Uncertainties Surround MGM Mirage Buyout Offer

Investors waited intently today as a 5 p.m. deadline neared on MGM MIRAGE's $7.65 billion offer to acquire Mandalay Resort Group and as buyout talks continued between the Las Vegas casino-resort giants.

As the deadline neared, observers and analysts mulled over several uncertainties:

Whether Mandalay management and directors are truly interested in having the company sold.

Whether another casino operator would bid for Mandalay. Harrah's Entertainment Chief Executive Gary Loveman ruled out a bid by his company this morning.

Whether regulators would require a combined MGM MIRAGE-Mandalay to sell key assets on the Las Vegas Strip.

How Kirk Kerkorian, MGM MIRAGE's controlling shareholder, would finance the transaction and how he would deal with the massive $7 billion-plus debt load created by combining the companies. The uncertainties appeared to be reflected in this morning's trading, with Mandalay down 46 cents at $69.77 after soaring 17 percent, or $9.96, on Monday as investors bet on an ultimate sales price for the company that would beat Kerkorian's initial offer of $68 per share.

MGM MIRAGE shares, on the other hand, were up $1.04 this morning after falling $1.19 Monday.

Analysts said today they expect Mandalay ultimately to accept a deal despite a report in the Wall Street Journal this morning that the run-up in Mandalay's stock price over the past three days could lead to the proposed deal falling apart.

A source close to the negotiations said talks continued this morning and that in particular the sharp increase in Mandalay's stock price Monday wouldn't scuttle a deal. That's because the frenzy of upward bidding in Mandalay stock appears to be dying down. "The Street has gotten the message" about what Mandalay's stock is worth, the source said.

Mandalay and MGM MIRAGE officials couldn't be reached for comment on the status of the talks today.

As tonight's deadline nears, some of the remaining questions center around whether Mandalay officials are even interested in selling. Analysts think they are.

"I think they will," Deutsche Bank gaming analyst Marc Falcone said today. "They see long-term benefits in a combined company and a number of future real estate opportunities that would be hard for the board to turn down."

Falcone issued a report today offering two possible outcomes tonight: that Mandalay indicates interest, but that the bid price is below the Mandalay board's value; or that the companies release a joint statement indicating that they have entered into negotiations together to maximize value for shareholders. Falcone offered no opinion as to which is more likely.

"In any cased, we believe this transaction will happen, which will maximize the value for both sets of shareholders," Falcone said in his report. Our best guess is $72 to $75 (a share for the price)."

Falcone said price is likely to be biggest issue in talks between the companies, but there are other points that would be discussed, including what would become of top Mandalay executives.

Falcone said it was too early to speculate on what would happen to executives if the acquisition is completed.

Fulcrum Global Partners analyst Joe Greff added that he believes a deal is likely at the low to mid-$70-per-share range because MGM MIRAGE would be able to structure a profitable deal at that price and because Mandalay officers sold a great deal of stock at much lower prices not too long ago.

"They sold between $35 and $40 a share. They're not going to come back and tell MGM MIRAGE management that the deal (is worth a lot more) than $70," he said.

"Similar to how MGM negotiated a deal with Mirage in 2000, their first offer is not going to be their best offer," he said.

Greff said a likely scenario will have MGM MIRAGE extending the deadline for its offer or Mandalay asking for a higher price.

Mandalay Chief Executive Michael Ensign and Vice Chairman William Richardson nearly liquidated their holdings in the company last year, each unloading about 6.8 million shares. Each has remaining stock options and recent grants of restricted stock.

Robin Farley, a gaming analyst with UBS Warburg, New York, also said she believes the deal will happen.

"I think it makes a lot of sense for both parties," Farley said today. "The choice is to go it alone."

Farley said competition will get tougher in the gaming industry, particularly on the high end, in the second half of 2004 and early 2005 with the opening of Wynn Las Vegas. That competition could result in earnings declines for MGM MIRAGE, she said.

"Sometimes merger cost savings can be a good substitute for a lack of organic growth," Farley said.

In other developments, a Securities and Exchange Commission filing explained a correspondence in which MGM MIRAGE urged Mandalay to publicly disclose the deal.

In a letter to Ensign dated Friday, MGM MIRAGE Chief Executive Terry Lanni said his company publicized the negotiations because it feared that the information had been leaked, which could constitute a securities violation if the information were not disclosed publicly.

A source familiar with the negotiations said MGM MIRAGE had no evidence that a leak had occurred but that it wanted to be careful considering the magnitude of the transaction.

On Monday, three companies that monitor corporate credit placed the two companies on watch, saying they could downgrade their debt ratings based on the outcome of MGM MIRAGE's acquisition plan.

The rating companies are Moody's Investors Service, Standard & Poor's Ratings Services and Fitch Ratings.

The moves by the three companies are in response to MGM MIRAGE's surprise bid to acquire Mandalay and create a casino empire with 29 casinos with nearly $7.5 billion in annual revenue and $2 billion in annual cash flow. That bid expires tonight.

Analysts say there are unanswered questions -- particularly, how MGM MIRAGE would finance its cash offer -- about how the companies' debt could be restructured.

But the rating companies made it clear in their respective announcements that the uncertainty of the purchase price and questions on financing were enough to issue the ratings watch warning.

Financial analysts said MGM MIRAGE's bid of $68 a share represents a 13 percent premium based on Mandalay's closing stock price on Friday. Some say Mandalay could fetch closer to $75 a share and that MGM MIRAGE could manage that price without issuing new stock.

