Bricks and Mortar: Look Past Melco's Losses

On the conference call, management was mum about possible increases in the City of Dreams costs, simply saying it anticipates some increase to the total budget at some point in time. Thus, investors should be prepared for future surprise announcements about cost overruns.

Admittedly, anyone buying Melco right now is gambling a bit, since there are no historical financials. However, the rewards for owning the stock will be hefty.

Melco should be able to grab at least $650 million of earnings before interest, taxes, depreciation and amortization in 2010.

Here's how I get that number. The large investor in the stock predicts that Macau's gaming revenue will grow to about $15 billion in 2010. By that year, or possibly in 2009, Melco is expected to have its three casinos fully up and running.

As one of just six operators in Macau, asking Melco to grab $2 billion of that revenue is not a stretch, the buy-side source says. Assuming a 25% margin, the company should have $500 million to $550 million of gaming EBITDA. Another $100 million of EBITDA will come from hotel and other nongaming profits.

If you also assume Melco can grab $1 billion to $1.5 billion of asset sales from condos and retail sites, that knocks down the stock's enterprise value.

Taking the midpoint, the enterprise value drops to $5.15 billion, down from $6.4 billion today. (Asset sales produce cash, which is not included in an enterprise value of a company.)

Discounting the future cash flows back to today, the stock today looks to be trading at a 9.5 times multiple on that future EBITDA stream.

That's way too cheap. Investors are paying 12 to 13 times EBITDA for Las Vegas casinos, and Macau is a much more profitable market.

Bricks and Mortar Portfolio
	Rating date	Price at rating	Rating	Current price*	Return
Brookfield	1/23/2007	$43.00	Own	39.68	-7.7%
Global R.E. ETF	1/23/2007	$64.00	Own	66.85	4.5%
Ryland	1/23/2007	$56.00	Flag	42.33	**24.4%
Trump	1/23/2007	$17.50	Flag	18.19	**-3.9%
Penn National	2/6/2007	$45.56	Own	42.56	-6.6%
Hilton	3/2/2007	$34.69	Own	35.98	3.7%
Melco	3/12/2007	$15.46	Own	15.9	2.8%
*(3/29/07 closing price)
**Since the stock was "flagged," a drop in price is tracked as a positive for the portfolio, and a rise in price is a negative.

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