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 Winter 2020, Issue 5
Promontory Investment Research
http://www.promontoryir.com

Nvidia (NASDAQ: NVDA)

Nvidia Corporation| NASDAQ: NVDA Investment Overview
Negative Neutral Positive
We are recommending a BUY rating for Nvidia Corporation. We believe that Nvidia has strong potential to
Share price, 3-07-2020: $266.04
dominate in their main pursuits and enjoy increased profit, significantly increasing company value. With a
Market capitalization: $164,388,000,000 history of success in the gaming GPU industry, Nvidia is poised to continue to seize upon the growing gaming
Shares outstanding: 618m market through their high cash holdings and high-equity capital structure that allows them to invest more in
52-week range: $132.60 / $316.32 the industry, and their pioneering in the newest trends in the industry. Nvidia also has great ability to grow in
EPS (FY19): $4.59 the datacenter GPU industry, with explosive growth, brand advantages, and a strategic acquisition. Lastly,
Beta 1.787 Nvidia is diversifying their revenue streams by investing in rapidly growing industries including augmented and
Average analyst opinion: $320.00 virtual rerality, autonomous vehicles, and conversational AI. They show potential to dominate in these fields
Price target: $302.17 because of an ambitious approach, significant R&D spending, and a reputation for reliability.

Price Chart Company and Industry Overview

Company History
Nvidia was founded in 1993 in Santa Clara, California as a technology company specializing in graphics
processing units (GPUs). Through continued innovation, Nvidia has become a giant in the semiconductor and
general tech industries with a market cap of around $180 billion. Between fiscal years 2016 and 2018, Nvidia
increased their annual revenue by over 150% through the gaming industry and bitcoin mining, outpacing the
broader semiconductor industry’s revenue growth of 105% in the same period. Although the majority of their
sales still come from GPU products, Nvidia is actively growing its data center and AI products to capitalize on
the growing cloud computing and AI industries.

Business Lines
Financial Highlights Nvidia products are primarily geared towards markets in video gaming, professional visualization, data centers,
and auto markets. The company can be split into two reportable segments: GPU and Tegra Processor. The GPU
(Dollars in segment includes the core profit generating GeForce series, which is primarily integrated with PCs and
2019 2020E 2021E
millions)
VR processors in order to serve gamers. Other GPU products include Tesla and DGX, which both utilize deep
Revenue 10,018 13,624.48 18,256.80
learning algorithms to aid data scientists, Quadro, which is geared towards professional graphics content
% Growth -14.5% 36% 34%
designers, and Grid, which is utilized for cloud-based computing.
EBIT 2,150 4,768.57 6,024.75 Nvidia’s other segment, Tegra, makes up only slightly over 1/9th of the company’s sales. This particular product
-
line combines both a GPU and a computer processing unit (CPU) in order to support online gaming, artificial
ROIC 15.4% 23% 25% intelligence, and autonomous vehicles. Though it currently pales in comparison to Nvidia’s larger GPU segment,
Tegra may become a key business line amidst the rapid growth of the markets it aims to serve.
EPS $4.59 $7.00 $8.25
Competitive Landscape
Nvidia’s competitors include AMD, Intel, Xilinx, Broadcom, Texas Instruments, with AMD and to a lesser extent
Research Analysts Intel being the most important and direct competitors. These products compete on performance (speed and
consistency of graphics), pricing, and software integration. In general, Nvidia is known for its high-end GPUs,
Sparsh Jain| sparsh@uchicago.edu
AMD for affordable GPUs, and Intel for their integrated graphics on lower end laptops and desktop PCs.
Anthony Khaiat | akhaiat@uchicago.edu However, AMD has recently emerged as a serious challenger to Nvidia in GPUs through their much anticipated
Big-Navi and Radeon GPUs that offer comparable performance at often much lower price points.
Elif Koç| elifkoc@uchicago.edu
The market for GPUs relies on the demand for better 3D graphics and the scale of the gaming market. Gaming
Ben Sarasin| btsarasin@uchicago.edu revenue rose 13% driven by the growth in gaming GPUs, and the total revenue for the semiconductor and
circuit manufacturing industry was $53.8 billion in 2019 with an annual growth rate of 1.2% between the years
David Si | davidsi@uchicago.edu
2014 and 2019. Projected annual growth for the next 5 years is 1.1%.

© Promontory Investment Research 2020

1
A student-run publication at the University of Chicago
Value Drivers
Nvidia products compete with and beat out competitors through their superior quality supported by consistently innovative R&D. Nvidia is uncontested in the top-
end GPU market segment. AMD’s most expensive, highest-tier GPU is the Radeon Rx 5700 priced at $400. Nvidia’s consumer grade GeForce products top off with
the GeForce RTX 2080 Ti at $1200. Nvidia’s professional oriented Quadro product lineup has the Quadro RTX 6000 priced at $4000. For consumers that demand the
highest gaming performance or 3D graphical fidelity for professional E-Sports, cinema, VR, or data applications, Nvidia remains uncontested.

Investment Thesis
Domiant Hold in the Gaming Market
For much of Nvidia’s existence, the company has been primarily oriented around its GPU segment, with the gaming market drawing most of their GPU demand. This
profit driver has also seen considerable growth recently, as gaming revenue was $1.49 billion in the fourth quarter, up 56% year-on-year. Moreover, Nvidia has
dominated the broader GPU market historically, consistently holding above 50% of market share, and has been growing market share, holding 72.92% after Q3.

Nvidia has an opportunity to enjoy significantly increased revenue and profit from the gaming industry contingent on two requirements: the gaming market
continues to grow, and Nvidia can retain much of their market share. As for this first requirement, the gaming and broader GPU markets are projected to expand
explosively in coming years. Driven by growing markets of tablets and PC gaming, the GPU market is expected to grow at a CAGR of around 30% in the next five
years. The gaming market is expected to grow at a substantial clip of around 11% CAGR to around $286 billion in revenue by 2025. Within the gaming market, the
rise of the esports industry, which demands high performance GPUs to meet its competitiveness, has been demonstrated through a flux of venture capital and
private equity activity along with substantial revenue growth.

For the second requirement, Nvidia has several competitive advantages that will allow them to retain or grow their market share as a provider of gaming GPUs.
Before these competitive advantages, a sign of Nvidia’s prospects at market dominance is its current out-performance of its competitors. In comparing recent
gaming GPUs, using Nvidia’s RTX 2080 Super and AMD Radeon VII for our examples, Nvidia has a clear edge over AMD. The RTX 2080 Super, though priced above
the Radeon VII at around $730 compared to about $700, had much higher memory speed, with 15.5 Gbps compared to 4 Gbps, and greater megahertz per second
on both base clock and boost clock. Greater performance is manifested in a wide variety of games, as the RTX 2080 Super delivers higher frames per second on
games including Fortnite, Battlefield V, and Rainbow Six Siege.

When it comes to securing their market share for the future, the first advantage that Nvidia enjoys is that the high-end GPU industry is heavily characterized by high
capital requirements, so Nvidia is relatively insulated from new, smaller entrants crowding out its margins. Second, compared to their main competitor in the gaming
GPU market, Nvidia enjoys significant advantages in cash availability and capital structure that will allow them to dedicate more resources to research and to make
strategic acquisitions, which are incredibly important in creating innovation needed to stay ahead in high-end GPUSs. At the end of Q3, Nvidia had 9.765 Billion Cash
on hand, compared to 1.156 billion cash for AMD. Similarly, Nvidia holds an impressive current ratio of 8.42, compared to AMD’s current ratio of 2.099. Nvidia has
an ability to take on much more debt and has greater access to credit because of a superior debt to equity ratio of .41 compared to AMD’s debt to equity ratio of
1.414. Even further, Nvidia has shown an ability to efficiently allocate capital and enjoy sizeable returns useful for greater reinvestment with a ROIC of 15.432% in
2019, as compared to AMD’s 2019 ROIC of 9.954%.

