cost of the capital to build them.

"And that’s one of the central reasons why the stocks have come down from some of the levels we’ve seen in the past," he says.

Schaeffer is basing his projection of double-digit cash-flow growth on three factors, two of which - higher Las Vegas room rates and higher casino revenues - are topics of debate among analysts and observers.

Anders has "some lingering concern" about just how robust Las Vegas will prove to be in the months ahead as it wrestles with a declining economy, possible cutbacks in leisure spending and the impact of California’s energy crisis.

"It’s not so much a Mandalay issue, it’s much more a market issue," he says.

Then there’s the third component of Schaeffer’s program, an aggressive policy of share repurchases, which is like the music Wall Street wants to hear.

A few hours after the shareholders meeting adjourned Friday, Mandalay announced that its board of directors had approved a plan to take up to 15 percent of the stock off the market. That’s roughly 11.3 million shares. They’re worth close to $300 million based on current prices.

The company has bought back shares before, 14.5 million last year. The current round of buy-backs will be funded with free cash flow, Schaeffer said.

Schaeffer said cash flow will also pay for a $75 million retail mall the company intends to build as a link for foot traffic between Mandalay Bay and the Luxor next door. He was mum on the details Friday - an indication the company is still searching for an upscale anchor tenant after talks with Harrods and Nordstrom came to naught - but he promised a formal announcement this summer. The company did set a target date for opening: late fall of 2002.

The mall is part of the company’s focus on growing same-store sales at Mandalay Bay, Luxor and Excalibur - the resort cluster it calls a "Strip within a Strip" at the south end of Las Vegas Boulevard, the home of 80 percent of its invested capital and 55 percent of its revenues.

The same-store theme was another key plank in the upbeat show the investors got on Friday. About two months ago, the company announced plans to build a $225 million convention center at Mandalay Bay. It will be the second-largest such facility in town after the Las Vegas Convention Center.

Schaeffer also trumpeted the Affinity-type slot-club card the company is testing, which will allow it to track play and purchases in real time at its four wholly owned Strip resorts, which includes Circus Circus, and eventually at the Monte Carlo, in which Mandalay shares a 50 percent interest with MGM Mirage. Schaeffer said the card will be the most advanced of its kind and will bolster that "cluster concept" of marketing outlined at the shareholders meeting. The goal is to ensure that for the length of their Las Vegas stay, guests will gamble, dine, shop and sleep exclusively in a property owned by Mandalay.

It’s too soon, obviously, to say how investors will react. The stock rose 19 cents on the New York Stock Exchange on Friday to close at $26.21. The stock closed Monday up another 69 cents to $26.90.