Here's Why MGM is a High-Profit Play on China

By William Patalon III, MBA
Managing Editor
Money Morning & The Money Map Report

When it comes to MGM Mirage (MGM), to borrow a phrase from an old rock-n-roll hit, "you ain't seen nothing yet."

That seems to be the general consensus on Wall Street, where investors and analysts alike are salivating over the efforts of the state of Dubai to acquire a 9.5% stake in the vaunted casino-and-hotel operator. MGM's shares surged to a new 52-week high for the second straight day yesterday (Wednesday) after one analyst boosted his price target to $118 a share and another said that Dubai is going to have to pony up more money to shareholders if it wants to close the deal.

On Tuesday, MGM shares surged $1.36 each, or 1.59%, to close at $86.72 - and established a fresh 52-week high of $89 during the trading session. Then yesterday (Wednesday), MGM's shares established another new high, trading up to $90.38. For the day, the company's stock rocketed $3.61 a share, or 4.1%, to close at $90.33.

Helping ignite that move was a report by Jeffries & Co. analyst Lawrence A. Klatzkin, who boosted his earnings forecasts for both 2007 and 2008, and boosted his target price for the stock from his prior estimate of $115 a share to a new target of $118 a share.

From yesterday's close, hitting that target would require an upward move of $27.67 a share, for a hefty gain of 31%.

A nice gain, to be sure. But Money Morning Contributing Editor Keith Fitz-Gerald, a longtime expert on Asia - and especially on China and Japan - sees a much-bigger payday ahead for MGM investors who understand the "real game" that's being played here.

And for investors who fear they've missed out, Fitz-Gerald says not to worry: That "real" game hasn't really even started, yet.

"I first started following MGM more than a decade ago, when this story really began," Fitz-Gerald said in an interview yesterday. "People might wonder why I'd recommend a stock that's trading at a 52-week high. That's because this game hasn't even started yet. This stock is going to be another Google (GOOG) once MGM gets fully situated in China - and Dubai knows it."

On the Move

Until the big stock-price surge of the past several days, MGM's shares had previously traded in a 52-week range of $38.14 to $88.69.

The shares were mobilized Tuesday by a client note from J.P. Morgan Securities Inc. analyst Harry Curtis, who said that suitor Dubai World would mostly likely have to raise its tender offer in the next two weeks, The Associated Press reported. The reason: Only about 730,000 shares had been tendered - far short of what Dubai was seeking.

Indeed, earlier Tuesday, Infinity World Investments LLC, a subsidiary of holding company Dubai World, said it was extending its cash tender offer for MGM's stock until Oct. 5. Infinity is offering to buy up to 14.2 million MGM Mirage shares for $84 each. MGM has about 284.3 million shares outstanding.

Between the tender offer and an additional existing agreement to buy an additional 14.2 million newly issued MGM shares at the same price, Dubai World would end up with an approximate 9.5% percent stake in the Las Vegas-based casino operator. Curtis, the JP Morgan analyst, said that he anticipates that Dubai World will look to increase its equity stake to 20% once MGM has issued the additional stock and Dubai World has completed the tender offer and received the necessary regulatory approvals. For that reason, Curtis maintained an "Overweight" rating.

Then yesterday, Klatzkin, the Jeffries & Co. analyst, further fueled the share-price gains by boosting his MGM earnings forecasts and share-price target.

But here at Money Morning, we believe the potential long-term gains are even greater than most analysts are projecting - and for one key reason.

And that reason is China.

The MGM-Dubai ‘China Connection'

We agree that Dubai will seek to boost its stake in MGM. Fitz-Gerald, the contributing editor, is a longtime expert on Asia - and especially China and Japan, where he lives for part of the year. And he says that MGM has been pursuing a China strategy since 1994, estimating the company has invested more than $1 billion on Macau alone.

