"The man who passes the sentence should swing the sword…"
Eddard Stark - Game of Thrones
One way or another Chicago Federal Judge J. Benjamin Goldgar has set a final deadline for the litigants in the now 18-month-old Caesars (NASDAQ:CZR) Chapter 11 bankruptcy filing. You can access the original filing on Prime Docket. The case number is US Bankruptcy Court (Chicago) 15 01145. The judge, who has issued postponements to provide time for the company to detail its offers, has since strongly indicated no further postponements are in the cards. Either Caesars makes a deal with the junior note holders by then, or faces a final gavel, which according to most legal opinions at the moment, could throw the company into a Chapter 7 liquidation.
The judge has set August 22 as the deadline for a deal.
In what many observers view as a possible omen, the battlefield at the moment looks grim. On May 6th, Caesars Entertainment appointed former Manhattan bankruptcy judge Robert Gerber as Chief Restructuring Officer. This presumably is a contingency in case no deal is made by the August deadline. Meanwhile the happy talk from management continues, stressing it continues in serious talks with the juniors to make a deal that would halt the litigation and enable it to get on with its restructuring plan. Our sources in the gaming industry who have periodically consulted in the hedge fund world have been following the case with interest, though they have no direct or indirect connection to any of the principals.
One of these observers is a former colleague, who had worked with me back in 1991 on a casino bondholder prepackage restructure deal we successfully completed. He is of the personal opinion that management has yet come up to a number that would unlock a deal.
"If you read the public history of the deals and investing approach of both Tepper (Appaloosa) and Leon Black (Apollo Global) you can get a sense of where they're coming from. In my opinion both these guys are busier landing blows than making kumbaya. Unless there's a really big piece of change added to the offer for the juniors, there's no chance. Its just my sense of the way the case is moving. Not saying it couldn't happen. The key question is: Where the hell would Caesars find the additional money? As far as I can see, they're out of bullets as far as new debt issuance is concerned."
On May 16th, Reuters reported from a Wall Street Journal story that Caesars had retained Raine Group LLC to seek out bidders for their interactive business (CAC). Though there was no formal process, Raine was asked to field bids that reportedly hit $4 billion. Presumably, if a buyer was found, we could see the possibility of some of the proceeds used to add to the juniors' pot. That could be real but just as likely a head fake since, other than the initial announcement last month, there has been no follow-up news on the initiative.
The state of play now
Since the original Caesars Chapter 11 filing in January of 2015, the private equity owners of the company had almost entirely focused on making the senior lenders as whole as possible, shooting to build support to around 80%. Black has thus far offered them between 96c and $1.28 on the dollar. The seniors, led by Paul Singer who holds $12 billion of the total $18 billion in markers, appear to be on board. Both they and Apollo clearly are moving to trigger a cram down on the juniors pushed by the judge.
The juniors beg to differ so far. They're feeling pretty good about their legal position and don't feel overly threatened by a cram down at the moment. On the contrary, even though they're holding $5.5 billion of the debt, management has subsequently sweetened its original offer that yields between 29c and 48c on the dollar. (The paper is trading at 42c). They're holding out for 60c plus court approval of their own restructuring plan.
"They (the juniors) believe they have the knockout punch already ready to throw past the August deadline," says our source. "The court appointed examiner charged to investigate whether Caesars acted properly in the pre-filing asset shuffle, came down hard on the company in his final report." He estimated the damages to debt holders at $5.1 billion, an amount Caesars at present has no way of raising.
With legal fees mounting past $345 million and the phalanxes of lawyers still gleefully punching their time clocks, it would seem neither party would have the appetite to continue the litigation ad infinitum. In its announcement of appointing a restructuring officer, management indicated that not only was it running out of time, but also running out of money.
Appaloosa Management's Tepper by all indications, has a history of willingness to fight these deals down to the last penny. Both he and his co-litigants have the resources to finance a continuing fight. They believe today as strongly as they did from management's original offer that they're still being stiffed. And the examiner's report has agreed with them. The most recent total put on the table, valued at $3.1 billion, is still $2 billion away from where the court examiner placed the damage number.
The odds and how to play them now
As you know, odds are made by valuation of prospects for each combatant based on past performance, conditions, and bettor's instincts. The odds business is at best a tricky enterprise. And as we all know, they are regularly beaten. Oddsmakers go wrong, longshots win, there are always unknowns. We've compounded the odds in this $18 billion game for investors based on a consensus of sources inside the casino industry with intimate knowledge of the company as well as colleagues in the financial and gaming legal community.
But we do believe based on this research that at the very least they can do is impart a sense of perspective to investors to decide whether a move on Caesars' shares before the judge's hammer comes down one way or another, is justified.
In brief, how best can you bet this deal with the best chance of turning a profit if you bet on the outcome of the brawl now?
1. The odds of Apollo getting 80% of seniors.
Two to One favorable. Clearly, Leon Black is highly confident of a cram down. Or at least that's what his legal team may be saying. Given their recent performance since the bankruptcy, that's not saying much. The advice they've rendered to date, especially after the rough going over the court examiner gave them, has been spotty. True, this case has not been a walk in the park. It's too big with too many moving parts and too many well-heeled, tough-minded litigants lined up against them.
