Caesars Entertainment Corporation (CZR) is that largest gaming company in the world with over 50 casinos. Nonetheless, the company may be on the verge of bankruptcy due to an untimely LBO by Apollo Global Management (APO) and TPG. In 2008, subsequent to the privatization, the company raised $20 billion of debt. Unfortunately, immediately after the LBO, the housing market crashed, disposable income evaporated and gaming revenues tanked. In early 2012 the company had an IPO for about 10% of the shares outstanding at $9 a share. Since then the company has had to restructure debt numerous times in order make repayments, yet even with the recovery the company is burning cash and approaching insolvency. Recently, a plan was announced to spin off some of the better growth properties into a separate entity and to offer shares in the new company to existing shareholders for $9.43 per share. This should raise approximately $1.2 billion in much needed cash for the parent company and will shelter some assets for the firm in case of a bankruptcy. The new entity will also take on a $2.6-$3.2 billion of debt from the parent company.
Caesars shows strength in its online gaming presence. As the online gaming industry slowly eliminates red tape in the United States, Caesars can eventually expect to profit from that. How long it will take and how much profit there is to be made in what promises to be a highly competitive market is wildly speculative, and assumes Caesars can stay solvent until legalization, something that cannot be taken for granted. Caesars lacks gambling properties in the world's hottest market, Macau, and the company's one asset there (a golf course) is up for sale with no reported bids. Recently, the company's bid for a gambling license in South Korea, something management was optimistic about during the last conference call, was rejected.
On news of the spinoff, shares of Caesars spiked 13% to $16.50. Essentially, the spinoff will shuttle 6 of the best assets out of the parent company which will may potentially enter bankruptcy thereafter. Ostensibly, the only reason bondholders are allowing for this transaction to take place is that bankruptcy is all but certain without the cash infusion and unloading of some debt.
In 2012, Caesars reported a $1.5 billion loss in spite of some recovery in the gaming industry. Operating cash flow was a meager $26.5 million while the company raised another $3.5 billion in debt. Last year, interest payments alone from the $20.5 billion in long-term debt totaled over $2.1 billion. With negative cash flow and huge debt levels, the company is time constrained in finding a solution to insolvency.
Assuming the spinoff goes through, the shares in the new entity will be the quality equity left for shareholders and the shares in the parent company will be a solely speculative regional casino recovery. Thus, common sense dictates that every shareholder with the available cash should buy into the spinoff. In the most optimistic valuation of the new entity where the enterprise value of the assets involved is worth $2.5 billion (see chart), the new shares would have to be worth $25 for it to be worthwhile to buy shares at today's price.
|Asset||Equity Value||Debt Associated||Enterprise Value|
|Associated Mgmt Fees of Min. Stakes||60||-||60|
The value per share assuming all shareholders exercise would be $19.95. The residual equity value of the shares of the parent company would be negative, and valued at 15X EBITDA would be under $5 by subtracting the total 2013 EBITDA of the spun off assets from the parent company, projected as an increase of 10% YoY.
The total cost of the shares plus the cost of buying into the spinoff would be $29 per share. The remaining collection of marginally profitable and heavily leveraged assets would be worth about $4 per share. This would imply a combined 15X EV/EBITDA multiple across the assets, which would value the assets at a premium to the stable and profitable peers of Caesars. A more reasonable multiple of 11X EBITDA (or lower) would yield a total value of closer to $20 per share meaning that the investor would be overpaying if he/she were to buy in today.
How to Play the Spinoff
Whether you are a bull or a bear on Caesars, crucial to risk management is investment method. The way to trade the spinoff is neither to buy shares now in or to short shares outright. A bullish investor is better off waiting for the spinoff and buying on the open market where the shares of the new entity will likely be undervalued if shares trade in line with the offering price. Nonetheless, with over 26% of shares short, and with such wild fluctuations in share price, shorting shares does not look attractive due near impossibility of finding shares to short and the potential of a squeeze with only 10% of shares publicly traded. The implied volatility also does not make put-buying very attractive either as you end up paying through the roof for time value. Bear spreads may be a better choice to recapture time premium, but the market is not liquid and you must expect to pay a large spread to the market makers. An options owner is also subject to the CBOE's adjustment of the deliverable subsequent to the spinoff, which is likely to be fair, but leaves the investor at the mercy of the board. Depending on how the shares trade on the day of the spinoff, the best option may be to short the shares in the parent and buy shares in the new entity on the first trading day.
Additional disclosure: All views in this article are strictly my own opinion. Numbers may be pro-forma based on personal opinions.