Scott Longley – Caesars – An Infinite Jest…

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One of the most fascinating bankruptcy filings in recent US corporate history, Scott Longley examines why so many Caesars stakeholders called its leveraged growth strategy wrongly.

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The denouement of the case brought against Caesars Entertainment Corporation (CEC) by its creditors in the bankruptcy court in Chicago produced a document that was commensurate with the size of the original buyout’s $30bn-plus debt load.

At over 1,700 pages the judgment from the examiner Richard Davis laid bare the increasingly desperate attempts of CEC and its private equity owners Apollo and TPG to keep a central element of the business afloat even as the waters were lapping around the wheelhouse.

As indictments go, the view of the examiner Richard David is damning. He found there was a “strong case” that Caesars Entertainment Operating Company (CEOC) – the larger of the two entities which constituted the original acquisition – was insolvent right from the off in 2008 and was “certainly” so from the last quarter of 2013 onwards.

Davis goes on to explain why the “most financially savvy investors in the country” got it so wrong. “One of the rationales for the (Apollo and TPG’s) investment in Caesars was that the gaming business was generally recession proof,” he writes. “The recession in 2008 proved this rationale to be wrong and by the end of 2008 Caesars was plainly a troubled investment.”

From that point onwards, the report suggests that CEC, Apollo, and TPG were merely shifting around the corporate chess pieces while delaying the inevitable as they attempted to create “runway” for a business which internal documents admitted would never be able to pay off its debts. As the report details, over the period between 2008 and 2014 there were over 30 complex financial transactions designed to extend debt maturities and which resulted in a complex corporate structure diagrammatic that to the uninitiated was utterly bemusing.

Indeed, the same could be said of company insiders. As Davis also reveals in his report, the company’s 2010 and 2011 US stock exchange 10-K earnings announcements also somehow managed to mistakenly identify Caesars Interactive Entertainment (CIE) as being a subsidiary of the wrong entity.

The efforts to stave off Chapter 11 bankruptcy were to no avail. Over the six-year period, the leverage multiple at CEOC rose from a barely sustainable 8.8 times EBITDA in 2008 to a wholly improbable 16.9 times EBITDA in 2014. At the same time, CEOC’s ability to pay off the debt deteriorated in no small measure due to the various assets sales to other CEC entities. As the examiner’s report lays bare, by 2014 the enterprise value of CEOC had dropped from $14.6bn to just over $6bn while the face value of the interest-bearing debt stayed almost static at $18.4bn. It meant that by the last quarter of 2014 the company was insolvent to the tune of $12bn.

The rabbit hole which the company and its owners had gone down at this point is perhaps best expressed by the comment from ex-CEC chief executive Gary Loveman who made the extraordinary claim in an interview with the examiner that the market value of the debt should have been taken into consideration when considering issues of solvency, not the actual value. As Davis adds in a caustic footnote: “If this were true, the worse the financial condition of a company, the less likely it would be insolvent since such a company’s debt would be trading at an ever increasing discount. Loveman was plainly wrong.”

The company also got it wrong on its interactive division. Davis prefaces his report by suggesting that one “uncertainty of potentially significant magnitude” about potential damages was the degree to which CEOC should be due “some or all of the value” of the social gaming business that now makes up the majority of profits at the Caesars Interactive Entertainment (CIE).

In May 2009, “through a complicated series of steps,” the WSOP business was transferred from CEOC to the newly created CIE in return for a slug of shares in the new entity valued at $15m. CIE was a subsidiary of CEC, though discussions were held that would have made it a direct offshoot of CEC’s ultimate holding company Hamlet Holdings to further distance itself from CEOC’s regulated gaming activities.

CIE was created to exploit the potential of World Series of Poker (WSOP) should the US legalise online poker federally. When that outcome proved to be elusive, CIE bought the social gaming entity Playtika in 2011, and as Davis says, “largely as a result of this acquisition CIE is now hugely successful”.

The examiner’s report makes it clear that though the Playtika acquisition occurred after the transfer of WSOP to CIE, “an argument exists” that CEC “usurped” 100% of any upside from CEOC. Should such a conclusion be reached then, damages amounting to the lost profits or the current value of CIE might be due. Though this exact figure is omitted from the public version of the report, the examiner says that a PwC valuation of the business from December 2014 was “in excess of the billion dollar-plus range”.

David points out that such a claim might struggle in court, not least because it wasn’t clear that were was any big play-for-fun or social gaming opportunity at the time of the WSOP transaction. But even without that, the damages total is sizeable enough. In finding against CEC, the examiner has adjudged that the debt-holders are due potential damages of between $3.6bn and $5.1bn due as compensation for the value that was stripped out of CEOC over the course of six years.

Despite (unsurprisingly) disagreeing with Davis’ findings, CEC responded to the report by agreeing to contribute “substantial and appropriate value to creditors” of CEOC and in early April the company announced it had reached a non-disclosure agreement with certain creditors in relation to moving its “restructuring proceedings forward”.

We can only assume this is progress but whatever amount is agreed will act merely as a coda to the tale of one of the clearest failures of private equity stewardship to have ever been recorded. It’s hard not to conclude that all involved would have had more of a chance of success if they had taken the original $30bn and put it all on black.

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