Caesars Entertainment Corp. is working to improve its capital structure, but despite moves to cut costs, buy back debt and pursue a spinoff transaction during the second quarter, Caesars' $23.7 billion debt load is still the elephant in the room and could push them into Chapter 11.
It's not just the size of the Las Vegas-based, private equity-backed casino operator's debt burden that is worrisome; substantial maturities in 2015 and 2016 are also a cause for concern.
However, Caesars CEO Gary Loveman promised in a July 29 second-quarter earnings call that he is "acting aggressively to improve the company's capital structure."
But debt investors aren't too optimistic. One hedge fund invested in Caesars' debt, which asked not to be named, said, "They would need a meteor to destroy the earth, or they'd need [PE owner] Apollo Global Management LLC to come in and buy billions of debt" to avoid filing for bankruptcy protection.
In fact, the hedge fund investor thinks Caesars may already have bankruptcy on the mind. "They're not acting like a company that's hoarding cash, and maybe they're figuring that the end is near."
Although the hedge fund investor is pessimistic about recoveries for creditors of the operating company Caesars Entertainment Operating Co. Inc., he thinks the situation at the property-owning unit, Caesars Property Co., is "fixable."
"We think that's covered," he said, explaining that Caesars could refinance that debt ahead of a bankruptcy filing. PropCo first-lien debt is trading at 93 or 94, up from 70, he said, counting that as a statement of faith in a PropCo refinancing. The mezzanine debt in the PropCo unit is trading at about 70 cents on the dollar, but the investor thinks there's hope for that class too.
"If I was them, I'd just tank the business, buy back debt in the 20s [20 cents on the dollar range], and equitize those notes," the investor said, adding, "I've seen people try to run down their stocks, and that's not what they were doing [on the earnings call]. They were all smiles, and 'everything's fine.'/"
Caesars did take some positive steps toward debt extinguishment in the second quarter ending June 30, by raising capital to repurchase some of its debt at a discount. The company paid $183.7 million for $225 million of its commercial mortgage-backed security loans, and $40.9 million for $51.2 million of its second-lien senior debt due 2018 held by its operating company.
However, the hedge fund investor said that he was confused by the company's decision to buy back notes due in 2018 alongside debt held in the property-owning unit.
"It makes a lot of sense for them to buy back the PropCo debt at a discount--what doesn't make sense is for them to buy back their operating company paper," the investor said. "They'd have to buy back billions of that to move the needle, and the company can't buy back all of that given where it's trading -- they're way too under water."
The investor characterized the buyback of notes due in 2018 as a "waste of money."
Because the debt load is so large, "you can't just buy up the debt and turn it into equity," the hedge fund investor said, adding, "I think this is totally terminal. I have them running out of cash sometime in 2014 or early 2015."
However, that assumes that Caesars' debt covenants would not allow it to issue another $1 billion of first-lien secured debt, a matter that is a point of contention among investors and analysts, the investor said, adding that selling assets or downstreaming cash from the parent company could keep the company alive for longer.
"We're always evaluating options with respect to our balance sheet," Caesars spokesman Gary Thompson said in an e-mail statement Tuesday. "We balance investing in growth opportunities with repurchasing debt and maintaining liquidity. When we do elect to buy back debt, we evaluate current market pricing and other factors and elect which piece of debt best fits our objectives."
Caesars has $215 million in second-lien notes held by its operating subsidiary, Caesars Entertainment Operating, and $792 million in unsecured notes held by the operating company and itself coming due in 2015. In addition, another $1.05 billion in unsecured debt comes due in 2016, according to a July 11 report from Fitch Ratings Inc.
Still, with $1.9 billion in liquidity as of June 30 and under-construction projects such as its Linq shopping and entertainment strip in Vegas still requiring hefty capital expenditures, Caesars needs a more proactive approach to address its upcoming maturities.
For now, the company is focusing all of its restructuring efforts on spinning out a new entity, Caesars Growth Partners, which will include Caesars' online gaming properties, its Horseshoe Baltimore casino and Planet Hollywood Resort & Casino in Las Vegas, along with an infusion of $1.2 billion from existing shareholders, which will include $500 million from its majority owners Apollo and TPG Capital.
The spinoff will give Caesars a vehicle for growth--the gaming market is highly competitive, and requires substantial capital expenditures to keep up properties--but it doesn't help the company pay down its debt.
Growth Partners will be a separate corporate entity from the operating company and the unit that owns the properties, and it will have a more attractive leverage profile.
Caesars' existing units are steeply levered: The operating company has a leverage ratio of 12.96, while the property-owning unit is levered at 10.4 times, according to Fitch.
Still, the Growth Partners transaction leaves the operating company's creditors out in the cold. "They've tried to maneuver assets away from the [operating company], so the overall [operating company's] value is weaker," said Fitch analyst Michael Paladino, adding that this transaction reduces the prospect of recovery for the operating company's creditors.
"They're choosing to reinvest in assets rather than paying down external creditors--they're not looking to pay down any external creditors without significant discount," he added.
Paladino said he believes the operating company's first-lien creditors can expect a return of 70 cents on the dollar.
Once Caesars completes the Growth Partners' spinoff, which is currently awaiting regulatory approval, Paladino expects the casino operator will turn its attention to debt refinancing options.
Hiving off the assets with the most growth potential is attractive for Apollo and TPG, which will own slightly under half of the new unit if it raises $1.2 billion as planned.
Private equity firms Apollo and TPG hold 69.9% of the company, which they acquired in a $30.7 billion buyout in 2008 that included $12.4 billion in debt.
Caesars certainly has its work cut out for it. "The overall market for gaming in the U.S. has been pretty lackluster," Paladino said, adding that the U.S. gaming market is fairly mature and key areas are already saturated with competitive properties. Caesars has not succeeded in getting licenses to open casinos in the Asian market, which is performing much better than the U.S. market.
Caesars did succeed in reducing its net loss for the second quarter by 12.2% year-over-year to $29.5 million on net revenue of $2.2 billion.
Casino revenues were down by 7.5% to $116.8 million, which was largely offset by gains in nongaming revenues.
The parent company is publicly traded on Nasdaq under the symbol CZR; its market capitalization is $2 billion, and its shares closed at $16.85 on Tuesday.
Steven C. Todrys joined Evercore's investment banking business as a senior adviser, focusing on transactional tax and structuring solutions. For other updates launch today's Movers & shakers slideshow.
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