"We believe the bond market will view the acquisition negatively, but the selling will be muted given the chance that the acquisition falls through, MGM MIRAGE uses some equity to finance the purchase or some assets are sold to de-leverage or reduce the absolute debt burden," John Mulkey, a gaming analyst with Bear, Stearns & Co. Inc., New York, said in a report.

Moody's said in a statement that if the transaction were consummated on current terms and financed with all debt, leverage would be considered high for the company's current Ba1 rating category.

"The ratings of the combined company could be confirmed at Ba1 if the transaction is not entirely debt financed, if there is a well defined plan to reduce absolute debt levels and assuming Moody's could gain a high level of comfort with the future financial policy of the combined entity," the company said.

Moody's said both MGM MIRAGE's and Mandalay's current and historic financial policies have included a fairly high allocation of free cash flow to share repurchase as opposed to debt reduction.

Standard & Poor's said it put both companies, which have BB-plus corporate credit ratings, on watch.

"If a deal is ultimately consummated, we would review several factors in resolving our CreditWatch listings," said Standard & Poor's credit analyst Michael Scerbo. "These factors include the method of financing, the combined company's pro-forma capital structure, the potential for asset sales, management's near- and longer-term growth objectives, integration plans and overall financial policies."

The company said a downgrade for the combined entity would be limited to one notch. The companies have comparable credit ratings at the highest junk-bond level.

In its announcement, Fitch said its review would include a review of the strategic benefits that may be achieved with the acquisition with respect to competitive positioning, potential synergies and cost savings.

A Fitch analyst said Monday that there would be no significant cost savings for MGM MIRAGE if it were to refinance the $2.8 billion in Mandalay debt it would be taking on. MGM MIRAGE itself carries about $5 billion in debt.

MGM MIRAGE's bonds carry interest rates ranging from 5.875 percent to 9.75 percent. Mandalay's bonds have interest rates ranging from 6.375 percent to 10.25 percent. Both companies have strong cash flow and stock repurchasing plans in place and Mandalay paid a quarterly dividend of 27 cents a share in December.

Fitch research director Patricia Wright said the two debt portfolios are different in that MGM MIRAGE senior debt is secured -- the assets are collateralized, giving it a higher priority to a note holder. But that's not the case for Mandalay, whose debt is unsecured.

Wright said one of the key details of the deal, if it happens, will be how MGM MIRAGE would convert the Mandalay debt and whether the company would sell assets to reduce it.

And the other nagging issue is regulatory matters.

"It is difficult to speculate on whether federal or state regulators will have a problem with MGM MIRAGE's potential Strip ownership position and a decision against the acquisition could force a regulatory body to specifically indicate what level of concentration is too prohibitive," Bear, Stearns' Mulkey said. "We believe that would be a difficult precedent to set, but could facilitate the sale of certain assets to make the acquisition work from a regulatory standpoint. If regulators set a threshold, MGM MIRAGE could simply sell enough assets to be under such a threshold."

Traders, in the meantime, drove down the price of MGM MIRAGE bonds on the belief the deal would add debt to a combined entity.

MGM MIRAGE's 8.5 percent notes due in 2010 fell $3.50 Monday to $107.75. Its yield rose to 6.81 percent from 6.16 percent.

"The devil is in the details," said Michael Goldstein, a portfolio manager at Lord Abbett & Co. in Jersey City, N.J., who holds Mandalay bonds as part of a $7 billion portfolio of high-yield, high-risk bonds. "The debt burden may restrain and possibly negatively impact trading levels."

"We haven't heard any details of the financing," added Wright of Fitch. "The assumption is it will be purely debt-financed."

In that case, a combined MGM MIRAGE-Mandalay would have about $7 of debt for every $1 of annual cash flow, compared with $4.80 for MGM MIRAGE and $4.60 for Mandalay at the end of their 2003 fiscal years, Wright said.

"We'll be looking for a credible plan to repay debt, whether it's from equity sales, asset sales or cutting capital expenditures," Wright said.

Rising profits have helped casino junk bonds return 0.8 percent on average in 2004 including price gains and interest payments, according to a Merrill Lynch & Co. index that includes MGM MIRAGE, Mandalay, Caesars Entertainment Inc. and Station Casinos Inc. Junk bonds overall are unchanged on the year.

"Casino bonds have proven to be a good defensive investment given the positive cash flow of these companies," said Goldstein of Lord Abbett.

MGM MIRAGE's first-quarter earnings more than doubled to $105.8 million and Mandalay's profit for the quarter ended April 30 surged 98 percent to $87.3 million as more travelers visited the companies' hotels and casinos.

The bid for Mandalay affirms the value of casino companies as targets, Goldstein said. "I would expect more consolidation," which may lead to better credit ratings over time as companies reduce debt relative to capital, he said.

Kerkorian is more likely to finance a Mandalay buyout with a combination of debt and equity rather than just debt, Deutsche Bank AG bond analyst Andrew Zarnett wrote in a report.

If a deal is financed half with debt and half with stock, the combined company would have about $5.37 of debt per $1 of annual cash flow, compared with $6.57 if the financing is all debt, according to Zarnett.

"We expect that additional bidders may emerge for the Mandalay assets, and the final purchase price may differ materially from the initial reports," Zarnett wrote. He declined to comment further.

MGM MIRAGE will be "a much larger company with weaker credit ratios" if it buys Mandalay, BNP Paribas bond analyst Gregg Klein wrote in a report. Both company's bonds could fall about 3 cents on the dollar if a deal goes through, according to Klein."