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Caesars:Ettu,1stlien?|FTAlphaville

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Caesars:Ettu,1stlien?
Sujeet Indap

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Dec1810:007comments

Oneofourfavoritethemesisthelengthstowhichshareholderswillgotoexpropriatevalue
fromcreditors.
InMarchwetoldthestoryofVersoPaper,alistedUSpapercompanythatwasslouching
towardsbankruptcy.Thatis,untilitannouncedinJanuaryamergerwithitsbiggestrival,
NewPageHoldings.VersoPapersharesshotfromunder$0.65toover$4,thebiggestM&A
acquirorpopoftheyear.Thepopwasnotjustaboutthemergersynergiesbutaboutwhogotto
keepthevalueofthesynergies.
Thetieupwasconditionedontwoclassesofdebt,taking50percentorsohaircutstopar,in
anexchangeoffer.Asexpected,thebondholderswerenttookeenongivingupthatkindof
valuewhiletheshareholders(holdingpreviouslynearlyworthlessequity)kepta400percent
gain.Negotiationsensuedandthesides,moreorless,splitthedifference.Versotradesnowat
justover$3.00,waybetterthan$0.80,butnotasgoodasabove$4.00.
Whichbringsustothisstockpricechartofthecasinocompany,CaesarsEntertainment
Corporation.

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Caesarsismakingheadlinesthesedays.Itisquicklyapproachingsomesortoffinancial
restructuringfromitsdoomed2008$30bnleveragedbuyoutledbyprivateequityfirmsTPG
andApollo.OnMonday,itannounceditwouldntmake$225mworthofinterestpaymentson
onetrancheofbonds(2ndliendebt)whileitnegotiatesadealwithamoreseniorclassofbonds
(1stliendebt).Similarnegotiationswith1stlienbankloanholdersended,atleasttemporarily,
lastweekwhichledtothereleaseofafloodofdocumentsdetailingthemonthsof
negotiations.ItwasreportedthatBlackRock,anownerofboth1stlienbankdebtand1stloan
bonds,departedallsettalks.
ThebasicshapeofareorganizedCaesarshasthecompanytransformingintoarealestate
investmenttrust(REIT)wherethecasinounitpaysrenttotheotherunit.Forthebestblowby
blowcoverage,followLauraKellerfromBloombergNewsandDebtwire.
Restructuringshappensforoneofthreereasona)badcapitalstructureb)badbusinessc)both
a)andb).
Caesars,likeVersoPaper,seemstobeavictimofoptionc).Itscrushingdebt(debt/EBITDAof
astaggering12xatclosing)couldnthavecomeatatworsetime,asthefinancialcrisiswas
abouttohit.TourisminLasVegasrecoveredveryslowly,theUSregionalcasinobusiness
sufferedfromanexplosionofnewdevelopmentsacrossthecountry,andCaesarsfamously
whiffedontheopportunityinMacau.
ThatCaesarshaspushedoffareckoninguntillate2014isevidenceofbothitsaggressiveness
andtheamountofliquidityinthemarketavailabletoeventhemosttroubledcompanies(the
companyboastsofover40differenttransactiontorepairthecompanysbalancesheet).
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WhichbringsusbacktotheconundrumofthestockpriceofCZRabove.Howisitthata
companycareeningtowardsbankruptcy(2ndliendebttradingbelow20cents,withhundreds
ofmillionsofotherdebtbehindit)hasanequityvalueofaround$2bnwhentheseemingly
correctvalueshouldbesomethingaround,say,$0?
HalfoftheanswerisinthiscurrentCaesarsorgchart,viaMoodys.Thinkofthispresent
structureastheafter.

Theotherhalfoftheanswerisinthisorgchart.(thinkofitasthebefore).

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SoashareinthepubliclytradedCaesarsisintheparentcompany,CaesarsEntertainment
Corporation(CEC).However,mostofthedebtisheldinthesubsidiarycorporation,Caesars
EntertainmentOperatingCompany(CEOC).

