Wynn Resorts – All Risk, No Pot

I have tentative plans to play poker at the Wynn, Las Vegas later this month.  The casino is known for it’s grand architecture and the poker room is a favorite for tourists and locals alike.  With discipline and a bit of luck I hope to build a decent chip stack over the course of a few sessions…

Before heading out, I may very well have a chance to book trading gains shorting the house.  Wynn Resorts (WYNN) has had a stellar run since the stock bottomed in early 2009, but may soon see its luck run out.

Wynn recently restructured a decent amount of its debt by making a tender offer for some of its notes due in 2014, and issuing $1.3 billion in  new 7 3/4% paper due in 2020.  The transaction gives the company short-term liquidity, but the significant debt burden requires the resorts to generate a hefty amount of cashflow to keep the lights on.

Macau Drives Growth

Although Wynn has built its street reputation around its Las Vegas developments, the true hope for the company lies with its expansion into Macau.  The Chinese gaming city has expanded rapidly in past years as tourists from the mainland are flocking to take advantage of legalized gaming.

The Wynn Macau currently features 600 hotel rooms and suites and the casino spans more than 200,000 square feet. In addition to the flagship hotel and casino, the company recently opened Encore – adding more than 400 rooms and suites and additional retail and gambling square footage.

As long as a healthy Chinese economy continues to drive traffic growth to the new expansion, Wynn should continue to be profitable.  But with the Chinese economic expansion expectations in flux and policy makers experiencing growing pains, the long-term stability may not be as robust as investors are currently expecting.

Excessive Debt

Building high end casinos and resorts is an expensive undertaking.  As of the end of the second quarter, WYNN was saddled with $3.2 billion in debt compared to a cash balance of $1.9 billion.  The cash cushion gives the company plenty of flexibility in the short run, but interest expense can cut sharply into profits during weak economic cycles.

Ironically, the majority of debt ($2.5 billion) is backed by Las Vegas properties which are facing tough revenue trends due to a constrained US consumer.  The remaining $682 million is attached to the Macau properties which have much better revenue prospects.

Analysts are currently expecting a sharp rebound in earnings – bringing 2010 EPS up 512% to $1.59 per share.  In 2011, the expectation is that the company will tack on another 38% to earn $2.20 per share.  But keep in mind, these robust earnings figures are still well below the $2.97 that the company earned in 2007 when the economy was arguably much healthier.

The stock is currently trading near $84 – implying a multiple of 38 times 2011 expectations.  That kind of multiple implies investors are extremely bullish on the growth prospects despite the challenges in the US and the uncertainty abroad.

Bullish investors will point to the company’s prime real estate as offering value above and beyond the actual operating earnings of the company.  While of course the real estate has a great degree of value, that value is only attractive to shareholders if it A) generates operating profits, or B) is marketable for sale.

The last few years have taught us that deflating real estate bubbles can hurt individuals and companies alike, and usually correspond to weak economic and earnings periods.  So investors who have concerns about the current state of the Chinese real estate bubble OR the US consumer could quickly become concerned with the valuation of this growth stock.

Looking at the chart pattern, WYNN has run into resistance above $90 twice.  It appears institutional investors DO have their valuation limits even if the price point represents a huge premium to earnings.  A break below $80 would likely set off the sell programs and kick out a number of momentum players.

The setup looks attractive and while price action will dictate when and if we get involved, I’m happy to find a short opportunity that combines excessive valuation with the weakening consumer theme, along with China concerns.