Considering CityCenter

by Nick Christenson
November 5, 2009

As we're approaching the phased opening of MGM Mirage's behemoth CityCenter project, it's worth revisiting how we got here, and what this milestone means for MGM Mirage, Las Vegas, and the gambling industry as a whole.

The first of the CityCenter hotels, Vdara, will open on December 1, followed by the Crystals, which includes the bulk of the retail space and entertainment venues, on December 3. The Mandarin Oriental, a 400 room non-gaming hotel, will open on December 4. The largest of the CityCenter hotels, Aria, is scheduled to open on December 16. We don't have an opening scheduled for The Harmon, another non-gaming hotel, but "late 2010" is what we're hearing. MGM Mirage doesn't seem to be in a huge hurry to open it up, especially considering that this piece of the property is primarily (unsold) condominiums.

It has been well documented that CityCenter represents the most expensive single construction project in human history with a price tag well over eight billion dollars. Some experts believe that when all is said and done the final tally will exceed $11 billion. When construction began in the summer of 2006, the project was greeted with universal acclaim. CityCenter was lauded as the logical next step for Las Vegas. Even as construction costs doubled from the initially projected $4 billion, the business community lined up to throw their money at the project.

It's easy to say now with the benefit of hindsight that this was a mistake, that Las Vegas and gaming were "obviously" overextended, and that CityCenter was "doomed" from the start. I don't recall seeing any articles saying this in 2006 or the first half of 2007, and I sure didn't see a significant amount of short interest in the stock before the collapse in value, so I'm not all that inclined to listen to the "I told you so" crowd who was conspicuously quiet during the upswing.

Moreover, given the amount of money flowing like a tidal wave down Las Vegas Boulevard from 2004 to early 2007, MGM Mirage management would have been crucified if they had told shareholders that the prudent thing to do was to stand pat rather than pursue a "risky" expansion strategy.

None were more anxious to "build, baby, build" than the folks at Dubai World, who bought in to CityCenter at just about the peak of the project's valuation. During the run-up to the financial melt-down, Dubai World seems to have been drawn to exciting, but overpriced projects much the same way that a magpie is drawn to shiny objects. The basics of business say to "buy low", but Dubai World's philosophy seems to be "buy whatever is hot at the time, and to heck with the price". This plan of action has led to what some believe is in excess of $22 billion in debt for this company [2].

Just as timing is the legendary secret to comedy, it is equally the secret to financial success. Boyd Gaming dodged a bullet by starting Echelon after CityCenter. For their massive construction project on the other end of the Strip the way out was much easier (and cheaper) than the way forward, which led to the moth-balling of a steel lattice-work, rising over the city like the dessicated skeleton of a long-dead dinosaur. CityCenter didn't have that option. By the time the extent of the financial crisis became apparent, MGM Mirage was too far along (and had accumulated too much debt) to do anything but complete the project and hope for the best.

Then, last March, their partner, Dubai World, sues MGM Mirage for breach of contract, claiming mismanagement and that MGM Mirage can't possibly finish the project [3]. Further, as a form of self-fulfilling prophecy, they elect to withhold their share of the payments that were due. Basically, it turned out that they made a bad investment, and once this became crystal clear to everyone, they wanted to get out of it.

I'm not the only person to suggest this, but it seems likely to me that at the time the lawsuit was filed, Dubai World was very likely in such bad financial shape that they couldn't make their scheduled payment. So, they had a choice, either default themselves and get sued, or preemptively sue their partners and force them to come to the bargaining table on their own terms. It may not be polite, but it's absolutely sound business. From their own perspective, I doubt they had any choice but to do what they did.

As it turned out, due to some intense negotiations between MGM Mirage, Dubai World, and the project's creditors, along with some significant cajoling by just about every Nevada politician with any influence, a deal was struck completing the financing and allowing the project to go forward. It's rare these days that I believe that a public company's chief executive truly deserves as much money as he makes in a given year. For 2009, MGM Mirage's Jim Murren probably comes awfully close. Arguably, it was his maneuvering, along with a lot of very long weeks by his team at the top of the management food chain, that prevented Armageddon for this project.

Of course, just because CityCenter will open, that doesn't mean that it will be smooth sailing going forward. Once revenue starts coming in, creditors will expect the property to start paying off the debt incurred in its construction. The only problem will be that it's doubtful that in this economy the CityCenter components will earn anything near their initial projections. It's entirely possible, perhaps probable, that including the debt, MGM Mirage will not be generating positive cash flow on these properties until the economy turns around.

CityCenter will attract many of the top players at the Bellagio. The Bellagio will likely fill those rooms with the sorts of players who regularly frequent Mandalay Bay. Mirage-type customers will fill that void and on down the list until we get to Circus Circus, who may elect to fill their rooms with current residents of the Washington Avenue freeway underpass, many of them victims of the same financial crisis that created this situation in the first place. CityCenter will get some net adds early on, as those who can still afford a high-end vacation in Las Vegas will make a special trip to see what the next new thing is. While it will still increase MGM Mirage's bottom line after that, everyone expects that net add to the company's (and Clark County's) revenues will be significantly less than the gross receipts of the CityCenter properties.

MGM Mirage management knows all this, of course. They know that the opening of CityCenter isn't the end of their cash flow issues, it's just the next check box on their list of obstacles to overcome. After opening it's likely that their next hurdle will be to deal with long time majority owner Kirk Kerkorian selling out his stake, which would be no simple task in an up market. After that comes making the CityCenter debt payments. Their financial issues would be eased considerably if they could sell off a non-core asset or two in order to raise some cash.

Probably the best case scenario for MGM Mirage along these lines is for Boyd Gaming to be rejected in their bid for part of Station Casino's holdings as Station winds its way through Chapter 11. Boyd would still be sitting on top of cash and $2 billion in credit that was ostensibly, but not contractually, slated for use on the now moth-balled Echelon project. It would make sense for both companies if Boyd were to use some of that money to purchase MGM Mirage's stake in their joint Atlantic City project, Borgata. If someone wanted to buy up New York-New York, Excalibur, Luxor, or Circus Circus, I'm sure management would be borderline ecstatic to take that meeting as well.

If the recession is short and Las Vegas returns to its 90s and early to mid-00s ways, then MGM Mirage will likely be able to weather this storm. Suppose, however, that the recession turns out to be more protracted than this, or we have the dreaded double-dip recession. In that case, even with the sale of some assets, a worse-than-expected City Center performance might lead to a serious cash crunch, one that could conceivably require some sort of restructuring.

MGM Mirage's path forward is precarious, and the opening of City Center is just the next checkpoint on their way out of the mine field in which they find themselves. The good news is that so far, management seems to be up to the task. Remember, though, paraphrasing that old investing chestnut, there's always the risk that the economy can stay lousy longer than you can remain solvent. So far, though, MGM Mirage seems to be making the right moves, and that's all anyone can expect.

References:

• [1] Green, S., "MGM Mirage loses $750M as CityCenter's value drops", Las Vegas Sun, November 5, 2009.
• [2] Kerr, S., "Dubai World debt pile decision looms", Financial Times, October 6, 2009.
• [3] Stutz, H., "Despite lawsuit, MGM Mirage plans to finish CityCenter", Las Vegas Review-Journal, March 24, 2009.