MGM Mirage and Mandalay Seal Vegas Wedding

Updated from 7:50 a.m. EDT

The $7.9 billion cash-and-debt deal between MGM Mirage ( MGG) and Mandalay Resorts Group ( MBG) is so large that its impact can even be seen from Las Vegas' street corners, where the combined company dominates the world's largest gambling market.

As expected, the merger of MGM, the third-largest U.S. gaming company, and Mandalay, the fourth-largest, was unanimously approved by the boards of both companies. Under the terms of the deal, MGM bought Mandalay for $4.8 billion in cash, or $71 a share, up from an earlier offer of $68 a share, with the assumption of $2.5 million in debt and $600 million in convertible debentures. MGM said it expects the transaction to be completed by the end of the first quarter of 2005.

"This acquisition will create the world's leading gaming and leisure company with an unmatched portfolio of resorts," said Terry Lanni, chairman and CEO of MGM. "Mandalay is an outstanding franchise with top-notch properties that complement MGM Mirage's existing footprint as well as brands that are recognized and respected worldwide."

Barring any asset sales and pending regulatory approval, MGM and Mandalay have a combined 28 properties -- 10 of which can be found on the Las Vegas Strip, giving it near-complete control over a three-mile stretch of gaming, concentrated mainly on the west side. Eight of the 10 casinos between Treasure Island and the Mandalay Bay casino belong to MGM. Caesars Entertainment's ( CZR) flagship casino, situated between the Mirage and Bellagio, remains the lone oasis of non-MGM gaming on one side of the street.

"We are clearly bullish on Las Vegas and its potential," said Jim Murren, CFO of Mirage, "and believe the combination will better position us to meet the needs of a broad range of customers in an increasingly competitive regional and national gaming marketplace."

According to research from UBS, MGM now controls 48% of the gaming positions, 46% of the square footage and 49% of the hotel rooms on the Las Vegas Strip. But, depending on how the deal is financed, the acquisition could come at the expense of shareholders and future earnings potential. MGM hasn't revealed details about the deal, but said on a conference call that the full merger agreement would be released next week.

Even at $71 a share, MGM said the deal was immediately accretive to earnings, with the combined companies having pro forma revenue of $6.5 billion last year. Banc of America Securities estimates the acquisition could add 20 cents to 30 cents a share to MGM's annual EPS, while Prudential Equity Group said it could add as much as 62 cents to MGM's earnings in 2005.

Investors like the merger as well. Shares of both companies have appreciated since the takeover play began June 4, with MGM gaining 7.5% and Mandalay gaining 12.5%, but on Wednesday, shares of MGM fell 59 cents, or 1.2%, to $48.91, while Mandalay dropped 8 cents, or 0.1%, to $67.80.

Cash or Charge?

But some outcomes are better than others for current shareholders of both companies. A deal that issues more equity instead of debt would be dilutive, sapping some of the earnings leverage.

This is precisely what happened when MGM bought Mirage four years ago. The company spent about $4.5 billion in cash and assumed $2 billion in debt -- but issued 46.5 million shares of stock, or $1.2 billion, to help pay for the deal. In 2000, Tracienda, an investment group headed by billionaire Kirk Kerkorian, the largest shareholder in both MGM and entertainment conglomerate Metro-Goldwyn-Mayer ( MGM), bought nearly half of the offering.

This time around, MGM Mirage could structure its financing in a similar way, according to UBS analyst Robin Farley. With the other MGM issuing a one-time dividend of $8 a share a month ago, Tracienda and Kerkorian are flush with cash. Farley estimates Tracienda netted $1.3 billion, while Kerkorian took home $80 million from the dividend.

At the moment, MGM would not reveal how it will finance the nearly $5 billion needed for the deal, but said it would be accretive no matter how it was structured, even if it has to dole out new equity or finance the entire transaction with debt.

"You'll find a capital structure that makes sense," said Murren, on a conference call. "The Mirage transaction -- there may be some lessons to be learned from there as well. We're going to take our time. The good news is the capital markets are open and hungry for business."

Indeed, as MGM executives noted on the conference call, times have changed since MGM bought Mirage. For one, the gaming industry had not been stress tested by the terrorist attacks and subsequent decline in business. And unlike the airlines and other travel-dependent industries, the casino operators bounced back first and have seen business boom in the years since, fattening cash positions and shoring up balance sheets.

"We've learned that our business is more durable than we thought it was," said Linni, on the call. "That said, we are a growth company and need to put together a balance sheet that will allow us to grow, and that's going to require capital. We're in a capital intensive industry."

The difference between issuing debt and equity will have a remarkable impact on how accretive the merger is.

"The most accretive acquisition financing would, of course, be the most leveraged," said Farley. "Assuming that the acquisition is financed entirely with debt, we estimate that it could be accretive to annual EPS by 45 cents. However, if the acquisition were financed with $1 billion to $2 billion in equity, we estimate it could lower the EPS accretion by 10 to 15 cents."

Antitrust issues could dramatically change the financials surrounding the deal, especially if MGM is forced to sell assets to comply with regulators. Given the concentration of hotel rooms MGM will have in Las Vegas -- especially at the high end of the market -- the Federal Trade Commission could step in and ask MGM to sell an upscale property, which would help raise cash to pay for the deal.

Already, MGM will have to sell one of its Detroit casinos -- an action included in analyst estimates on the deal -- because companies are not allowed to hold two gaming licenses in the same jurisdiction. And there could be more asset sales to come, either to comply with regulators or simply to streamline operations. Prudential Securities estimates as many as 13 properties are good candidates for sale, including a number in Nevada.

But with Wynn Resorts' ( WYNN) 2,500-room Wynn Las Vegas opening in April 2005, Caesars expanding its flagship property and a number of other hotels weighing the construction of new towers, MGM's dominance over the Strip may not be such a pressing regulatory concern.

"Las Vegas Strip sales may not be necessary," said Farley. "Competition on the Strip is not limited by license restrictions, so nearly 50% of the market concentration today could fall. ... By 2006, MGM/Mandalay's share could fall to less than 45%."

For its part, MGM also downplayed any antitrust risks and said the company had no plans to sell assets at this time.

"As for non-core assets, we'll take a look at assets as they come up -- but there won't be the opportunities at Mandalay that we saw at Mirage," said Murren. "We look at the company as a portfolio and we've been buyers and sellers. We'll take a look and do what we think is best from efficiency standpoint."

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