Lastly, Nvidia distinguishes itself from competitors by displaying ambition in pursuing the newest trends in high-end gaming, acting as an early and aggressive mover
on new markets. Nvidia has emerged as an industry leader in ray-tracing technology, which is designed to produce incredibly realistic lighting effects, with the
release of their Turing micro-architecture in their RTX 2000 cards in 2018. Nvidia currently has the only cards capable of ray-tracing in consumer hardware, and
demand has been growing rapidly, with several major games recently supporting Nvidia’s ray tracing, including Battlefield V, Call of Duty: Modern Warfare, and
Minecraft. Additionally, Nvidia has been a leader in cloud-based gaming with their service GeForce Now, competing with Alphabet’s Stadia. Because of greater
platform compatibility and significant price discounts, including a free tier, Nvidia has significant advantages over Stadia in amassing a customer base. Additionally,
with a first-mover advantage in amassing a library of games and the network effects going along with this that will bolster growth, as well as a collaboration with
Tencent that allows important engagement with China’s large gaming market, Nvidia is sure to excel in this expansion.

Exhibit 1: Growth of ESports Industry

© Promontory Investment Research 2020

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A student-run publication at the University of Chicago
Strong Data Center Performance
Data Centers, one of NVIDIA’s four target markets, also shows potential for growth. In 2019, datacenter revenue was $2.93 billion, up 52% from a year ago, and
253% from 2017. All in all, it contributes 25% of NVIDIA’s revenue, the second largest source of revenue after gaming. The source of this growth relies on the
growing number of applications of artificial intelligence and high performance computing (HPC). As more and more organisations (public and private) are shifting
toward cloud, the demand for datacenters is increasing from customers who rely on GPU-accelerated deep learning for processing large data sets. NVIDIA’s CFO,
Colette Kress, announced the total addressable market to reach $50 billion by 2023, with $10 billion coming from high performance computing, $20 billion from
hyperscale & consumer internet, and $20 billion from cloud computing and industries.

There are three reasons that NVIDIA is likely to capture this growing market. First, NVIDIA is ahead of its competitors. NVIDIA has a first-mover advantage as they
were a key part of the tech industry's realisation that the computational elements in GPUs used to process pixels could be used for crude scientific calculations on
a mass scale. Thus, as early as 2006 NVIDIA began incorporating HPC-related functionality to its GPUs. Their first major move into data centers was 2007’s CUDA
platform, which became key to the machine learning world. Since then, NVIDIA has capitalised on this near-monopoly on high end GPUs, evidenced by strong sales
of their Volta architecture-based products, including NVIDIA Tesla V100 and DGX systems. Current competition is limited, with notable substitutes including
Google’s Tensor Processing Unit 3 which is still behind NVIDIA’s Tensor Core GPU. While competition may increase in the future, NVIDIA has a strong place in the
market in the present.

An Eye to the Future

Second, given the overlap between GPU architecture needed for both gaming and data centers, NVIDIA’s excellent reputation and brand recognition (particularly
In recent years, Nvidia has made a concerted effort to diversify their revenue streams, and have designed GPUs with an eye to the future, specifically in the fields
with experts) in gaming should mean that as competitors roll out datacenter-related products, consumers are more likely to go to NVIDIA who already has a proven
of autonomous vehicles, conversational AI, and augmented and virtual reality. These movements are conducive to long-term success because they reduce Nvidia’s
track record in this area.
volatility to individual markets by giving them a broader base and diversified revenue streams. Second, and more importantly, Nvidia is pursuing markets which
have tremendous room for growth, and they are poised to enjoy great success within these markets.
Third, NVIDIA has shown that they are clearly acknowledging this trend. CEO Jensen Huang proclaimed that “NVIDIA is a data center company” focused on the “big
problems of data center scale computing” and “delivering an accelerated computing platform.” This is evidenced by NVIDIA’s $6.9 billion dollar purchase of
One field in which Nvidia has excelled is conversational AI. Through Nvidia’s TensorRT 7 software development kit, the company has developed massive AI language
Mellanox, an Israeli-American supplier of computer networking products used in HPC, data centers and cloud computing. This is NVIDIA’s largest acquisition and
models with special emphasis on running a quick inference and response time of milliseconds, offering solutions to unnatural lag, as well as utilizing machine
shows that they intent on making data centers a prominent revenue stream.
learning to build neural networks and progressively improve speech. In the coming years, conversational AI is poised to have explosive growth in industries including
healthcare, financial services and retail. This flux of demand is substantiated by research showing that nearly 50% of internet searches will be conducted by
conversational AI during 2020, and there will be around 8 billion digital voice assistance in the US for home and business use by 2023.

Nvidia has also made inroads in the augmented and virtual reality sphere with their Nvidia CloudXR, which utilizes GPU technology and VR hardware and software
to allow portable AR and VR to any application. The growth of the AR and VR industry is projected to be massive, with estimated CAGR of 42% in the next five years,
disrupting educational, entertainment, and travel industries. The augmented and virtual reality industry is driven by complex and capable GPUs that have the ability
to handle intense graphic loads at FPS rates that do not induce motion sickness, while being small enough to remain portable. As an industry leader in capable
GPUs, Nvidia is well positioned to profit from this explosive business trend.

Lastly, Nvidia has been an early mover in the autonomous vehicles industry. The company has long been a leader in developing the raw computational power
needed to operate autonomous vehicles, and nearly all autonomous vehicle producers have acknowledged Nvidia’s platforms as a key part of their computing
stack. Additionally, Nvidia management has announced intent to dedicate more energy and resources to their AV segment, and this has been backed up by
incredible improvement in their latest AV software platform, AGX Orin, in which operation speed increased to nearly 7x its predecessor’s. Though AV revenue has
remained slow, Nvidia’s centrality to the industry and the industry’s expected growth as level 4 autonomous vehicles project to hit markets in the coming years
spell great success for this segment.

In all of these hot markets, Nvidia enjoys an important advantage over their competitors: brand recognition and reputation for quality. These markets are all highly
underdeveloped and entail a lot of risk, but also a lot of potential reward. Because of this, pioneering companies will be keen on implementing chips they know
they can trust in their early stages of production. Nvidia has established its brand as a long-time leader in GPUs with a reputation for continuously producing cutting-
edge products and leading its field in computing power and complexity. Nvidia’s prospects for success in these endeavors go beyond their powerful intangible
brand effects, though. Nvidia has expressed an interest in staying ahead of the curve in innovation, as they have been heavily involved in R&D compared to
competitors. Their R&D expenditures rose from $1.797 billion to $2.376 billion to $2.829 billion in the past three years, with year over year growth rates of 32%
and 19% respectively. At the end of this year, R&D expenditures amounted to nearly 26% of their revenue, much of which has been directed towards improving
software engineering and hardware engineering for GPUs, which is central to development in the fields mentioned above. Though GPU competitors still put a focus
on R&D--AMD spent $1.547 billion, 23% of their revenue, in 2019--they do not match up to Nvidia’s intense focus on continuous improvement.

Exhibit 2: Yearly R&D expenses as percentage of net revenue Exhibit 3: Business Lines by segment (mil)

© Promontory Investment Research 2020

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Investment Risks
Risks for the company include the potential loss in market share of Intel Semiconductors into the GPU market, the overall cyclicality of the industry is extremely
volatile as the beta is 1.7, reliant on favorable macroeconomic conditions to sustain growth, the heavy reliance on technological innovation, and the fact that
the company is mainly concentrated in the production and sale of GPUs outside of the United States.

Competition
For over a decade now, AMD has posed a significant challenge to Nvidia in the GPU market. Though Nvidia has largely widened the gap between their largest
competitor since the beginning of the decade--Nvidia had roughly 55% market share and AMD roughly 45% in 2010 Q2--they have faced significant threats to
their control of the market within the last couple years. In Q4 of 2018, Nvidia had dominant control of the GPU market with 81.42% market share, but in less
than a year has dropped to 72.92 market share.

