WYN announced this morning (1/18/2018) that it will acquire LQ’s management and franchise business following the planned spinoff of LQ’s real estate in 2Q18. WYN will pay $1.95B in cash ($1B in aggregate, $715M to pay off LQ debt, and $240M for taxes from the spinoff).
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We believe global growth, and especially U.S. growth, will improve in 2018 from tax reform, which we believe will benefit consumer discretionary spending. That macro backdrop might also lead to higher oil, higher rates, and broad inflation, and the purpose of this note is to analyze how that potential environment could affect each name we cover. Our work suggests these inflationary pressures won’t necessarily derail our bullish thesis, and could even be helpful in some cases. In fact, we found our group normally performs well in rising interest rate environments.
Overnight (01/16/2017) DICJ reported Macau mass/VIP revenue for 4Q17, which showed VIP baccarat up 22% and the remaining mass up 17% y/y. Actual mass revenue has been slightly higher than the reported DICJ numbers for several quarters now as operators have reclassified mass tables to avoid smoking restrictions, but that may be coming to an end given new smoking rules that take effect beginning in 2019. We previously assumed mass revenue would grow 13%, so if 17% is in fact the actual number then this would be an upside surprise. Higher mass market revenue is positive because 1) it’s higher margin, 2) it’s the longer-term growth driver of Macau, 3) the government cares more about mass than VIP, and 4) investor concerns about slowing VIP may be offset by improving mass trends. These trends would also be positive for the opening of MGM Cotai later this month. The stocks are trading up about 3% right now, which makes sense to us.
This morning (01/16/2018) MGP (not covered) announced a proposal to acquire VICI (not covered) for $19.50/share under a 100% stock transaction. The offer price is below VICI’s current price we believe because VICI is owned by former CZR creditors who are not natural equity investors, which means exiting the stock is difficult, and M&A could also result in a higher multiple for VICI. We’re not sure that VICI is interested right now considering they have “elected not to engage in meaningful discussions,” and the offer price is 5% below the current stock price. We believe MGP has made this public in order to facilitate discussions with shareholders, but there also aren’t many overlapping MGP/VICI shareholders, though MGM/CZR has much more overlap. We don’t think anti-trust concerns would be an issue, but we also can’t rule it out given MGM’s ownership interest in properties operated by its biggest domestic competitor. We understand the rationale for M&A for both parties, but we also think MGM is more incentivized to get this done given a path to work down its MGP position.
MGM’s tax situation is complicated, but we think MGM should receive a small near-term benefit to cash flow from tax reform (~$225M in 2018 by our math) that isn’t well understood. Previously before tax reform management had been targeting a ~17.5% cash tax rate, despite producing 84% of its LTM EBITDA in the U.S. Very simplistically 84% of income at a 35% tax rate would imply a cash tax rate of 29%, but it’s target was ~17.5% because MGM has been able to reduce its cash taxes through ODLs. We think these ODLs were previously set to run out by YE2020. With tax reform MGM can accelerate these ODLs, and we see them possibly running out in 2019.
Earlier this morning (1/2/18), Mike Kiernan, Wolfe’s Director of Research, sent around the Wolverine update for the firm’s top fundamental picks for the next 6-12 months (see his email below). Always a believer in marrying the fundamentals with the technicals, I thought it would be helpful to provide the charts for each. While a few have some work to do, there are plenty of constructive setups on both the long and short side.
On Monday (1/1/18) early AM DICJ released December Macau GGR which showed a 14.6% y/y increase, below consensus of we think around 22% and our 20% estimate. The monthly data can be very volatile, and October and November were unusually strong perhaps borrowing some from December, so we won’t place too much judgement on one monthly data point. However, we do expect Macau GGR to continue to decelerate throughout 2018 while possibly missing expectations. Two weeks ago we published a note flagging some cautious signs on Macau GGR with 8 of 16 forward indicators we track seemingly inflecting downward. Today we’re lowering our 4Q17 estimates by about 2% for our names with Macau exposure, as the quarter missed our expectations.
Upon exiting bankruptcy last October we believe this is a great turnaround story with low hanging fruit to drive continued earnings improvement.
We upgraded H and the entire lodging space in late December after the tax reform bill passed the House and Senate. We think H’s stock is the cheapest in the group, especially after factoring in tax related savings. Meanwhile, industry data has also been improving, and we think tax reform could lead to further accelerating RevPAR growth and H has more operating leverage to the cycle.
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