FORTUNE — Blackstone may have just hit the jackpot with its $1.73 billion acquisition of The Cosmopolitan Hotel of Las Vegas. Not only did the private equity firm nab the hip hotel and casino from owner Deutsche Bank at a considerable discount to its development costs, it did so just before the hotel appears set to finally generate some real profits.
But nothing is a sure bet when it comes to the cutthroat Vegas hotel market. In order for Blackstone
to achieve the sort of strong returns its investors expect, the firm’s real-estate team will need to trim costs and boost profitability at the Cosmo’s floundering casino business. While Blackstone lacks relevant experience in the casino space, some out-of-the box thinking on its part, combined with an experienced management team poached from a rival resort, could be the winning ticket to permanently move the Cosmo from red to black.
At first blush, it seems as if Blackstone may have overpaid for its first piece of the Las Vegas Strip. That might sound odd considering that the purchase price works out to a whopping 60% discount to the $4.3 billion Deutsche Bank
ended up sinking into the project. Cosmo’s trailing 12-month Ebitda (which is what it earned last year, before taking into account interest, tax, depreciation, and amortization expenses), based on its latest quarterly filing, works out to around $115 million. As such, the $1.73 billion purchase price implies an enterprise value (ev/ebitda) multiple of 14.8. That compares with rival MGM Resorts International
, owner of such Las Vegas mega hotels as the Bellagio, Mandalay Bay, and the MGM Grand, which has a trailing ev/ebitda multiple of around 11.8. This suggests that the Cosmo’s valuation at the moment is a bit rich compared to the valuations of its peers.
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But those metrics are backwards looking, so they don’t really paint an accurate picture of the hotel’s potential profitability. For example, the company’s Ebitda growth rate has accelerated rapidly quarter over quarter, doubling in the last year alone. As Vegas recovers from its post-recession slump, so too will the Cosmo’s dismal earnings.
But despite its expensive rooms, which average around $300 a night; pricey hotel bars where cocktails average around $15 a pop (before tip, of course); and profitable nightclub venues, where bottle service can set you back thousands of dollars; the Cosmo still doesn’t make money. It isn’t because people aren’t sleeping, drinking, and playing at the resort — it is actually sold out on most weekends and even during the week while big conventions are in town. No, the Cosmo has two big problems — its expenses are out of control and its casino isn’t pulling its weight.
General and administrative expenses at the hotel rose 3% in the first three months of the year compared with the same time last year to a whopping $25 million, or around 14% of revenues. Meanwhile, G&A expenses at rival MGM was at around 12% of revenues. If the Cosmo’s expenses were on par with the MGM this past quarter on a revenue basis, it would have saved around $3 million. That’s around 25% of the $12 million net loss it posted for the quarter.
G&A expenses don’t include sales and marketing expenses, which, for the first quarter of the year, came in at around $20.7 million for the Cosmo. This is Vegas, and while it is understood that hotels need to spend big bucks to make money, there must be a point of diminishing returns. A marketing and sales budget of around 11% of revenue may be overkill. Trimming the budget even 5% would save the Cosmo around $1 million per quarter.
Blackstone can cut all it wants, but the battle for profitability will ultimately be decided by what happens to the top line. If it doesn’t boost revenue, chances are the hotel will continue to struggle. How Blackstone intends on achieving this feat remains to be seen. It could take a page out of its recent successful leveraged buyout of Hilton Hotels and try to expand the Cosmopolitan brand as it did with the Waldorf-Astoria and Conrad luxury brands. Rebranding top Hilton resorts as Cosmopolitans in major cities would create greater brand recognition and could build a loyal following, something the hotel currently lacks.
The casino is the Cosmo’s weakest link. While the casino makes money, it doesn’t make enough to cover the high taxes and fixed costs associated with running a massive resort. Blackstone may try to tackle this conundrum in a few different ways. It could first lower the house odds, drawing in customers and getting them hooked on the Cosmopolitan “lifestyle.” That’s a risky ploy, which could end up backfiring on the hotel if doesn’t monitor tables like a hawk.
But it does present an opportunity to bring in new and younger customers to the tables who may be apprehensive playing against an unbeatable house. While the Cosmo’s young clientele spends a great deal of cash on booze and food, they tend to walk past the tables and slot machines on their way up to the second floor clubs and bars. Monetizing clientele already in the building is always easier than trying to draw in new people off the street. Incentives that link entry to the exclusive lounges with play time could draw in a whole new set of customers for the Cosmo’s hungry casino.
Bringing in younger players is a good start, but it probably won’t be enough to ensure the property’s long term potential. For that, Blackstone needs to target high rollers at other casinos, most of whom tend to be older with deeper pockets. This can be done by poaching management from rivals that have personal relationships with high net worth gamblers.
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But the biggest trouble with the Cosmo and its casino is that it may be too unique. A high roller at the Bellagio will be treated like a king at all of MGM’s 15 properties in both Vegas and Macau, the gambling mecca of Asia. The MGM’s MLife loyalty program keeps a large chunk of clients out of the Cosmo’s casinos. Sure, these high rollers might go for a drink at the Marquee nightclub at the Cosmo, but they won’t be hitting the casino floor. Figuring out a strong loyalty program is essential for the Cosmo to win over the “whales,” those gamblers who drop millions in a night of obsessive gambling. Blackstone could gain some customers by connecting the hotel with Hilton’s loyalty program, but it really needs to align with another casino.
Besides the casino, Blackstone can do a number of things right away to pump up profits quickly. For example, The Cosmopolitan isn’t really using its presence on the Strip very well — actually, it isn’t using it at all. It could gain more foot traffic and lure more potential gamblers to its floor if it actually does something with that space, like new retail and restaurant options. And the top four floors of in its two towers remain empty — devoid of anything. That space could be sold off as exclusive condos or turned into a nightclub. It could also be an exclusive high rollers-only gambling paradise.
There is no denying that the Cosmo has enormous upside potential for Blackstone. It still has the cache of being the newest big hotel on the strip — a distinction it has milked for all its worth. Based on the way the economy is improving, there isn’t much that Blackstone has to do for the Cosmo to post modest profits. But the Cosmo is right on the cusp of making big money. It just needs a good push.