Macau - like Hong Kong, a so-called "Special Administrative Region," or SAR - is a resort area situated just off of China's southern coast. That Macau region alone has been the focus of some stunning development. Late last month, the Las Vegas Sands Corp. (LVS) opened the doors on its $2.4 billion Venetian hotel and casino project, one of several that have already opened - or that will be opening - on Macau's white-hot ‘Cotai Strip.'

[Currently, gambling is illegal in Mainland China; but it is legal in Macau, because of its designation as an SAR].

But, as Fitz-Gerald notes, MGM is set to develop several billion dollars worth of additional real estate projects in China and around the world through a joint venture with the Diaoyutai State Guesthouse of Beijing. This long list of projects begins with a series of non-gaming-oriented hotels in second-tier Chinese cities, where branding is in its infancy - enabling MGM to deploy one of its typically well-crafted marketing campaigns (customized for China's culture, and for its emerging consumer constituency).

That strategy has an excellent chance of success, according to Professor Eugene Fram, a marketing expert who has made studies of brand-awareness involving middle-class consumers in the China market.

And what he found was this: China has a fast-growing middle class that - while currently unfamiliar with such global brands as MGM - has traditionally displayed a high-degree of strong brand loyalty, once they become aware of the brands they have to chose from.

"This is a great market for brand loyalty," said Prof. Fram, the J. Warren McClure Marketing Research Professor at the Rochester Institute of Technology College of Business. "Case studies such as Nike bear this out. MGM is evidently very brand-aware itself. And the company understands that, as incomes rise, a lot more people are going to be able to financially afford taking vacations, even taking family vacations. This opens up opportunities for many things."

China isn't MGM's only target-market overseas. It's also working with the Mubudala Development Corp., in both Dubai and Abu Dhabi, on some similar luxury-level (non-gaming) projects, according to Fitz-Gerald. And that's where the loop on his "MGM-China" connection strategy really closes, because of all this expansion - coupled with its existing U.S. properties - will make MGM a truly global brand, Fitz-Gerald and Prof. Fram both say.

The Strategy Comes Together

By making this purchase, Dubai is doing more than just "buying" a substantial chunk of MGM's future cash flow, Fitz-Gerald says. More importantly, Dubai has also guaranteed itself a big stake in the future development of China's nascent-but-promising vacation-and-travel market.

By going into second-tier cities, which lack these amenities, MGM will build leisure-time destinations that have little in the way of competition. Also, congestion in those cities is markedly less than in the big coastal or capital cities, meaning a traveler can really "get away" from the buzz and bustle of China's fast-growing and vastly overcrowded key cities, and relax - an especially attractive proposition for a family foray.

Rising wages make that possible for China's consumers. And a growing middle class makes it potentially profitable for ventures such as the destination hotels MGM hopes to build on the Mainland, experts say.
Indeed, according to one recent study, Chinese travelers have now eclipsed Americans and Europeans in their spending habits. They are spending an average of $900 a day while on a journey. Their counterparts in Europe and the United States are spending only $400 a day - and are cutting back.

Fitz-Gerald gets noticeably excited when he starts talking about the time in the not-too-distant future when MGM launches the very first "real" marketing campaigns to "tell the MGM story," and to stoke consumer interest. For Dubai, he says, this is like getting a second chance to invest in the U.S. consumer market - at mid-1800s prices.

And that's how U.S. investors must view the opportunity to own MGM shares, too, Fitz-Gerald says.
"Dubai is getting in on the ground floor of some very powerful trends," he said recently. "It's a classic Asian business strategy and one that reflects a very sophisticated understanding of how Asian consumers think and act when it comes to their money …

"At its most basic level, Dubai is hoping to grab a share of the ever-increasing power of the Chinese consumer at a time when China's consumers have not yet formed opinions about branding or luxury travel experiences. Given that Asian consumers in general - and Chinese consumers in particular - tend to be much more highly brand savvy than their European and American counterparts, this is an especially important strategy to execute at the present time."

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.

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