Andthedeltabetweenthetwoorgchartsisthebasisofbothofthevalueofthepublicstockof
CEC(firstfloatedin2012)andthesubjectofsomehotlycontestedlitigation.
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Certain1stlienbondholders,2ndlienbondholders,andunsecuredbondholdershavesued
Caesars.Theallegationsarestraightforward:CEOCseniormanagement,whichiseffectively
CECmanagement,soldandtransferredplumassets(casinosandintangibleassets)that
originallyresidedatCEOCtootherCaesarsentitiesforinadequateconsideration.Thevictim
ofthesetransferswerecreditorsofCEOCwhowereleftwithdebtbutnotenoughcashorcash
generatingassetstoservicethedebt.ThebeneficiariesareCECshareholderswhoownthe
interestsintheunitsthatacquiredthepreviousCEOCassets.
Fromthe1stliencomplaint:
Thisisacaseofunimaginablybrazencorporatelootingandabuse
perpetratedbyirreparablyconflictedmanagement.Aschronicledbelow,inlittle
morethansixmonths,Defendantowners,fiduciaries,andaffiliatesofahopelessly
insolventDelawarecorporation,CaesarsEntertainmentOperatingCompany,Inc.
(CEOC),havestrippedCEOCofeightofitsmostvaluablehotel,casino,and
entertainmentpropertiesincludingasixpropertystrongholdintheheartofthe
LasVegasStripontermsthatwerepatentlyunreasonableinordertoenrich
themselvesattheexpenseofCEOCscreditors.Becauseoftheseactions,a
hollowedoutCEOCtodayretainsonlyaportionofasinglepropertyontheStrip,
whichDefendantshaverecentlythreatenedtotakeaswell.Defendantsalso
siphonedCEOCsothervaluableassets,includingitscustomersandindustry3
leadingTotalRewardscustomerloyaltyprogram,itslucrativeonlinegaming
platform,andevenitscash.Throughthisepicandfraudulentschemeofasset
stripping,andthepurportedreleaseeffectedthroughashamequityinvestment
oftheguaranteeofCEOCsdebtsbyitsparent,DefendantCaesarsEntertainment
Corporation(CEC),DefendantshavethoroughlyransackedCEOCinasweeping
andnowtransparentplantotakeCEOCsprimeassetsforthemselvesandleaveits
liabilitiesandcreditorsbehind.
Thefirstliencomplaintisalivelyreadawordsearchrevealsthatrob,steal,plunder
andpillageareemployedcollectively14times.
Caesarsisnottobeoutdoneonthelitigationfront.Ithascountersued,claimingthatithas
behavedlegallyandhasaccusedcreditorsofbadbehavior,particularlyElliottManagement
who,whileowning1stlienand2ndlienbonds,alsoistryingtoprofitoffofitsholdingcredit
defaultswaps.AccordingtoCaesarsintheirlawsuitagainstcreditors:
ThereisnobasisforanyofDefendantsattacks.Astheyknow,CEOChasnever
missedasinglepaymentofinterestorprincipalontheNotessincetheywereissued
in2008.Ashighlysophisticatedinvestors,Defendantsalsoknowthatthe
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transactionsexecutedbyplaintiffshaveprovidedCEOCwithbillionsofdollarsin
cash,dramaticallyimproveditsfinancesandextendeditsabilitytomakepayments
ofitsobligationsastheycomedue,totalingbillionsofdollarsofpaymentstodebt
holders,includingholdersoftheNotes.
Well,haventmissedaninterestpaymentuntilthisweek.
The1stliencreditors,accordingtoatableintheircomplaint,valuetheeconomiclossofthose
transfersat$3.6bn.

HereistheirversionofthelatestCaesarsorgchart.

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AndsoifaCECisgettingCEOCassetsonthecheap,thenthesharesofCECwouldseemto
benefitattheexpenseofcreditors.Heresanotherchartfromthefirstlienlawsuittheyclaim
showsthedivergingfortunesofdebtandequityholders.

