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Rod Smith

MGM Mirage-Mandalay Deal May Produce Big Debt Burden

22 June 2004

Even while MGM Mirage is keeping mum about its plans to finance the largest corporate buyout in gaming industry history, Wall Street analysts Monday were speculating the deal is likely to leave the surviving company heavily mortgaged and deeply in debt.

The proposed $7.9 billion megamerger would create the largest gaming company in the world, with about 30 casinos and total revenues of nearly $7 billion a year.

MGM Mirage last week agreed to pay $71 per share for Mandalay in a cash transaction that would include $600 million of convertible debentures and the assumption of about $2.8 billion in debt.

For Wall Street, however, the biggest question now is how the Las Vegas-based gaming company will finance the deal, particularly given the possibility of a stock component to the sale.

Deutsche Bank analyst Andrew Zarnett said MGM Mirage's plans to finance the deal are important because they raise questions about how much debt burden the new company would carry once a deal is complete.

Zarnett called the proposed buyout "a brilliant move by (Kirk) Kerkorian" even though it is uncharacteristic because the billionaire usually buys when a target's stock has tanked, as he did with Mirage Resorts in 2000.

"He realizes the real estate supply is getting smaller and is getting incredibly valuable," he said of Kerkorian, who is the majority shareholder in MGM Mirage. This is like buying oceanfront property. "There's only so much anyone will ever get, but the price will keep going up."

Another Wall Street analyst, who asked not to be named, believes the financing will prove workable despite the heavy debt involved because of billionaire Kerkorian's name.

"He has a record with takeovers and paying down debt loans that gives investors confidence. The track record is an asset that sells on the Street," he said.

A Texas-based financial analyst who asked not to be named said the debt financing likely will be sweetened with a stock offering of more than $1 billion -- which Kerkorian could use to increase his control of the new company -- along with some asset sales. The analyst suggested Kerkorian would end up selling one of the Detroit casinos the new company would own after the merger, Mandalay Resort's Circus Circus in Las Vegas and MGM Mirage's Jean resorts: Buffalo Bill's, Primm Valley and Whiskey Pete's.

"He could potentially do all debt, bank financing, but it would be more prudent to do an equity deal and part with some assets, too," he said.

Other analysts, who asked not to be named, said MGM Mirage is in a good position to manage any added debt, especially with a new stock offering, partially because Kerkorian is rolling in cash from a recent $1.4 billion, tax-free cash dividend paid out by Metro-Goldwyn-Mayer, in which he owns the majority stake.

MGM Mirage, with annual cash flow of around $1.3 billion, carries net debt of $5.2 billion. Mandalay brings in just more than $700 million in cash flow and carries almost $3 billion in debt. Cash flow, a key measure of profitability, is generally defined as earnings before interest, taxes, depreciation and amortization.

Without the buyout, Deutsche Bank had forecast MGM Mirage leverage to decrease to 4.2 times cash flow from 4.4 times cash flow, and Mandalay leverage to fall to 3.8 times cash flow from 4.1 time cash flow.

If MGM Mirage pays $4.8 billion cash, the combined company should expect some $2 billion in cash flow and a potential net debt burden of about $13 billion, and leverage has been estimated to increase to about 6.5 times cash flow, analysts said.

Eric Hausler, gaming analyst for Susquehanna Financial Group, said that would be a heavy debt burden for the company, especially compared with other players in the gaming industry, although MGM Mirage generates a lot of cash flow compared with its peer company group.

By another measure, that debt would represent nearly double the revenues of the two companies, compared with Caesars Entertainment and Harrah's Entertainment, the new company's biggest rivals, which each have debt loads of less than 1.5 times revenue.

Las Vegas developer Steve Wynn, who sold Mirage Resorts to MGM Grand in 2000, said Kerkorian historically has been successful in making acquisitions and is willing to live on a very thin margin.

In the case of the new takeover bid, Wynn said the combined MGM Mirage-Mandalay debt compared with cash flow would be even higher than it appears at first blush because the new company would either have to sell off one of the two casinos the combined company would own in Detroit, or pay steeply higher taxes on average.

While no analysts would go on the record as being critical about the possible debt load, some said it would prove a challenge for managing the company. Still others, however, said with interest rates at near-record lows and heading up, there would never be a better time for this kind of financing.

A source close to the buyout negotiations suggested looking at the 2000 takeover of Mirage Resorts by MGM Grand as a model for the Mandalay takeover deal.

To complete its acquisition of Mirage Resorts, MGM Grand raised $4.5 billion with new credit facilities, $1.2 billion through a private stock placement and $710 million in senior note offerings, Zarnett said.

The Mandalay buyout would increase MGM Mirage's debt leverage to a ratio of around 6.8 times cash flow if it is 100 percent debt financed, or about 5.6 times cash flow if it is half financed with debt and half with a new stock offering. The latter is more likely given Kerkorian's history of managing debt in the casino business, analysts said.


MGM Mirage- Mandalay (2004) MGM Grand- Mirage Resorts (2000)

Price $7.9 billion $6.4 billion

Debt (est.) $6.1 billion $4.5 billion

Senior notes (est.) $600 million $710 million

New stock offering (est.) $1.2 billion $1.2 billion

SOURCE: Wall Street investment banks

MGM Mirage-Mandalay Deal May Produce Big Debt Burden is republished from