Nvidia faces threats from a new competitor in the market, as Intel is planning on releasin their own discrete GPU called the Intel Xe GPU. Early engineering
samples have already been sent out, and the retail product is set to be sold during the summer of 2020. This GPU product covers a wide range of price points
ranging from entry level to exascale high performance computing. The hype and media coverage surrounding the product is substantial. Moreover, given
Intel’s existing available capital, massive R&D expenditures of over $10 billion, and expertise in making integrated GPUs with the addition of former AMD
architect Raja Koduri, their movement has great potential to shakeup the current duopoly between Nvidia and AMD. These developments are significant
threats for more than one reason.

Industry Cyclicality
The semiconductor industry is very sensitive to macroeconomic conditions. Nvidia has benefited from the economic prosperity of the Trump era and has seen
an increase its stock price for the last few years. Therefore, the success of Nvidia is closely tied to GDP growth. Nvidia, at the end of the day, sells luxury
products. Its products are used in gaming, professional visuals, data centers, and automobiles. These industries all could do without the latest GPU technologies
during times of economic downturn, as the typical money allocated towards upgrading GPUs every few years would be one of the first expenses to be cut. This
is supported by the fact that the current beta is 1.7.

Although Nvidia has made strategic decisions to expand its customer base and market presence by investing heavily in R&D, as shown by 19% increase in R&D
expenses, and acquiring various companies, it is still affected by the semiconductor industry’s dependence on innovation and novelty. Nvidia’s current
competitive advantage against rival companies can be potentially seen as an advantage; however, it is also important to note that Nvidia’s future will depend
on maintaining this in the long- run.

Market Characterized by Rapid Technological Innovation

Tech companies rise and fall in accordance with innovation, and the same could apply for Nvidia if they do not effectively keep up with innovative tech trends.
Recently, there has been a worrying trend that challenges the need for consumers and prosumers to go out and purchase their own discrete GPU. Due to
innovations in cloud computing, internet infrastructure, and streaming systems, there are now services that allow for gamers to play high quality, graphically
intense desktop PC games without having to purchase an expensive GPU as a part of a gaming PC. The prices fall over time as newer and better products are
introduced by semiconductor companies, and companies keep dropping their prices to compete. This may result in a significant decrease in Nvidia’s revenues
and subsequently result in losing its strong market position

One way to avoid this would be constantly innovating and delivering new products that can be sold for higher prices. The rise in the % of total revenue for data
centers has increased from 12% to 26% over the last 2 years, while the other sections such as gaming have been decreasing in % revenue, which shows a shift
in its strategy to gain market share. Therefore, this shift could pose additional risk to Nvidia since it drives away from Nividia’s fabless manufacturing strategy.

Reliance on GPU Segment and International Markets

Nvidia can not afford poor performance in its GPU segment, which makes up over 85% of its revenue. Even if their AI additions and consumer GPUs prove
lucrative, their heavy reliance on high-end GPU demand means that even a slip in performance could damage the company’s outlook. For the fiscal year 2020,
It’s important to note that 92% of the total revenue was from sales outside of the United States, which is a 5% increase since 2019. Revenue from China,
including Hong Kong, amounted to 25% this fiscal year, which leaves the company vulnerable to large currency fluctuations as well as trade disputes.

Another major concern is the new threat of coronavirus on the customer base and supply chain of Nvidia. The shutdown of manufacturing in commerce in
China will result in the 2020 fiscal year’s financial performance to be lower than its expectations at the end of the 2019 fiscal year. Additionally, its reliance on
China as one of its biggest sources of GPU and datacenter revenue could cause a drastic decrease in revenue growth. Neighboring countries of China such as
South Korea could see a decrease in the demand for Nvidia products.

© Promontory Investment Research 2020

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Valuation
Historicals:
Year: 2015 2016 2017 2018 2019
Revenue Growth: 11.80% 37.9% 40.6% 20.6% -14.49%
EBIT Margin: 18% 28% 33% 32.47% 21%
CapEx (% of rev): 2% 1% 6% 5% 5%
D&A (% of rev.) 4% 3% 2% 2% 4%
NWC 3,702 6,748 8,102 9,228 10,945
Changes in NWC -1,771 3,046 1,354 1,126 1,717
Change in NWC (% of rev): -35.35% 44% 14% 10% 17%
Base Case Assumptions
• Revenue and EBIT will remain relatively steady in growth, around 30%, over the next five years.
o Advances from new models
o Strong gaming performance
o Growth of gaming market
o Datacenter Surge from growing demand and Mellanox Acquisition
• As datacenter slows due to market maturity, strong growth will be buoyed by
o Solid gaming performance
o Emergence of Level 3 Autonomous Vehicles
o Maturation of conversational AI and augmented/virtual reality
• CapEx will rise initially and working capital will drop due to Mellanox acquisition
• Slightly muted growth this year due to Coronavirus effect

Base Assumptions
Terminal Growth Rate: 2.5% EV/EBITDA Exit Multiple: 18x Terminal Shares Outstanding (B): 6.18
Year: 2020 2021 2022 2023 2024
Revenue growth: 28% 32% 32% 33% 33%
EBIT Margin: 29% 32% 32% 32% 32%
CapEx (% of rev) 7% 3% 2% 5% 4%
D&A (% of rev) 5% 5% 3% 2% 5%
Changes in NWC (% of rev) -13% 7% 6% 5% 5%
Tax Rate 6% 6% 6% 6% 6%

Bear Case Assumptions

• Revenue growth will decrease to an average of 15%, and EBIT margins will decrease to 29%
o Coronavirus fears result in a decrease in demand and supply of datacenters and GPUs
o Fewer advances in GPU technology
o Almost no growth in the gaming market
o Mellanox Acquisition failure
• As datacenter slows due to market maturity, growth will be kept by
o Continued solid gaming performance
o Emergence of Level 3 Autonomous Vehicles
o Markets outside of Asia for GPUs and datacenters
• CapEx will rise initially and working capital will drop due to the $350 million termination payment
from the Mellanox acquisition
• Growth will be tremendously affected by the effects of coronavirus on its supply chain and on its
Chinese consumer base

© Promontory Investment Research 2020

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A student-run publication at the University of Chicago
 Bear Assumptions
Terminal Growth Rate: 1.5% EV/EBIT Exit Multiple: 10x Terminal Shares Outstanding (B): 6.18
Year: 2020 2021 2022 2023 2024
Revenue growth: 15% 14% 14% 14% 14%
EBIT Margin: 29% 29% 29% 29% 29%
CapEx (% of rev) 6% 7% 5% 5% 4%
D&A (% of rev) 3% 3% 4% 4% 4%
Changes in NWC (% of rev) -9% 11% 7% 5% 5%
Tax Rate 6% 6% 6% 6% 6%

Bull Case Assumptions

• Revenue growth and EBIT margins will strongly increase to an average of 35%
o More advances in GPU technology that resulted from a 19% increase in expenses in R&D
o Higher growth in the gaming market due to the increase in gaming industry from countries outside Asia
o Mellanox Acquisition becomes successful with share repurchasing continued
o Growth in the healthcare sector will accelerate the adoption of AI, alongside a rise in demand for GPU products
• Datacenter popularity increases, which will drive alongside
o Continued solid gaming performance
o Emergence of Level 3 Autonomous Vehicles
o Markets outside of Asia for GPUs and datacenters
• CapEx will rise initially and working capital will drop due to the Mellanox acquisition
• Growth will be only temporarily slowed from the coronavirus concerns on a part of Nvidia’s supply chain

Bull Assumptions

Terminal Growth Rate: 2.5% EV/EBIT Exit Multiple: 18x Terminal Shares Outstanding (B): 6.18

Year: 2020 2021 2022 2023 2024

Revenue growth: 30% 35% 35% 40% 40%

EBIT Margin: 35% 35% 35% 35% 35%

CapEx (% of rev) 7% 3% 2% 5% 4%

D&A (% of rev) 5% 5% 3% 2% 5%

Changes in NWC (% of rev) -13% 7% 6% 5% 5%

Tax Rate 6% 6% 6% 6% 6%

WACC

Share Price: $ 266.04

Shares
Outstanding: 618,000,000

Market Cap: $ 164,412,720,000.00

Debt: 1,988,000,000.00

% of Debt: 29%

% of Equity: 71%
Cost of
Equity: 13.0%
Cost of
Debt: 3%
Implied
WACC: 10%

© Promontory Investment Research 2020

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A student-run publication at the University of Chicago
 Bear Base Bull
Enterprise Value $38,464.71 - $87,615.85 $111,020.95 - $186,742.09 $ 171,779.45 - $259,318.72
Equity Value $38,464.71 - $87,615.85 $111,020.95 - $186,742.09 $ 171,779.45 - $259,318.72
Implied Share Price $62.24 - $141.77 $179.65 - $302.17 $277.96 - $419.61
Implied Upside -327.44% - -87.65% -48.1% - 12.0% 4.5% - 57.7%

