"Only peril can bring the French together. One can't impose unity out of the blue on a country that has 265 different kinds of cheese..."
- Gen. Charles DeGaulle
Last week, a consortium led by China's Giant Interactive Group, a privately held operator of gaming sites controlled by billionaire Shi Yuzhu, prevailed in an auction of Caesars Acquisitions Company's interactive casino and social gaming business (NASDAQ: CACQ). That business is 70% controlled by Caesars Growth Partners, which in turn is a unit of Caesars Entertainment (NASDAQ:CZR), all part of the 3-card monte shuffle that preceded the parent's Chapter 11 bankruptcy in January 2015.
This month, parent Caesars announced a plan to remerge CACQ back home through an exchange of shares. The presumed intent is to reassemble the parts broken up, to protect them from creditors, back into an entity that would re-emerge in a reorganization plan slated for a vote by January 2017.
Is this latest move just another piece of fancy financial engineering to shuffle the CACQ assets back into the CEOC deck to help enable management's REIT reorganization plan? Yes, but it's a tinker toy unless the junior note holders now suing the parent are given access to some or all of the proceeds of the possible sale to the Chinese interests, according to some gaming legal minds we consulting.
Meanwhile, the company and its litigants face an August 22nd deadline from the Chicago bankruptcy judge to come up with a palatable settlement through the mediation process. The tenor of his voice is getting shriller, his patience wearing thin, according to our sources in the legal community there.
What's on the table thus far is a strategy by the company's private equity owners, Apollo Global (NYSE:APO), to achieve an 80% "Yes" vote from the senior creditors presently being offered 96c to $1.28 on the dollar.
The juniors, meanwhile, are still claiming foul. They've been offered a sweetened deal that amounts to a range of 29-48c on the dollar.
They're demanding 60c. Steven Davis, the court-appointed examiner who prepared a detailed report on the validity of the juniors' claims, agreed with them and set a $5.1 billion price tag on the value of their position.
The rescue squad from China?
According to Reuters, the billionaire Chinese Internet entrepreneur offered $4 billion for CACQ's interactive business, with forward earnings projected to reach over $300 million in 2016.
If, and we repeat, if, Caesars can clear any possible legal obstacles to the sale thrown up by the juniors and liberate $4 billion, can part of it be used to sweeten the deal for the juniors and make the litigation go away? Right now, given its situation, Caesars has no other realistic way to borrow enough to make the juniors wave bye-bye.
The stated purpose of the remerge filing is that it's a logical move toward an ultimate reorganization filing next January. But is it?
Publicly admitting that part of the proceeds from such a sale would be used for the juniors would be a mea culpa for the company and its owners - no chance there. Yet, facing a deadline imposed by the judge now just a month away, Caesars needs to roll the dice on his gavel: Will he or will he not impose a cram down on the juniors?
According our sources in the gaming legal community, Caesars and Apollo could announce that its CACQ China deal, when concluded, would include a clause promising X amount of the proceeds received would be escrowed and earmarked to sweeten the juniors' deal. It's possible too that if the magic number or close to the magic number is reached, the juniors could agree in advance, and let's turn out the lights and the lawyers' time clocks and everyone go home.
Can it be done?
1. According to our legal associates, such a deal, or some form of it, could be constructed. The next question then is: What will the seniors have to say about it? Thus far, Leon Black of Apollo's entire strategy has been focused on attaining that magical 80% of agreement by the seniors, believing he could do a cram down on the juniors. Again, we spoke to several investment banker friends familiar with the industry, who expressed doubts that if such a windfall did materialize, it could set the stage for the seniors to up their demands for a piece of those proceeds as well.
2. Assume the sale closes and the juniors get nothing more than what has been offered thus far regardless of the windfall? Again, both our legal and banking sources opine that the juniors could go to the mattresses again. They can claim that a Caesars entity, shuffled away to avoid their reach in bankruptcy, now confirmed by the court examiner, is indeed reachable and can impose legal obstacles to block the sale. And we have no solution and lots more ka-ching! for the lawyers.
