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Financial Risk Management Case Study

MSC Finance (Year 2020)

Name : Kalpita Adesh Somwanshi (18_MF_29)

Roll no: 18-MF-29

Question 1) Is the merged company’s business position weaker or stronger than the position of the
individual companies?

▪ The merged company’s business position becomes weaker than the position of the individual
companies in case there are no immediate measures to address the weaknesses.

▪ The room capacity of the Vegas strip is almost full and any further addition is not expected,
which might increase the pricing power when it comes to rooms for hotels and resorts.
▪ As the two companies merge, they will highly benefit from economies of scale, which is
reflected in increase in EBIDTA margin of the merged entity. But in this case, although
post-merger EBIDTA Margin is favorable (28%) , the post-merger EBIT is declining
considerably (22.88%). Which indicates that the company has high depreciation &
amortization costs which are fixed and company has invested aggressively in fixed assets.
▪ The mirage resorts debt is too high i.e. 4.6 bn hence the interest expense would be too high ie
more than 40% which is another matter of concern. The merger would represent growth for
both companies involved in the transaction. Moreover, it will mean more financial power as
the revenue generated by pooling the incomes of both businesses. As a chain reaction, having
a greater financial power will also mean occupying a larger share of the market and having
more influence over the customers by reducing the competition.
▪ Company could liquidate a part of assets to service the loans but that would again make the
balance sheet weaker for further expansion. The merged company will result in merging of
some of the largest casinos in Las Vegas under the same ownership. This will further yield in
cut costs and domination of the high-end gambling business with resorts favored by
international big spending customer base. The sooner the merger takes place, the better would
be the merged company’s earning position. The merged company will be able to reduce its
operating expenses by eliminating duplication of functions, and by offering smaller rebates to
high end customers.
▪ Since the company at beginning would have high geographical concentration, It would require
a lot of additional capex for benefiting from penetrating a new market gaining new
geographical area or a specific niche in the industry, It would mutually benefit from each
other’s real estate acquirements and already existing developments. One of the most important
advantages offered in this merger is related to a wider range of services or products which can
be explored.
▪ High degree of competiton in more mature markets. Both the companies has higher
contribution to EBIDTA from the Las vegas Strip i.e. 87% for Mirage and 66 % for MGM,
merged entity will have approximately 76.5% contribution from the Las vegas Strip which is
the bellwether and extremely significant market for the industry with high revenue generating
abilities as it is the primary destination for tourists and convention goers.
▪ Demand on the strip has historically been driven by new supply and capacity additions.
Additional capacity always gets easily absorbed. But this holds true as long as volumes are
good & potential credit losses can be managed due to volatile nature of the earnings which are
primarily generated because of “whales”.
▪ The total debt on MGM’s balance sheet is around $199 bn and Interest cost around $78 bn,
which results in extremely high interest cost of 39%. Which is deepely concerning. In addition,
MGM G plans to acquire Mirage R by taking on banl loan worth $4.3 bn and assuming debt
worth $2 bn of Mirage R. Which further results in extremely high interest cost.

The long term outlook for Las Vegas & the casino gaming industry in general is favorable
To become one of the world’s largest casino companies
built-in mathematical advantage : Higher volumes results in more money on operating basis
There is little in the way of inventory or receivables
very good demand characteristics
Strong cash flow business
location advantage in long term outlook, strong cash flows
1.Aquisitions financed with debt
2. Higher Interest expense payments due to Mirage resorts
3. high capex to achieve any operational or scale benefits or for expansion
4. Geographical concentration
5. High volatility in earnings
The total revenue of the casino industry stands at $22 bn is set to grow given the favorable demand
side conditions. Geographically Las Vegas and Atlantic City account for $5.7bn (25%) and $4.2 bn
(19%) respectively.

