Caesars Restructuring Enters New Phase

NEW YORK (The Deal) -- Speculation about Caesars Entertainment's (CZR) next step in managing its $23.85 billion debt load is intensifying, and sources suspect that the private equity-backed casino giant may move to eliminate the second-lien notes at its operating subsidiary in the coming months.

One hedge fund manager who holds Caesars' debt has a cynical take on reports that the Las Vegas-based company is working with advisers from Lazard on initiatives to revamp its capital structure, including moving assets from the beleaguered operating subsidiary, Caesars Entertainment Operating Co. (CEOC), to the healthier Caesars Growth Partners unit.

The investor, who asked not to be named, believes that Caesars is looking at more than just ways to siphon off assets.

"They're trying to figure out how best to screw the second-lien noteholders [at the operating company level]," he suggested. There is about $5.5 billion in second-lien debt at CEOC.

One restructuring adviser who follows the Caesars debt debate had a more charitable take on the fate of second-lien noteholders.

"Conventional wisdom is that there's some type of equity exchange offer coming down the pike to give second-lien holders an opportunity to participate in the equity value [at the parent company level]," said the adviser, who also asked not to be named.

The restructuring adviser suspects Caesars will pursue an exchange offer for second-lien notes that would either buy up their debt at a discount, offer them equity in the parent company, or give them convertible securities at the parent company level, which would be less dilutive than pure equity.

Those options would "give [second-lien noteholders] some of that upside they're looking for, even if they take an impairment [in the debt exchange]," the adviser said.

Caesars can turn to private equity backers Apollo Global Management LLC and TPG for advice as it considers the best strategy.

A Feb. 11 report by Gimme Credit LLC analyst Kim Noland also focused on the potential for restructuring CEOC bonds.

"The company said bankruptcy was not imminent and this looks to us like an out of court restructuring of the operating company bonds that we have been predicting for some time," the report said.

Noland noted that different tranches of second-lien debt at CEOC are trading for 50 cents to 80 cents on the dollar, depending on the collateral protection and maturity date on the bonds, which creates "an 'opportunity' for Caesars private equity owners to reduce principal claims of bondholders."

The restructuring adviser believes the second-lien exchange offer option may be more attractive than another possibility that has been floated - an incremental first-lien debt raise at CEOC - which "would arguably be very expensive."

Another option the restructuring adviser is not keen on is a CEOC bankruptcy. "A bankruptcy at CEOC could be pretty destructive," the adviser said, citing the expense of the process and also the risks that come with a capital structure comprised of highly interdependent assets siloed in different subsidiaries.

The adviser listed the July 28, 2009, Chapter 11 filing by Station Casinos Inc. as a cautionary tale for Caesars.

Las Vegas-based Station failed because of an unsustainable debt burden from an $8.8 billion buyout in 2007 by the Fertitta family and private equity firm Colony Capital LLC. When Station hit a rough patch, it began promoting its wholly-owned properties at the expense of the properties it owned major stakes in, hurting its business and sparking fights among bondholders, the adviser said.

Still, a holdout problem could make an out-of-court solution at CEOC difficult. There is a contingent of bondholders who are protected against a default by credit default swaps, diminishing their incentive to compromise.

"There are still people who are willing to play chicken and play the holdout card, and they are probably talking to financial advisers about the game theory here," the restructuring adviser said.

Although there is a broad consensus about the likelihood of Caesars turning to its CEOC second-lien debt first, it is less clear where the company may turn next.

"As with most Apollo contracts, there are a number of bond and loan document loopholes remaining to try to take credit support away for bondholders," Adam Cohen of research firm Covenant Review said on Tuesday.

The restructuring adviser believes Caesars should tread carefully around these legal uncertainties. "Regardless of who's right, it would be expensive to find out," he said.

The adviser noted that, now that Caesars isn't in the running for a Massachusetts casino license, the company is freer to start playing up the doom-and-gloom angle.

Caesars could use that strategy to encourage nervous investors in the CEOC second liens to sell at a discount to distressed funds, filling that part of the capital structure with investors who would accept a lower value in an exchange offer, the restructuring adviser said.

Ultimately, "The capital structure at CEOC is highly levered, and it's unlikely they'll grow into it anytime soon, given weakness in regional [gaming] markets," the restructuring adviser concluded.

"Caesars is suffering along with the rest of the gaming industry as consumers pull back, but its fate is worsened by the leveraged buyout that increased debt to near 10 times Ebitda," Gimme Credit's Kim Noland said.

The company admits that its debt load is unsustainable. In its third quarter financial report filed on Nov. 8, Caesars warned, "We do not expect that our cash flow from operations will be sufficient to repay this indebtedness, and we will have to seek a refinancing... If we are unable to service our debt obligations generally, and if we are unable to refinance our debt obligations that mature in 2015 or thereafter, we cannot assure you that our company will continue in its current state or that your investment in our company will retain any value."

The hedge fund investor doesn't see great opportunities for new investors in Caesars'. "On a fundamental basis, there's nothing that looks attractive right now," he said. "When you look at the numbers, I think it's going to be pretty dire, especially looking at [CEOC]."

The hedge fund investor concluded, "There's a premium built in to virtually everything because Apollo has been generally supportive of their businesses, and has tried to keep them out of bankruptcy - although they're not above trying to cram down bondholders."

Caesars is being watched almost rabidly within the distressed investing world.

"It's hard to think of a credit that has more conjecture floating around it in recent memory, probably partly because default rates are so low and there are so few distressed opportunities," the restructuring adviser said.

A Caesars spokesman declined to comment, and a Lazard spokeswoman also declined to comment.

Private equity firms Apollo and TPG hold 69.9% of the company, which they acquired in a $30.7 billion buyout in 2008 that included $12.4 billion in debt.

The company reported $1.7 billion in cash, plus $527.5 million in restricted cash, as of Sept. 30. At that time, it had $23.85 billion in debt.

Caesars Entertainment is listed on Nasdaq under the symbol CZR. Its shares finished at $21.99 Tuesday, with a market capitalization of $3.01 billion.

Caesars Acquisition Co., a unit that was formed last year to hold a stake in Caesars Growth Partners LLC, is listed on Nasdaq as CACQ. Its shares finished at $12.84 Tuesday, with a market cap of $1.74 billion.

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