3. What if the CACQ sale moves forward and no new sweetening is offered the juniors by the August 22 court-set deadline?
"If that happens, you could well be back in the craziness of herding cats. Apollo's best shot is based on the judge coming down on their side. But that begs another question. If that's the case will the juniors throw up their arms and surrender, take their lumps and go away? I can't see any sign of that - just my opinion," said this lawyer who has represented many casino companies and knows the business well.
"Somebody out there believes the Caesars interactive business is worth $4 billion. Based on their forward earnings projections (Their next earnings call will be August 1 to 8th). Their operating numbers are good. The Caesars base added to Giant Interactive's could be very accretive to earnings," said one banker. "The deal doesn't include the Planet Hollywood and Horseshoe Baltimore casinos or the World Series of Poker so this is a straight off bet on online social and real money gaming for Giant, expanding their global footprint."
Sitting in the wings
Who benefits from the $4 billion sale of the interactive business, and what's their position on a possible diversion of proceeds to the juniors? Well, here's an interesting band of brothers. Among the biggest institutional holders of CACQ are Paulson & Company with 1.3 million shares, Soros with 6.5 million, Vanguard with 2.7 million and good old poppa Apollo sitting on the largest single chunk of the equity, 27.9 million shares, or over 20% of the company.
These are all guys notable for their reputation of not letting a penny left on the table untouched. All have been on board with management from the get-go. What's their position on the possible inflow from the sale of the interactive business to Giant? We need to assume they've been well briefed long ago by management on this possibility. We have to assume they remain on board.
As of writing, the stock is trading at $10.80 against a 52-week range of $4.48-12.43. The company's market cap is $1.45 billion and its P/E ratio (TTM) is 44.79. Volume is thin and its operating numbers strong, but must be viewed as colored by the company's odd position as a creature of another entity, Caesars Growth Partners, in turn a creature of Caesars Entertainment. So, certain elements of its financial structure remain cloudy.
Is the situation playable now?
Shorn of the interactive business, CACQ is left with Planet Hollywood and Horseshoe Baltimore, two essentially legacy casinos, neither of which prompts much enthusiasm unto themselves. In fact, it is within the realm of possibility that should Caesars find itself cornered into a Chapter 7 filing, neither would bring premium bids at auction. The World Series of Poker and the databases that are also part of the asset base not being sold do have value. But translated into a residual post-sale share price, they do not seem promising for the individual investor at the moment.
We see no rush now to buy CACQ in anticipation of the sale until there is much more clarity on the legal issues surrounding the company. It seems to us that would-be investors need to watch the calendar.
On August 22nd, the Chicago judge will rule. I'd never bet on any judicial decision - anyone who does is shooting craps.
Post-August 22 to January 2017. This period is key because:
1. If the result is a cram down, we see a possibility that the juniors, armed with the Davis report, will appeal. More delay, more uncertainty.
2. If the judge orders Caesars to get real and sweeten the deal - possibly in the light of the cash inflow from a CACQ sale - we can begin to see some daylight on resolution of the juniors' claims. That assumes the seniors don't up their claims and don't try to legally block any move to sweeten the juniors' deal.
3. If all the legal bramble bushes are cleared and Caesars is green-lit to move ahead with its original plan to split the company into an Opco and a PropCo (REIT), then a far clearer picture of the post-bankruptcy company will emerge. And not until then can a reasonably sensible call be made on the forward potential of the resultant new shares. As we have often alluded to in our SA posts, as both an industry person as well as Caesars alumnus, I believe the company under new, competent management can value the assets it wishes to keep and those to jettison. It can also begin sorting out pressing issues, like any future it may have in Asia and other emerging markets.
This was once a great company, a pioneer, and a visionary operator of first-class properties. It created and expanded a priceless brand name, probably the most famous in gaming. Those assets need to be redeployed, polished, and set on a sound financial basis. And when that happens, we can see a strong upside for the new shares going forward.
For now, we don't see any rationale on the stock other than to hold for those in it and to wait out events for those who see the potential over the intermediate term of a smart entry point.
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.