1.Aquisitions financed with debt
1. Highly volatile business hence
high earining potential 2. higher Interest expense
payments due to Mirage resorts
2. location advantage in long term
outlook, strong cash flows 3. high capex to achieve any
operational or scale benefits or for
3. 500mn non startegic assets
4. Geographical concentration
Opportunities Threats
1. Increased Economies of scale 1. Peers with better valutation and
liquidity will be able to progress at
2. Geographical expansion and faster speed
diversity can be achieved
2. companies with lower rate of
3. Operational costs can be interest to pay will have higher
distributed and reduced. profitabilty

Question 2. What is the impact on the key financial credit measures?

Following values are calculated taking the average financial statics of the last 3 financial years:

Figures in $mn MGM Grand Mirage Resorts

EBITDA ( 439.3939394 559.77
Las Vegas Strip EBIDTA/
% of Total EBIDTA)
EBIT ( 214.76 380.52
Operating income as % of Cost
Sales* Sales) synergies
EBT (EBIT – Interest) 136.2967965 316.18 Expected :
Total Capital (EBIT/ 908.6453102 1976.116297 $80- $100
Pretax Return on Capital) Mn
Total Debt ( 199.9019683 691.6407039
Total Debt to Capital/
Interest ( 78.46320346 64.34
Total Equity ( 708.743342 1284.475593
Total Capital – Total Debt)
Total Assets 1334 2441
D&A (EBIDTA – EBIT) 224.6339394 179.2501149
Free Operating Cash Flows ( 45.9774527 -262.8234675
Free Operating Cash Flows
to Total Debt* Total debt)
Forecast MGM Grand Mirage Post-Merger
Inc Resorts
Sales 2391 1460 3851
EBIDTA 561 440 1081 (Including cost synergy of
$80 Mn)
EBIDTA Margin 23.46 30.14 28%
Combined Market Share 51.48%

In $mn Post-Merger value

Debt 5805.60
Equity 1908.74
Capital 7908.65
Interest (Assumed 12%) 719.99
EBIT 881.00
EBT 161.01
Debt / EBIDTA 5.55
Debt / Capital 75.87%
Interest Coverage Ratio 1.50
Debt/Equity 3.14
Free Operating Cash Flows/Total Debt NA
Pretax Return on Capital 2.04%
Operating income as % of Sales 22.9%

The above post-merger values are arrived at by taking into account following calculations &
Debt : Total debt of MGM grand + $2 bn debt assumed by MGM Grand + $4.3 bn Bank Loan -
$500 mn proceeds from sale of non-strategic assets
Equity : Total Equity of MGM Grand + $1.2 bn new equity
Interest : Assumed 12% similar to other BBB- firm's Interest cost
EBIT : EBIDTA calculated in the previous table – Depreciation & amortization of $200 mn

Analysis the above data we can derive that the leverage and profitability ratios have deteriorated
post-merger. The cost synergies of $80- $100 mn are negligible when compared to the high amount
debt that the merged entity will have.( 75.87 % of the total capital)

3. Should the bank reduce its exposure to MGM Mirage?

Indeed, the bank ought to lessen it's introduction to MGM Mirage

The FICO appraisal of MGM extraordinary is currently BBB-with a negative perspective. Post the
merger the commitment is depended upon to increase inside and out as noted beforehand.
In spite of the way that the FICO evaluation of Mirage is BBB with an inspiring perspective, it has a
negative Free Operating Cash Flows to Total Debt extent which could be a sign of alarm. Besides,
The Share cost of Mirage had fallen 47% in the earlier year in view of powerlessness to achieve
expected return by its most exceptional betting clubs regardless, when the market is acceptable and
additional limits are ingested with no issue.
Considering all the above concentrations and credit assessment and being the fundamental
advancing association to both the substances, the bank needs to step with alert before considering
growing its introduction to MGM Mirage.
Question 4. Questions for the executive management teams of both the entities:

1. What caused the failure to achieve expected returns by Mirage’s newest casions; especially
by Bellagio in Las Vegas, where every additional capacity is easily absorbed?

2. When and how are the above units expected to meet expected returns?

3. How does the company plan to fund the additional acquisition of assets i.e. land on Las
Vegas strip from Mirage?

4. How do the companies see the competitive landscape changing after the merger particularly
given the high degree of geographical concentration?

5. What are the expansion plans of the MGM Mirage?