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AndwhiletheircreditorscitenumerousexamplesofassetstrippingfromCEOC,twoare
especiallyinteresting.
TotalRewardsGaryLoveman,CEOofCaesars,isnotthetypicalheadofagamingcompany,
orreallyanymultibilliondollarcompany.HeearnedaPhDfromMITandthenbecamean
expertincustomerbehaviorasaprofessoratHarvardBusinessSchool.Harrahs(the
predecessortoCaesars)hiredhimfirstasaconsultant,thanasCOOandhethenbecameCEO
in2003.
HeconceivedofthecompanysTotalRewardsloyaltyprogramwhichnowhasmorethan
45mmembers.TheprogramisdesignedtomakethefamilyofCaesarscasinosmoreprofitable
thantheywouldbeontheirownbycreatingincentivesformemberstofirstvisitregional
casinosandthenultimatelyvisitLasVegascasinos.
ThecreditorsobjecttotwoactionsrelatedtoTotalRewards.First,thecasinosthatwere
divestedbyCEOCweretheprimeandmoreprofitableLasVegasproperties(withtheexception
ofCaesarsPalace)consigningthemoretroubledregionalpropertiestoCEOC.
Second,earlierin2014,TotalRewardswastransferredoutofCEOCtoanotherentity,CE
Services,jointlycontrolledbytheotherCECsubsidiaries,CaesarsEntertainmentResort
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PropertiesandCaesarsGrowthPartners,foronlynominalconsideration.
CaesarsAcquisitionCorp/CaesarsGrowthPartnersCECisnttheonlypubliclytraded
Caesarsequity.CaesarsAcquisitionCorporationlisteditssharesin2013andhasamarket
capitalisationof$1.2bn.CACcoownsCaesarsGrowthPartners,anotherentitythathad
acquiredseveralassetsfromCEOCincludingseveralcasinosanditspotentiallyvaluableand
highgrowthonlinegamingbusiness(againthelitigationsaysthroughsweetheartdeals).
WhatsmostinterestingishowCACwascapitalised(seetheorgchartsabove).CECconducted
arightsofferingamongitsshareholderstoraiseequityforCAC.CACisnow66percentowned
byApolloandTPGastheycollectivelyputin$600m.ThepublicshareholdersofCECputina
fewhundredmillionfortheremainingstake.
CACnowowns42percentofCaesarsGrowthPartnerswiththeremainderownedbyCEC
(whichitgotinexchangefortheassetsitcontributed).Inotherwords,TPG/Apolloand
whateverCECshareholdersparticipatedintherightsofferinghaveaninterestinGrowth
Partnersthroughtwodistinctvehicles,CECandCAC.
HereisCACsstockpriceperformancesinceitsdebut.

ButbacktoCaesarsEntertainmentCorporationandhow,exactly,itcanhaveanyequityvalue.
HeresthesummaryofitssubsidiaryCEOCsleveragefromFitchRatingsrecoveryanalysis
fromlastweek14xthroughthefirstliendebt,20xoveralldoesntlooksopromising.

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AndfromthatchartfollowsFitchsrecoveryrates(notethatthereisanupdatedrecovery
analysisthisweekthatslightlyraisesrecoveriesbecauseofthesavingsfromthemissed2nd
lieninterestpayment).

Notetheanalysisshowstherecoverywithandwithouttheguarantee.Andthisintroduces
perhapsCECmanagementsmostnotoriouspowerplay:theterminationoftheparent(CEC)
guaranteeonallofCEOCsdebt.Theterminationoftheguarantee,asthefirstliencomplaint
describes,isthecoupdegraceasitclinchesthetransferofvaluefromcreditorsto
shareholders.
TheCaesarsparentcompany,datingbacktopriortheLBO,hadguaranteedthedebtraisedat
theoperatingcompany.AndsowhileshiftingassetsawayfromCEOCtowardsCECisonlya
firststep.Thesecondstepistoterminatetheobligationoftheparenttomakegoodonthedebt.
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CECattemptedtoterminatetheguaranteebysellinga5percentstakeinCEOCfor$6.15m
which,accordingtotheindentures,releasestheguaranteebecauseitisnolongerwhollyowed
byCEOC.NotetheapparentabsurdityinsellingastakethatvaluesCEOCequityat$120m
whenitholds$18bnintotaldebt.
AswasreportedinMay,theguaranteereleaseisprovocativebecauseofnebulouswordingin
thedebtdocumentsthathingesonwhetherthreeconditionshavetobemettocompletethe
releaseinsteadofjustone(theonebeingthesaleofapartialstakeinCEOCwhichCEC
executed).HereisMattLevinewithananalysisofthedraftingoddity.
Butitgetsmorecomplicated.Asitturnsout,atthesametimeoftheCEOCequitysale,CEOC
sold$1.75bninfirstlientermloans(B7tranche)thatdidcomewithanamendedparent
guaranteefortheB7termloanalongwithotherexistingtermloanholderswhoagreedto
certainconcessions.
AndjustwhoboughtthefatefulstakeintheseeminglyworthlessCEOCequitythattriggered
thereleaseoftheparentguarantee?AccordingtoaDebtwirearticlecitedinthefirstlien
complaintitisthehedgefundswhosimultaneouslyboughttheB7bankdebt.Andthis
highlightsoneoftheothercrucialaspectsofthesituation:Thattherearemultiplesophisticated
investorsinvolvedintheequity,thecredit,andcreditdefaultswapswhomaybeparticipating
throughmultiplesecurities.
Andsoifandtowhomtheparentguaranteeappliestoisalltobedetermined,thereisstillthe
matterofvaluingtheguarantee.
Conceptually,theguaranteeissimplyworthwhatCECisworth.AndCECisworthwhatits
stakesintheotherentities,ResortPropertiesandCaesarsAcquisitionCompany,anditscash
areworth.
FromFitch:

