MGM Resorts (MGM) reported decent results for 2Q18 albeit against expectations that were lowered just 90 days ago.  When management lowered guidance dramatically for the rest of 2018, investors were very disappointed, sending the shares down 10% over a two day period.  The only real good news here is that by almost any measure the guidance appears conservative such that a weaker than expected 2018 on the Las Vegas Strip is now fully reflected in the numbers.

Northlake has been bullish on Las Vegas for several years given solid economic growth and consumer spending, low unemployment, and a slight uptick in wage growth.  This backdrop is usually good for Las Vegas visitation from leisure travelers along with a strong convention calendar from businesses.  It is now fair to reassess a bullish Las Vegas outlook especially against new casino and hotel openings scheduled for 2020 and 2021 that will add supply to the market.  MGM management along with the other major operator on the Strip, Caesar’s Entertainment, noted that the convention and event calendar is unusually light in 3Q18 versus last year.  One fewer prize fight, less concerts, and a normal summer lull in conventions that was not evident in 2017 make an argument for not reading too much into the 2018 shortfall.  Furthermore, the set up for a return to growth in 4Q18 is strong, especially for MGM, as it (1) laps the 10.1.17 shooting at its large Mandalay Bay property, and (2) finishes construction on the renovation of the Monte Carlo to Park MGM.  Caesars forecast a return to double digit growth in 4Q18, while the implied growth in MGM’s 2H18 forecast for 4Q18 seems to be around flat.

The investment theses is the near-term for MGM now revolves around the idea that the company has lowered the bar to a level that de-risks the outlook right as the company gets easier comparisons in Las Vegas, wraps up large capital expenditures in Las Vegas, Springfield, MA, and Macau.  Free cash flow is poised to surge and after the shares have pulled back over 20% from 2018 highs, the stock is trading at a historically inexpensive multiple of operating and free cash flow.

Finally, after a series of missteps, we believe that MGM is vulnerable to an activist investor.  One firm recently filed on MGM indicating it had moved its ownership position over 5%.  We see quite a bit of asset value at MGM including the real estate at its premier Bellagio and MGM Grand Las Vegas properties.  MGM also has a complex corporate structure with majority ownership of its publicly traded subsidiary in Macau and its REIT in the U.S.  There is value to be had in a breakup scenario and with sports betting and Japanese casinos as a catalyst, MGM has a theoretical growth profile and asset value that could attract an activist investor.

The bottom line is MGM has probably kitchen-sinked its outlook right as its free cash flow is about to inflect positively.  This should provide support for the shares as we await a resumption of growth or decisive action to realize value from either current management or an outsider.  We see MGM shares worth at least mid-$30s, lower than our prior hopes for 2018 but still offering enough upside to warrant holding.

MGM is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  MGM is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.