Company Name Market Cap ($M) EV/Sales EV/EBITDA P/E P/B

Advanced Micro Devices, Inc. (Nasdaq: AMD) $55,640.80 8.42 66.45 158.57 19.69
Intel Corporation (Nasdaq: INTC) $255,465.21 3.78 8.46 12.68 3.31
Qualcomm (Nasdaq: QCOM) $91,694.89 4.26 10.66 22.35 18.71
IBM Corporation (NYSE: IBM) $125,503.68 2.4 11.15 13.41 6.03

NVIDIA Corporation (Nasdaq: NVDA) $160,374.60 15.73 53.21 57.98 13.14

Mean $132,076.15 4.7 24.2 51.8 11.9

Median $90,572.24 5.4 38.8 86.0 12.9

© Promontory Investment Research 2020

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 Winter 2020, Issue 5
Promontory Investment Research
http://www.promontoryir.com

IDEXX Laboratories (NASDAQ: IDXX)

IDEXX Laboratories| NASDAQ: IDXX Investment Overview

Negative Neutral Positive After analyzing IDEXX Laboratories (NASDAQ:IDXX) we suggest a hold on the company’s stock. Our Sum-
Of-The-Parts DCF model returned a share price range of $201.38 to $340.05 with a 22x EV/EBITDA
Share price, 02/29/20: $254.51 multiple based on an industry median. We believe that our share price range, which both exceeds and
Market capitalization: $21831mm falls short of the stock's value, reflects the fact that the inherent positives and negatives of IDEXX as a
Shares outstanding: 85.78mm company have become known to the efficient market and its share price has been adjusted accordingly.
52-week range: $198.75-296.25 IDEXX is a strong player within its market with solid current baselines, strategic investments in technology
EPS (FY19): $1.17 and M&A, and a profitable outlook for international growth. However, due to its prominent role in the
Beta 1.01 growing companion animal healthcare market, we believe that all significant competitive advantages and
Average analyst opinion: $290.0 risks are already priced in and urge for a re-evaluation at a later date.
Price target: $285.60
Company Overview
Price Chart Incorporated in 1983 and headquartered in Westbrook, Maine, IDEXX Laboratories is an American
multinational corporation that develops, manufactures, and sells products and services that cater to the
3600 300
companion animal veterinary, livestock, water, and dairy testing markets. The company serves customers
290
3400 280 in over 175 countries. Like many companies in the industry, IDEXX relies on a bevy of patents to prevent
3200 270 other companies from simply copying its products, but it also has the brand recognition (at least to a
260 certain extent) and positive press from various peer-reviewed medical journals to set it apart from
3000 250
240 competition when its patents eventually expire.
2800 230
2600 220 IDEXX’s main source of revenue is generated from their Companion Animal Group (CAG) segment. In this
210
portion of their business their main revenue streams are reference lab consulting services (38.6%), VetLab
2400 200
3/ 5/ 6/ 8/ 10 12 2/ consumables (31.9%), and rapid assay products (11.2%). Their software products, such as VetConnect
5/ 1/ 27 23 /2 /1 14
19 19 /1 /1 1/ 7/ /2 PLUS, integrate with the customers’ systems creating switching costs when moving patient data from
9 9 19 19 0
IDEXX to a competitor. On the other hand, a majority of their products stem from contracts with third
S&P 500 IDXX
parties allowing them to spend less money on R&D and infrastructure to supply products while still
maintaining their role as a leading company. IDEXX’s ability to retain customers through their software
Financial Highlights and supply innovative products provides them with a stable and growing customer base.
(Dollars in millions) 2017 2018E 2019E
IDEXX relies on various third parties to manufacture a majority of its products, with clauses in place that
Revenue 2029 2212 2406
are meant to insulate them from potential supply shocks that could occur if a third party cannot deliver
% Growth +10.9% +12.4% +8.8%
the required amount. As of 2013, their largest US distributors are: Butler Schein Animal Health, MWI
EBITDA 425.48 493.17 552.6 Veterinary Supply Co., and Webster Veterinary Supply, Inc. The fact that Butler Schein Animal Health is
P/E Ratio 50.71 41.6 51.19 owned by one of IDEXX’s main competitors, Covetrus, presents a major risk, because it is almost inherent
% Growth +1.6% -17% +19% that they will prioritize the distribution of their own products and services.
EPS 0.77 1.01 1.17 Consumables 900000
800000
8% Rapid assay 700000
Research Analysts 7%
In Thousands $

600000
Diagnostic and
4% 500000
Joshua Shou | jshou@uchicago.edu consulting services
30%
CAG Diagnostics 400000
Cody Googin | codygoogin@uchicago.edu 300000
39% 12% CAG Diagnostics - 200000
Max Lewis | maxlewis@uchicago.edu instruments
100000
Software
0
2017 2018 2019
Exhibit 1: CAG Revenue Breakown (10K)
© Promontory Investment Research 2020
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Current baselines
IDEXX’s high rate of organic growth through cross-selling products provides them a dependable baseline. The increase in number of users purchasing IDEXX
VetLab and IDEXX Ref Lab from 33% to 50% over the past seven years has facilitated IDEXX’s ability to cross-sell. Specifically, major products such as Catalyst and
Hematology have a high history of customer loyalty. In fact, the number of users who purchased both Catalyst and Hematology in the past 5 years has risen by
22%. However, their capitalized customer acquisition costs have increased by $13 million ($124.4 - $137.4 during the past financial year) revealing a higher cost
to acquire customers. Additionally, IDEXX’s wide portfolio of patents allows them to secure their products and hold their dominant role in the market.

Industry Overview
The companion animal healthcare market has a total market cap of 15.91 billion dollars with a CAGR of 6.10% internationally. The industry cost structure is
dominated by wages (34.5%) and purchases (15.2%). The market has a low degree of globalization, with most firms focusing on one or two key geographical
markets. The key drivers of the US market are an increase in pet-owning sentiment among a younger population and increase in spending among older age
bracket. Moreover, the aging pet population (between 2002 and 2012 the average lifespan for cats increased 1.1 years), means that per-pet there is an increased
need for medical procedures and testing. Finally, high capital expenditure for PP&E and R&D to enter the market means that the market for companion animal
healthcare has steadily high barriers to entry.

Regulation
The relatively high degree of state enforced regulation creates extra costs and inefficiencies for the firms in the market. Laboratory accreditation, which is when
independent technical assessors conduct a thorough evaluation of all aspects of a laboratory, has recently become more of a focus for firms due to the fact that
it helps improve the legitimacy of their results in the eyes of customers. However, this labor-intensive process is highly costly and must be conducted at regular
intervals to maintain the accreditation. Another example of regulation that impacts companies' bottom lines is the fact that since 2006 all specimens that could
be considered infectious in any way must be classified as hazardous and shipped in triple sealed packaging.

Increasing Competition
Increasing competition arises from the increase in demand based on the shift to a larger number of pet owners. Overall, the total number of pet owners in the
US has risen 12% from 56% to 68% in the past 30 years. This growth has created more room for companies to break into the industry, this result is furthered due
to a lack of oligopoly or monopoly. This shift has happened relatively recently as the “pet as a member of one’s family” sentiment has increased in the past
generation as baby boomers account for 32% of pets owned while younger generations account for 62% of pets owned. Additionally, people ages 45-74 spend
60% more on pets than other age brackets.