The real burden of blame for the disaster is equally distributed through the economic crisis and a skein of terrible management decisions by executives and the legal teams. Despite this, it appears to our consensus that the seniors have little to lose. Taking their chances that the judge will okay a cram down on the juniors appears to be at least a reasonable prospect and betting on that leans sound.
If you believe this then at its current trading range, we'd say a buy signal on the shares now at $6.84 could yield at least a 15% spike if the judge rules based on Apollo achieving an 80% approval from the seniors.
2. The odds on a cram down. Predicting the decisions of judges has about as much credibility as a roll of the dice, even on a high percentage bet. It may appear easy for a judge to enforce a cram down assuming Apollo achieves its 80% and holds it. There is clear precedent down the line and it is in the best interests of the wider constituency that includes not only the juniors but also the employees and creditors of the company.
Though it may not always seem the case, judges are usually disinclined to enrich lawyers per se. And the juniors could contest a cram down decision and the litigation could take on a new life of its own, totally out of anyone's control.
So our consensus panel has put the odds of a successful cram down at even, 50/50. This is approximately the same odds court examiner Stephen Davis had set as the probability that the juniors' claims would prevail given the facts he'd uncovered suggesting alleged fraudulent asset transfers. Judge Goldgar would need to think long and hard about this one. It's not as automatic as it would seem. So we're putting the odds of a cram down at 1 to 1.
3.The odds on a win by the juniors with a sweetened deal. To achieve this, Caesars would need to reach for more cash, which as previously pointed out, does not exist other than in a possible sale of its interactive business. That means such a sale would need to liberate for the parent enough cash to sweeten the offer to the juniors in or near the 60% it is looking for at the moment.
The clock is against such a deal happening in time for the cash to move onto the settlement table. It's possible that part of the sale deal to the new interactive owner could be structured to divert x percentage of the payment directly to some kind of escrow account to be eventually drawn by the juniors when the deal closes. We put these odds at 3 to 1 against, given the timing and what we know at the moment.
In this case, we see the fact of the settlement of the case, even if it fattens the deal for the juniors, as a plus for the shares. The end of litigation historically has set a bullish tone for stocks of companies involved in eternal, bitter and costly litigations. We see this possibility as bringing an upside move to the stock as well, but the odds of it happening in a timely fashion, 5 to 1.
4. The odds on the parties not reaching a deal by August 22 and the judge issuing no more postponements, thus forcing Caesars into a Chapter 7 liquidation filing. In this case, the judge will virtually have no other choice. The negotiations have gone too long, advanced too little and the litigants too far apart. Judge Goldgar will have few other palatable choices and management would need to file for Chapter 7 litigation.
Our panel sees the odds of this outcome at 3 to 1 in favor, assuming that the final decision approves the alternate restructuring plan offered by the juniors. Right now, the estimates as to how much Caesars' assets could command at auction are all over the place. With some new supply coming into Vegas, with stepped up competition for many of its regional properties increasing (Ex: MGM's (NYSE:MGM) impressive National Harbor property in metro DC due to open at the end of this year could have a powerful poaching impact on Caesars' Horseshoe Baltimore property). Thus, a realistic valuation of what the note holders might recover is tough to make at present.
If you believe in this outcome, you need to sell your stock before the August 22nd date, or stay clear until after that date when a better picture of the company's future emerges. We happen to believe that there will be plenty of time and opportunity for investors to buy into a new Caesars at an attractive entry point. Once the market has a firmer grasp on its new ownership, management and mostly, its post-bankruptcy asset base, is when its equity can be intelligently valued.
The two main guys in the ring
Valuing the two main combatants is far more elusive than what we now know so far. Due to significant prior experience investing in the gaming sector, Black has a better sense of the business than Tepper. Yet given the results of Apollo's tenure, that would be a hard case to make. He's overseen many bad decisions on Caesars from the get-go. His current strategy tells us he's given up on the juniors per se, because he knows that Tepper is a junkyard dog operator. He's a guy who's not giving up once he gets his teeth into your leg. He'll stay tenacious until he reaches a point where he thinks the offer makes sense.
Tepper is a guy with strong bonafides in distressed securities. He's tough, patient and immensely resilient. His fund has returned an amazing 38% annualized over 20 years of operation. He loves deals he sees with a bottomed out downside against a huge potential upside. His estimated $11 billion net worth testifies to his capacity of smelling out undervalued situations, waiting them out and harvesting big baskets of shekels as his instincts prove out.
Our suspicion is that Tepper's recalcitrance to come to a deal so far is of course, centered on a sweetened deal from Caesars. But we also believe that he's looking beyond a resolution of the litigation and betting that the company could fall into the hands of a creditor group. In a restructured company, he could be looking at a gigantic payday on Caesars down the line. The brand and properties still have strong market presence.
The casino is open. Place your bets.
About the author: Howard Jay Klein is a 25+ year c-level executive veteran of the casino industry and a consultant in that sector. During the 1980's he spent 5 years as a senior executive at Caesars. He is the author of Mastering the Art of Casino Management, a Kindle book. He is the publisher of The House Edge premium site on Seeking Alpha. His own gaming stocks are held in a blind trust for his family to avoid potential conflicts of interest with clients past, present and future.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.