Caesars Entertainment (NASDAQ:CZR) is a regional gaming company whose assets are primarily held through its ownership of stock in three subsidiaries: Caesars Operating Company (CEOC), CMBS properties (NYSEARCA:CMBS) and Caesars Growth Partners (CGP). CEOC and CMBS own land-based casinos and have extremely levered capital structures, and as a result provide no residual equity to CZR. CGP owns online gaming assets, Planet Hollywood in Las Vegas, interests in a development project in Baltimore and certain other assets. CGP is the only subsidiary with any potential value after its debt obligations. CZR stock has recently soared due to the prospect of online gaming in the US and potential benefit to CGP. However, shareholders should recognize that CZR has guaranteed the payment of the majority of the $25 billion CEOC and CMBS debt obligations and upon a default the creditors of those entities will likely exercise their rights under the parent guarantees and seize the stock of CZR's only valuable asset, its stock in CGP. Note 8 to CZR's 2012 financial statements, states that CZR guarantees primarily all of CEOC's debt and states certain aspects of the CMBS financing are guaranteed.
Apollo and TPG (the sponsors) acquired Caesars in early 2008 and saddled the Company with approximately $25 billion of debt. The business was hit hard in the recession and revenue and EBITDA has declined 23% and 32%, respectively, from their 2007 peak levels. Despite multiple distressed debt exchanges and maturity extensions, total debt remains at approximately $25 billion and the company continues to burn cash flow at a rapid rate.
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Based on reasonable projections, the Company will run out of liquidity by early 2016 at the latest and much of the CEOC and CMBS subsidiary debt trade at a substantial discount to par in anticipation of either an out-of-court restructuring or Chapter 11 reorganization. Debt investors are not very optimistic about the Company's prospects.
CEOC has $20.7 billion of debt and LTM EBITDA of approximately $1.4 billion, after giving credit for over $100mm of "yet-to-be-realized" cost savings, this is ~14x debt/EBITDA. At 8x EBITDA, the CEOC assets are worth $12 billion, approximately $9 billion less than current debt. The benchmark second lien bonds due in 2018 have traded to the mid-50s cents on the dollar as bondholders realize there is not enough value to cover their debt obligations. Therefore, creditors at CEOC will likely use the CZR guarantee as a potential source of recovery.
Leverage at the CMBS properties is 10x LTM EBITDA, however given the second tier assets owned on the Las Vegas Strip and in declining markets such as Atlantic City, these assets are also underwater. Several large hedge funds have purchased CMBS debt and will likely extract a pound of flesh in a negotiated modification of the loans given their ability to exercise parent guarantees at CZR.
Apollo and TPG are sophisticated private equity investors and realize the only way to preserve any of the potential equity value in CGP is to siphon assets away from CZR given the subsidiary debt CZR has guaranteed. The sponsors therefore recently announced a plan to invest in a newly formed public vehicle, Caesars Acquisition Company (NASDAQ:CAC), which unlike CZR is not obligated to repay CEOC and CMBS debt. CAC will purchase an interest in CGP and CZR shareholders will receive the right to purchase shares of CAC at $9.43, the fair value of CGP assets based on an independent valuation. CAC will own 43% of CGP yet retain 100% of the voting shares, stripping control from CZR shareholders. The sponsors will of course only be investing additional dollars in CAC.
CZR shareholders that elect to pay the additional $9.43 for CAC on top of the $21.53 for CZR stock price will own 1 share of CZR that may ultimately be responsible for billions of debt at the CEOC and CMBS entities, and 1 share of CAC. So essentially, a CZR shareholder is paying $21.53 for the stock of a company that will ultimately be insolvent due to the aforementioned debt guarantees to obtain the right to buy CAC shares at fair market value.
While the prospect of participating in the proliferation of online gaming is enticing, CZR has a complicated capital structure and it is important to understand the obligations the company took on to support the original LBO financing. Any value in CZR from its stake in CGP will ultimately inure to the benefit of CZR creditors due to the parent guarantees. It is unlikely that the value of CZR's stake in CGP will be sufficient to make creditors whole, leaving CZR shareholders with the potential for de minimis recovery.
Disclosure: I am short CZR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.