High Technological Change

As the technological boom of the past couple decades continues, large companies must start outsourcing innovation to new startups. This same trend applies in
the $26 billion animal health industry, where the current explosion of start-up investing has led to annual spending of $156 million on pet centric startups.
Additionally, due to the recent technological boom, the presence of technology has increased within the veterinary healthcare market. In IDEXX this change is
reflected in the large number of products they contract from third parties.

Exhibit 2: Historical and Projected US Veterinary Services Expendatures (Harris Williams & Co)

50
40
30
20
10
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Investment Thesis
US Veterinary Services Expendatures Projected

Investment in Technology
IDEXX has demonstrated a commitment to continuing to develop its various platforms to improve the customer
experience, and it consistently outspends its competitors on research and development (one of its key
competitors VCA however does not report R&D spending). For example, IDEXX is piloting a new service, IDEXX Exhibit 3: R&D Spending ($M)
Cornerstone Cloud, which will replace the need for practices to use a local server to store medical data with a
160
subscription cloud service. With most of these services being subscription based, IDEXX reaps predictable 140
monthly revenue that currently accounts for 7.6% of the CAG revenue stream, which itself is 87% of the total 120
revenue stream. This number is sure to grow, but it still currently accounts for only a small fraction of total 100
revenue (7.5%). The fact that the majority of IDEXX software does not require IDEXX lab equipment to function, 80
there are few switching costs for firms that use IDEXX software than one might initially assume. One key area 60
where IDEXX’s VetConnect PLUS has a clear competitive advantage is in the turnaround time in the processing of 40

materials at its reference labs. In February of 2020, IDEXX will launch its digital cytology option, which will 20
0
reduce the time it takes to process certain samples from two days down to two hours. This system makes use of
2012 2013 2014 2015 2016 2017 2018 2019
the vertical integration of the VetConnect PLUS suite to digitally send in imaging from microscopes to labs to be
processed and evaluated. IDEXX is going to push this new service very aggressively, as they have a dedicated IDEXX Zoetris/Abaxis Heska

group of 150 technicians to train and install the requisite equipment at clinics across the country and world.

© Promontory Investment Research 2020

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Strategic M&A
IDEXX’s recent streak of acquiring SAAS companies, such as rVetLink and DataPoint, suggests the company’s shift to focusing more on software to complement
its consumables and lab equipment revenue streams. IDEXX is clearly attempting to achieve vertical integration in the space, since each of the latest
acquisitions focuses on a different aspect of medical data management from POC (point of care) all the way to managing integration with different PIMS
(Practice Information Management Systems). Management at IDEXX think that by integrating all these different platforms they will offer a better consumer
experience, thus giving them a competitive advantage over the competition.
IDEXX also used M&A to increase the size of its lab network by acquiring Marshfield Labs in the fall of 2019. Their lab network is centered in the midwestern
states of the US, and as a part of the acquisition, the laboratories will start to make more use of IDEXX products and services.

Company Cost of acquisition Rationale Synergies

$50 Million More labs in the network 24.8 Million in goodwill from the synergies of the labs
Q4 2019 means faster processing. which bolster the existing lab network.

$25 Million Global customers (Asia, Optimizes clinic practice workflow from patient processing
Q3 2018 Australia, Europe), another (admission form), to scheduling, to post-treatment.
link in the “digital” supply Additionally, since this is a cloud- based platform, it allows
chain IDEXX to increase switching costs.

** Integrates with existing Referral management system that improves transfer to

Q2 2017 IDEXX software such as specialty centers. This creates a network effect between
Cornerstone. Cloud based to veterinary clinics allowing IDEXX to increase their
reduce cost for the practice. presence.

$14 Million PIMs aggregator that allows Makes partial adoption of IDEXX products much easier.
Q2 2017 IDEXX products and
software to work with 3rd
party solutions.

Exhibit 4: Recent M&A (10K)

International growth
Exhibit 5: Revenue Breakdown By Region (10K)
1800000 600000
Furthermore, IDEXX expands their horizon by focusing these projects through global
perspective, which can be seen by their new global agreement with Applied Biocode,
1600000
500000 bridging customers through a “digital multiplex platform.” IDEXX has a high opportunity
1400000
for growth internationally as the market is growing rapidly. The company is also trying to
1200000 400000
bolster international growth through strategic acquisitions, such as with SmartFlow in Q3
1000000 of 2018. Beyond the fact that SmartFlow deals with the aforementioned storage and
300000
800000 processing of images and medical data the company has an existing customer base in
600000 200000 Asia, Europe, and Australia. With an internal CAGR of 8% and as high as 15% in certain
400000 regions such as Latin America, IDEXX has potential and intention to expand. For example,
100000 in Germany, IDEXX is constructing a core diagnostics processing lab that will act as the
200000
center of the European hub and spoke network of laboratories. Thus, IDEXX has
0 0
2016 2017 2018 2019 continually shown its ability to adapt and research the modern impetus for growth in the
United States/Canada Latin America industry, with smart and efficient investment in resources and communications. Their
Europe Region Asia Pacific Region
international recognition is significant, as they have the highest market capitalization at
24 billion.

Investment Risks
International Expansion: Consumer Preferences:
Differing consumer preferences and habits in the international market may result in a split business model thus hampering the growth rate of IDEXX in the US
and abroad. This is a significant risk, because IDEXX’s need to expand internationally is high due to the US CAG market becoming saturated. However,
differences between IDEXX’s current business model and needs abroad may lead to an inability to successfully cater to international consumers. This may lead
to a loss of profit since companies already based in the country will have a more complex understanding of the consumer base in their country. For example,
Veterinary Care in International Regions is more sick-patient-focused than in the U.S., with a greater emphasis on therapeutics than diagnostics. Due to this
difference in animal healthcare demand, IDEXX would need to diversify their business to add emphasis one sick patient-focused areas of care thus taking away
resources from their already prospering business. However, due to the high organic growth the company currently has, this would not cause a huge detriment.
A similar issue could arise with the production of certain goods because an overproduction of certain goods to meet the needs of international demand, thus
disrupting IDEXX’s economies of scale.
© Promontory Investment Research 2020
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 Exhibit 6: International Distribution Map
International Expansion: Distribution:
Another risk factor when expanding abroad is the fact that IDEXX will have to
largely rely on distributors for its products, compared to the US where it mainly
sells its products and services directly to customers. This may reduce the revenue
growth because IDEXX will have less control over selling to clients, which means
that the competitive advantages of its products may not be communicated as
effectively. Moreover, the company will have to pay the distributors, which will
further cut into revenue. International expansion is a large driver of IDEXX’s
projected revenue growth, but the fact that it will have to rely on distributors
may lead the actual growth to fall below expectations.
Patents
IDEXX laboratories relies on a bevy of patents to prevent other companies from simply copying its products, but it also has the brand recognition (at least to a
certain extent) and positive press from various peer-reviewed medical journals to set it apart from competition when its patents eventually expire. The main
patents include Catalyst consumables that expire beginning in 2023 and continuing into 2029 and Catalyst instruments that expire beginning in 2026 and
continuing into 2035. The Catalyst consumable is a slide used in the Catalyst instrument. Although this will expire, since there is no competition for the patent
since the Catalyst instrument patent is still valid, IDEXX should have little trouble securing a new one. If IDEXX were not to sufficiently protect their physical and
intellectual property, or not able to license it efficiently, they face risk of outcompeted by competitors such as Antech Diagnostics and Zoetis INC who can utilize
it better.