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Fitchsanalysisshowstheguaranteetobeworth$2.8bn(CECsmarketcaptodayisroughly
$2bn).Andgoinguptotherecoveryanalysischartabove,theguaranteemakesameaningful
differencetotherecoveriesofthe1stlienloans,1stlienbonds,andsecondlienbonds(Fitch
believesthatguaranteewilleventuallyflowthroughtocreditorspastthe1stlienbankdebt).
Butthatbringsusbacktotheoriginalquestion:Howdoshareholdershaveanymeaningful
valuewhenaccordingtotheFitchanalysis,thecumulativerecoveryforcreditorsisbetween46
and62percents?
Itsnotjustbecausethattheassettransfersandothertransactionsdirectlysnatchvalue
creditors.Thosedealsalsobuystimeandnegotiatingleverageforshareholdersintalkswhere
thereorganizationwillbedecided.Firstadealstruckwithoneclassofcreditors.Andthat
createspressureforotherclassesofcreditorstothebargainingtableratherthantakingtheir
chancesincourt.Andgettingnegotiateddealjustmayleavesomethingforequityholderseven
ifconceptuallytheyshouldbezeroedout.ThefactthatCEChasamarketcapof$2bn,avalue
between$0andthetheoreticalFitchvalueof$2.9bnevenwithapresenceofmodifieddebt
guarantee,isthecalloptionofasettlementthatgivesCECshareholderssomething.
Wecanapproximatehowmuchvaluethesponsors,ApolloandTPG,haveleft(Apollowasalso
thesponsorbehindthebuyoutofVersoPaperthatleftitsaddledwithdebt).Thepairputina
combined$6bnofequityintotheinitial2008buyoutalongwithanadditional$600mto
capitaliseCaesarsAcquisitionCorp.Their64percentstakeinCECiswortharound$1.2bnand
their66%stakeinCACQisworth$800m.Sotheirremainingvalueis$2bncollectively(likely
morewithmanagementfeeschargedtoCaesars)onatotalinvestmentof$6.6bn.Notgreat,
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butbetterthanthe$0thatstrictcapitalstructuretheorywoulddictate.
Andwhetherthemaneuveringisclever,cravenorboth,wedrawtwolessons.
1)Morerecentadvancedstatisticsinbaseballhavefoundrunprevention(defense)justas
importantasruncreation(offense).Thatprincipleapplieshere.Fromthedayitclosed,Caesars
wereneverdestinedtobegreatinvestment.Buttheover40maneuversthatthesponsorshave
executedareaboutbuyingtime,preservingeverypossiblenickeloftheirinitialinvestmentand
retainingasmuchupsideaspossible.
2)Thecaseforprivateequity,apartfromjustpurefinancialleverage,restsonthealignmentof
interestbetweenownersandmanagement.Thereisnoshortageofalignmentofmanagement
andequityownershiphere.Theproblemwiththatisthatvirtuallyeveryotherconstituency
creditors,thecompany,employees,customersareostensiblevictimsoftheownerscapital
structurechoicesaswellastheirdoggedattemptstodefendthem.
Links
1stliencomplaint
2ndliencomplaint
Unsecuredcomplaint
Caesarscomplaint
Bankdebtnegotiationmaterials
FitchRecoveryAnalysis(12/16/2014)
FitchRecoveryAnalysis(12/10/2014)

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ThisentrywaspostedbySujeetIndaponThursdayDecember18th,201410:00.

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