Key Competitors
The following chart displays IDEXX’s key competitors. These specific companies were chosen to illustrate the diversity of companies that IDEXX competes with.
EV/EBITDA Debt/Equity P/E PE calculated MKT price per share EPS

Zoetis (NYSE: ZTS) 30 245.60% 39.2 45.80 $142.43 3.11

Varian Medical Systems INC.(NYSE: VAR) 22 36.30% 44.7 47.50 $143.44 3.02

PerkinElmer, Incs (NYSE: PKI) 20 78.90% 45.56 45.51 $92.85 2.04

Envista Holdings Corporation (NYSE:NVST) 15 16.40% 17.3 5.58 $27.52 4.93

Edwards Lifesciences Corporation (NYSE:EW) 35 16.40% 64.6 46.91 $231.25 4.93

bioMérieux S.A. (ENXTPA:BIM) 22 31.60% 43.2 39.79 $95.90 2.41

Teleflex Inc (NYSE: TFX) 28 67.50% 34.47 37.76 $370.40 9.81

Covetrus Inc. (NASDAQ: CVET) 21 94.6% 0??? -1.31 $12.00 -9.17

Resmed Inc. (NYSE: RMD) 31 62% 55.5 55.55 $173.88 3.13

Median 22 49.15% 43.95 45.51 $142.43 3.11

IDEXX 40 5.56% 51.04 51.04 $254.51 1.17

Valuation
Discussion of Assumptions
Sum of Parts CAG Sum of Parts NON- Bear Bull
CAG

• 11% revenue growth meant to reflect
strong international growth
• D&A increasing to meet CAPEX because
more PP&E from CAPEX leads to
increased D&A
• EBIT margin that starts at historical
levels and decreases to model lower
profitability as more [international]
competitors enter market
• 1% revenue • Conservative growth strategy
growth to keep • 8%-7% revenue growth, with a
up with inflation 1% dip modeled in 2023 to
• All other reflect the hypothetical
categories based decrease in sales when
off historical consumable patents expire
data (allow for more competition)
• D&A increasing to meet CAPEX
• Assumes aggressive growth
strategy
• 14% revenue growth to model
robust growth in domestic and
international markets (this number
is close the prediction in the IDEXX
investor report
• Higher CAPEX due to modeling of
more aggressive growth strategy,
and consequently higher D&A

© Promontory Investment Research 2020

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Sum of the Parts DCF Valuation (Base)

CAG NON-CAG
2020 2021 2022 2023 2024 2020 2021 2022 2023 2024
Assumptions Assumptions

Revenue 2,599.45 2,807.41 3,032.00 3,244.24 3,503.78 Revenue 290.60 293.51 296.44 299.41 302.40

EBIT Margin EBIT Margin

45% 43% 41% 39% 19% 38% 38% 38% 38% 38%
(% Revenue) (% Revenue)

CapEx (% CapEx (%
5% 5% 5% 5% 5% 4% 5% 5% 5% 5%
Revenue) Revenue)

D&A D&A
3.5% 3.4% 3.8% 4.6% 5.7% 4% 4% 4% 5% 5%
(%Revenue) (%Revenue)

Change in Change in
NWC (% -4% -4% -4% -4% -4% NWC (% 10% 10% 10% 10% 10%
Revenue) Revenue)

CAG Implied Fair Values NON-CAG Implied Fair Values Totals

Enterprise Enterprise
17,244 ßà 26,972.64 927.43 ßà 3,094.10 18,171.43 30,066.44
Value Value

Implied Share Implied

$190.57 ßà $303.98 $10.81 ßà $36.07 $201.38 $340.05
Price Share Price

Implied
-25.1% ßà 19.4% -20.78% 33.61%
Upside

WACC Sensitivity Analysis for Sum-Of-Parts DCF

WACC

Nominal: -22.0% 7.48% 7.68% 7.88% 8.08% 8.28%

0% -0.343891957 -0.362507431 -0.380163273 -0.396931567 -0.41287735

1% -0.266221008 -0.28966776 -0.311745736 -0.332570997 -0.352246852

CAG Terminal Growth 2% -0.160202997 -0.191180317 -0.220056927 -0.247039187 -0.272307277

3% -0.006855518 -0.050604224 -0.090790738 -0.127833435 -0.16208756

4% 0.234622697 0.166371919 0.105107508 0.049806508 -0.000363303

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Bear and Bull Valuations Cont.

Bear Assumptions 2020 2021 2022 2023 2024

Revenue $2743.87 $3128.01 $35565.93 $3993.84 $4552.98

EBIT Margin (% Revenue 23% 21% 21% 20% 19%

D&A (%Revenue) 4% 4% 4% 5% 5%

CapEx (% Revenue) 5% 5% 5% 5% 5%

Change in NWC (%
-4% -4% -4% -4% -4%
Revenue)

Bull Assumptions 2020 2021 2022 2023 2024

Revenue 2599.45 2807.41 3032 3244.44 3503.78

EBIT Margin (% Revenue 23% 21% 21% 20% 19%

CapEx (% Revenue) 7% 6% 6% 6% 6%

D&A (%Revenue) 4% 4% 5% 5% 6%

Change in NWC (%
-4% -4% -4% -4% -4%
Revenue)

Implied Upside

Bear -59.5% ßà -31.4%

Bull -13.5% ßà 13.3%

© Promontory Investment Research 2020

6
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 Winter 2020, Issue 5
Promontory Investment Research
http://www.promontoryir.com

MGM Resorts International

MGM Resorts International | NYSE: MGM Investment Overview

Sports Betting:
Negative Neutral Positive
MGM has uniquely positioned itself to capitalize on the emerging sports betting market in the United
Share price, 03/06/2020: $20.39 States. With partnerships across multiple professional sports leagues and Yahoo! Sports, MGM has a
Market capitalization: $15.51B foothold in the market.
Shares outstanding: 529mm
52-week range: $19.36/ $34.64 Japan Expansion:
EPS (FY19): $3.88 With the legalization of casinos in Japan, analysts expect the market to return tremendous value.
Beta 1.48 MGM has established itself as the only contender for an integrated resort in Osaka, which is expected
Average analyst opinion: $35.94 to receive one of three government-issued casino licenses.
Price target: $40.00
Business Restructuring:
MGM is currently pursuing an asset-light strategy that allows them to become more liquid and pay off
Price Chart
debts. This both allows MGM to become more flexible to move into growth avenues and also clarifies
the value of MGM assets to investors.
120
Company Overview
110 Company
MGM Resorts International, incorporated in 1986 and based in Delaware, owns and operates casino
100 resorts. Its resorts are divisible into three central categories, Las Vegas Strip Resorts, Regional
Operations (in the US), and China. It’s domestic subsidiary consists of both gaming and non-gaming
90 operations, with hotel services, food and beverage, entertainment and other non-gaming amenities
available aside from gambling. Its casino operations span slot machines, table games, as well as race
80 and sports book wagering.
MGM SPY
Offerings
Following their fairly recent move into Asia, the majority of MGM’s resorts remain in the US, with
Financial Highlights
their Las Vegas Strip Resorts holding nine, their regional operations throughout the rest of the US
holding six, and China possessing two. MGM China operations consist of MGM Macau resort and
(Dollars in millions) 2017 2018E 2019E
casino and the development of an integrated casino which includes hotel and entertainment resort
Revenue 1704 1795 1555 on the Cotai Strip in Macau. Its resorts include gaming, hotel, convention, dining, entertainment,
% Growth -51.5% -5.3% -13.0% retail, and other typical resort amenities. Outside of their China holdings, MGM Macau possesses
EBITDA 780 897 410 various properties in the US as well, including the Valley Golf Club at the California/Nevada state line
% Payout -3.9% 15.0% -54.5% as well as the Fallen Oak golf course in Saucier, Mississippi. MGM continues to invest in its resorts
EPS 1.57 1.73 0.78 through remodeling and expansion of hotel rooms and restaurants, increasing its entertainment and
nightlife offerings, as well as new features and amenities.

Research Analysts
Victoria Gin| vgin@uchicago.edu
Alec Iannuccilli | aleciann@uchicago.edu
Eva Herget | eherget@uchicago.edu
Aaron Liu | aaliu@uchicago.edu
A student-run publication at the University of Chicago
MGP REIT
MGM also holds MGM Growth Properties LLC (MGP), a consolidated subsidiary which completed its
IPO in April of 2016. MGP is in a partnership REIT (Real Estate Investment Trust) structure which
owns the majority of its assets, while MGM Growth Properties Operating Partnership conducts its
businesses. It is a leading publicly traded REITs that specifically engages in the acquisition, ownership,
and leasing of large scale entertainment destinations and leisure resorts. MGP leases its properties
owned by the Operating Partnership to a subsidiary of MGM. MGP’s portfolio consists of premier
destination resorts operated by MGM: the Hard Rock Rocksino Northfield Park in Northfield, Ohio,
The Park in Las Vegas, and Empire City in Yonkers, New York. Outside of Las Vegas, MGP owns MGM
Grand Detroit in Detroit, MIchigan, Beau Rivage and Gold Strike Tunica in Mississippi, Borgata in
Atlantic City, New Jersey, ang MGM National Harbor in Maryland.
© Promontory Investment Research 2020
1
 2,500,000 10.98%
2,000,000
1,500,000
1,000,000 26.…
62.67%
500,000
0
Las Vegas Regional MGM China Total
Operations

2018 2017 2016 Las Vegas Regional Operations MGM China

Exhibit 1: Operating profit by year Exhibit 2: Operating profit in 2018

Industry Overview
Competitive Landscape

This industry is composed of companies that offer lodging and recreation to customers,
namely in the form of gambling. Amenities commonly include gambling, swimming
pools, health centers, and conference and convention capabilities. Casinos may offer
sports gambling, table wagering games, slot machines and others. Gambling is legalized
by licenses obtained by the company, with activity being supervised by the government.
It is common for the casino portion of each resort to have an additional entrance fee. To
combat the seasonal nature of leisure travel, most companies endeavor to provide
diversified services to maintain acceptable hotel occupancy rates during slow periods.

Major casino corporations include MGM Resorts International, Las Vegas Sands Corp.,
Caesars Entertainment, Penn National Gaming, and Wynn Resorts. Most US-based
casino companies operate in foreign countries (particularly Macau). Others are Exhibit 3: 2019 operating income by state
considering foreign expansion.

Within this industry, travel drives demand. This means that consumer income affects the revenue of the company, as does the state of the economy. During
a struggling economy, companies within this industry likely will see decreased revenue due to consumers’ more conservative spending on leisure. This
industry is particularly capital-intensive, and with poor cash flow, management often has to increase cost efficiencies to free enough cash for operations. It is
particularly important for companies to have enough cash to cover upcoming debt; too much leverage can have a severe effect on the company when the
economy has a downturn.

Competition exists globally between international resorts and casinos, such as MGM. Additionally, the rise of online casinos has increased competition in
recent years. For the gaming sector of this industry, competition between competitors is particularly intense due to geographical restrictions. Las Vegas and
Macau are the largest gaming centers in the world. However, much of the US and many foreign countries are beginning to expand areas where gambling is
legal, which means that gaming is a growth sector.

While global competition is intense, the threat of new entry is relatively low, because this industry is so capital intensive. However, the threat of substitution
is relatively high, partially because switching costs for consumers are so low. Top competitors distinguish themselves through superior “luxury” services
and/or competitive pricing.

Headwinds and Tailwinds

The most notable headwind within this industry is the coronavirus, which has negatively impacted the operations of casinos across the globe. Casinos in China
specifically, such as MGM Cotai, have suspended operations. This impacts these companies’ profitability. Furthermore, casinos in every country have seen
slight decreases in revenue due to decreases in travel associated with the Coronavirus.

In the coming years, sports betting will likely become a significant source of revenue for casinos. Annual revenue from sports betting is expected to reach ten
billion by 2028. Capitalizing on this new revenue channel will be important for casinos going forward, given its long growth runway.
© Promontory Investment Research 2020
2
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Investment Thesis
Sports Betting
As sports betting is legalized across the US, this emerging market will create a massive new source of revenue, lower fixed costs, increase accessibility, and
reduce the natural cyclicality of the casino industry. Currently 13 states have legalized sports betting and 6 other states are finishing up the legalization of
sports betting. MGM has partnered with the NBA, WNBA, NHL, and MLS to retrieve their data for members of MGM. These league partnerships make gamblers
much more likely to go to MGM, thus MGM has created an efficient scale moat for themselves.

MGM partnered with Yahoo! Sports, an official Digital Media Sports Partner, through its Roar Digital LLC, which is a joint venture between the global gaming
industry leaders GVC holdings and MGM Resorts. Through this partnership, Yahoo! will launch its sports app in the US where it will house BetMGM’s platform
for transactions to take place. Yahoo! wil help market and promote MGM’s exclusive live events and experiences. 60 million Yahoo! users will be exposed to
MGM’s sports betting through their partnership, thus making it easier to quickly place bets for its consumers. The annual revenue in US online sports betting is
expected to hit $7 billion by 2025.

Japanese Expansion
Gambling in Japan
In 2018, Japan passed a casino legalization bill that would allow three casinos to be opened in the country. Osaka is widely considered to be the first city to
open an integrated resort (IR) in the country. As of February 2020, MGM is the only bidder left in the running for an Osaka casino.

Casinos have historically been outlawed in Japan because of fear of addiction. Under current laws, locals will be limited to three visits a week or ten a month,
and will also have to pay a fee to enter. In recent years, MGM has been promoting an image of a socially responsible company, transitioning sustainable energy
and contributing to local food banks. This reputation has aided MGM’s bid in Japan. Further, MGM has taken part in multiple local events to improve goodwill
in the location. In December 2019, a Japanese official was arrested on suspicion of bribery in relation to integrated resorts. While this has damaged the
reputation of integrated resorts in Japan, we believe that Japan will still be able to follow through and open multiple integrated resorts. Prime Minister Shinzo
Abe reiterated as such in his annual address, and the controlling party – the Liberal Democratic Party – remains committed to opening casinos.

Osaka
So far, Osaka – the third largest city in Japan – is the largest city to have bid for an IR license. Along with government support for an IR, 45% of its residents
support the idea, with 42% opposed. This makes it the only city in Japan to have won a plurality of support among its residents. Tourism in Osaka and the
surrounding region has jumped by 363% in the past five years, more than double anywhere else in Japan. Osaka accounts for approximately 40% of Japan’s
overseas tourists. There are no restrictions on gambling for tourists in Japan as there are for residents, meaning that casinos can generate significantly more
revenue from tourists than locals. Yokohama is the other major city expected to bid for a casino license. Given Osaka’s accelerated time frame and reputation
as a tourist destination, Osaka is likely to capture a large proportion of the Japanese casino market.

IR Plans
MGM is expected to invest up to $10-12 billion in a casino in Japan. Both the Japanese government and MGM hope to have the casino open by 2025, which is
when the World Expo will take place in Osaka. Because of MGM’s recent asset-light strategy, the company is becoming more liquid, and seems to possess the
cash on hand to make this investment. In the early rounds of bidding, MGM was one of the only companies to pledge to open the integrated resort in 2025. It is
probable that the resort will open in 2025 if construction begins in 2021.

As the only competitor left in Osaka, MGM now has extraordinary negotiating power in discussions. It is expected to invest anywhere between $10 and 15
billion in constructing and opening the Osaka casino. Experts project the entire Japanese casino market to be worth around $20 billion a year, due to the
country’s rich population as well as its close proximity to other Asian markets.

Business Restructuring
Asset-Light Strategy
In order to solidify its balance sheet, MGM has been looking to sell off many of its physical assets to other companies, including Blackstone, private investors,
and MGM Growth Properties (MGP). MGM owns a 73% stake in MGP, and continues to operate most of its sold properties through sale-leasebacks. This allows
MGM to become significantly more liquid (up $900 million in cash from last year). By becoming more asset-light, the company is able to pay off its long-term
debts. In the last quarter of the previous fiscal year, MGM settled $3.1 billion of $15 billion of long-term debt. In the past few years, MGM has agreed to sell off
Bellagio, MGM Grand, Circus Circus, and Mandalay Bay for a combined total of about $12 billion.

MGM 2020
CEO Jim Murren has been aggressively cutting costs associated with running MGM. His plan looks to improve EBITDA by $300 million by 2021. The company
expects to cut costs by $200 million, half of which will come from reducing labor costs by restructuring management. This means that consumer experiences
will likely be unaffected. The other half of savings will come from improved sourcing of materials, and revenue optimization. So far, the plan has worked. In the
second quarter of 2019, MGM announced that its projected savings were ahead of schedule, at $100 million instead of the planned $70 million.

© Promontory Investment Research 2020

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A student-run publication at the University of Chicago
Investment Risks
Debt
MGM is substantially indebted; at the end of December 31, 2018, it had $15.3 billion of principal outstanding. They have $3 billion in term loans, $11 billion
in bonds, and $1.3 billion in revolvers not drawn down. Increase to interest rates or decrease in revenue would reduce the cash flow available to the
company, and could severely negatively impact the company’s operations. This is particularly concerning for MGM, because the casino/hotel industry is
particularly cyclical and dependent on economic conditions. That being said, MGM has begun to dramatically reduce its debt load, particularly by selling off
its properties to better focus on managing its casinos, which has increased profitability for MGM while also reducing this debt load. For example, in the past
year, MGM sold several properties to Blackstone Real Estate Income Trust, totalling almost $9 billion dollars. Through such strategic partnerships, MGM is
successfully employing its new “asset-light strategy” to reduce the risk of its indebtedness.

Japan
A short term risk is the coronavirus affecting MGM’s locations in Macau and Japan. As of February 4th 2020, Macau asked all casino operators to suspend
operations÷ for two weeks, which immediately dropped share prices. Macau’s casino revenue drops 11.3% alone in January. About 20.7% of MGM’s operating
income is derived from Macau. Entry into Japan presents a huge growth opportunity for MGM, however, with this also comes risk. Although MGM is the
forerunner for the first casino in Osaka, this has not been guaranteed. Furthermore MGM aims to complete construction of the casino by the 2025 World
Expo. If construction were not completed, the casino might miss earnings expectations which would negatively impact MGM’s operations. This is particularly
concerning because the project is highly capital intensive, and cost estimates for the casino exceed $10 billion. However, given the huge growth of casino
gambling in Japan, entering the market is still the smartest option. Gambling currently generates between $10 to $25 billion in Japan annually, and this will
continue to increase.

Cyclicality
The hospitality business has higher risks associated with it due to high fixed costs, but both hotel and casino industries are extremely cyclical. MGM is not
only affected by the US economy, but the far east and China's economy. Cyclicality is closely related to debt because of higher fixed costs associated with
higher debt. But, because MGM is employing an “asset-light strategy,” it will potentially lose the majority of its debt.

Valuation
Assumptions

Across both cases, consideration of macroeconomic headwinds and tailwinds was included. Extremely relevant to MGM is the coronavirus outbreak in
China, where they hold MGM Macau and have recently opened MGM Cotai. Coronavirus’ presence has mandatorily forced MGM Macau and Cotai to shut
their doors for two weeks in February, with short-term repercussions for both their gaming and non-gaming operations as the amount of guests recovers
from the drop coronavirus caused. The specific effects of coronavirus were calculated by calculating the average daily revenue and operational costs of
MGM China, and then subtracting that from projected revenue goals by the amount of days Macau & Cotai were mandatorily shutdown, with
considerations for reduced revenue over the next 4-6 months. The bull case took a more optimistic (though still negative) outlook on the long-term effects
of coronavirus, while the bear case sought to anticipate the worst case scenario for the length of the outbreak.

As was stated above, the bull case predicts that MGM is successful in its bid for the license to build a new resort in Japan. Should they acquire this bid,
construction would last approximately until 2025 (based on the timelines pursued by MGM management), which would be reflected through an increase in
capital expenditures throughout the process. The bull case also includes an optimistic outlook on a series of sports betting deals MGM is in the process of
making, which would allow real time, stat specific bets which are a rising favorite in sports betting. As these deals occur on a state by state timeline it’s
difficult to predict when all will be finalized, but MGM’s expectations are for a resulting increase in revenue starting in 2023, with a full realization of
revenue potential in 2028. We based our revenue predictions based off of a 10% share of a $10 billion market. The market size is in accordance with many
analyst views, while we believe that our market share estimate is conservative, given MGM’s leading status in the market. Finally, we projected a cash
influx due to a continued pursuance of MGM’s asset light strategy.

The bear case doesn’t predict the success of MGM in its Japan expansion, and relatedly sees less growth in terms of CapEx. It also predicts coronavirus to
have a longer effect on MGM, with slower revenue growth as a result. We projected that MGM would receive less revenue from sports betting, as well as a
decrease in CapEx. Finally, we do not expect MGM to continue to sell off their Las Vegas Strip properties, resulting in a smaller revenue.

From the current share price of $20.39, our bull case predicts an upside of 125.9% at an implied value of $46.06. Our bear case predicts an upside of 33.9%
at an implied value of $27.31. We felt that these two cases encompassed the two major possibilities for MGM’s performance in the future, and so did not
run a base case DCF.

We also ran a comps model on MGM to get a median EV/EBITDA of 12.98x for the industry. In our bull case, this results in an upside of 135.6% at an
implied value of $48.04. In our bear case, this results in an upside of 73.2% at an implied value of $35.32.

© Promontory Investment Research 2020

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A student-run publication at the University of Chicago
Bull Case DCF:

Implied Revenues

Year: 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

Revenue 18,631,646 15,821,177 16,999,872 18,387,363 19,480,604 22,252,135 23,769,741 25,335,728 26,652,515 27,872,641

EBIT 5,893,956 2,442,647 2,517,983 2,788,294 2,955,285 2,820,267 3,090,066 3,420,323 3,598,090 3,762,806

CapEx 3,648,155 3,080,340 2,542,073 2,042,073 1,595,780 666,673 765,924 819,189 835,473 843,778

D&A 1,583,690 1,265,694 1,019,992 919,368 779,224 1,112,607 713,092 760,072 799,575 836,179

Change in NWC 745,266 632,847 594,996 735,495 1,071,433 1,112,607 950,790 1,013,429 1,066,101 1,114,906

Free Cash Flow 3,084,225 (4,845) 400,907 930,095 1,067,296 2,153,593 2,086,444 2,347,777 2,496,091 2,640,302

Discounted FCF 2,853,331 (4,147) 317,441 681,321 723,295 1,350,208 1,210,180 1,259,813 1,239,127 1,212,593

Implied Terminal Values Growth Rate 2.50% WACC 8.09% Exit EV/EBITDA 12.98

Near-Term Cash Flows 10,843,162

Gordon Growth TV 22,226,245 Exit Multiple TV 23,264,062

Implied EV Value 33,069,407 Implied EV Value 34,107,224

Implied Equity Value 24,230,107 Implied Equity Value 25,267,924

Implied Share Price $46.06 Implied Share Price $48.04

Implied Upside 125.9% Implied Upside 135.6%

Bear Case DCF:

Implied Revenues

Year: 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

Revenue 15,938,151 17,356,130 15,908,998 16,764,538 17,618,713 18,424,180 19,199,147 19,908,867 20,641,678 21,701,261

EBIT 2,997,052 3,668,052 1,790,900 1,879,527 1,977,558 2,118,781 2,207,902 2,289,520 2,373,793 2,495,645

CapEx 824,431 886,958 955,225 1,024,719 1,105,970 1,210,562 1,325,090 1,457,099 1,602,309 1,778,013

D&A 796,908 867,807 795,450 922,050 969,029 1,197,572 1,343,940 1,393,621 1,444,917 1,736,101

Change in NWC 717,217 781,026 636,360 670,582 704,749 736,967 767,966 796,355 825,667 868,050

Free Cash Flow 2,252,311 2,867,874 994,765 1,106,276 1,135,869 1,368,823 1,458,786 1,429,686 1,390,734 1,585,682

Discounted FCF 2,083,697 2,454,553 787,660 810,379 769,767 858,192 846,125 767,167 690,398 728,245

Implied Terminal Values Growth Rate 2.10% WACC 8.09% Exit EV/EBITDA 12.98

Near-Term Cash Flows 10,796,183

Gordon Growth TV 12,408,699 Exit Multiple TV 16,622,545

Implied EV Value 23,204,882 Implied EV Value 27,418,728

Implied Equity Value 14,365,582 Implied Equity Value 18,579,428

Implied Share Price $27.31 Implied Share Price $35.32

Implied Upside 33.9% Implied Upside 73.2%

© Promontory Investment Research 2020

5
A student-run publication at the University of Chicago
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