How Long Will Caesars Entertainment Last?

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Recently, Caesars Entertainment (Nasdaq: CZR  ) went public with a wildly successful IPO -- depending on how you judge such things. The stock rose nearly 100% on its opening day, providing IPO investors a quick profit on their investment.

But Caesars’ finances and operations aren’t nearly as successful, and with the company sitting on an astounding amount of debt, I have to wonder how long the company will survive.

Digging themselves into this mess
After being bought out by private equity buyers in 2007, the new owners piled on debt at the worst possible time. When the recession hit, Caesars couldn’t even begin to pay off debt, and without modifications from lenders, the company probably would have been bankrupt a couple of years ago. A slight recovery in Las Vegas in the last two years has allowed Caesars to avoid bankruptcy recently, but losses are continuing to pile up in the meantime.

Debt trajectory
When looking at a company’s finances, one of the things you should note is how fast debt and revenue are growing. If debt is growing faster than revenue, eventually there will be too much debt for the company to handle, and creditors will stop the money flow.

At Caesars, debt has grown 4.2% from September 2010 to September 2011, not including debt added since Sept. 30. Over the same time, revenue declined 1.5%. That’s a recipe for disaster.

How do you pay for all of that debt?
When you see how big the hole is for Caesars, it’s hard to imagine a way out.

In the first three quarters of 2011, Caesars had debt payments of $1.45 billion -- almost a $2 billion per-year run rate. To pay for that, the company needs to generate in excess of $2 billion per year of operating profit. If it doesn’t, so begins a downward spiral where debt and net loss grow -- and which eventually ends in bankruptcy.

The problem is that Caesars only generated $663.9 million in operating profit in the first nine months of 2011 to pay for the $1.45 billion in interest payments. Even if the company could grow operating income 10% per year, it would take nearly six years to generate enough operating profit to pay for interest alone -- and that doesn’t include the new debt that would be racked up at the same time.

By the way, Las Vegas isn’t growing anywhere near 10% per year right now, so the outlook isn’t positive.

Lagging the market
Most of the other industry players are focusing growth on Asia, where Macau and Singapore have experienced astounding gaming growth. Las Vegas Sands (NYSE: LVS  ) and Wynn Resorts (Nasdaq: WYNN  ) , after getting a start in Las Vegas, now generate a majority of their revenue in Asia. Macau-centric Melco Crown (Nasdaq: MPEL  ) is a pure play on the region, and even Caesars’ major Las Vegas competitor MGM Resorts (NYSE: MGM  ) is focusing on Macau for growth.

The only notable growth opportunity Caesars has its sights set on is online gaming in the U.S. This could be a big win if legalized, considering the company’s casino brands and the World Series of Poker. But is it enough to save Caesars? I've projected that online gaming could generate more than $100 million of EBITDA for the big players, but that still doesn’t solve Caesars’ problems.

Writing is on the wall
Caesars has survived this long because bond investors have been willing to accept longer-term securities in the hope that operating conditions will turn around. But bond investors are taking notice of Caesars’ weak operations, which are usually the first sign of trouble. Investors recently demanded a higher yield than Caesars initially offered to amend and extend loan terms. Higher yields are the beginning of a bankruptcy spiral that Caesars is likely headed down.

Without major improvements in Las Vegas, it’s hard to see how Caesars won’t keep adding debt and eventually find itself in bankruptcy. I’ve made an underperform CAPScall on Caesars Entertainment that I will keep unless the investment thesis changes. And I don’t see that happening any time soon.

Caesars Entertainment certainly isn’t worth buying, but we have identified a stock that is. In the report, “The Motley Fool’s Top Stock for 2012,” we’ve picked a stock with great growth potential. And the good news is: The report is free.

Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings, or follow his CAPS picks at TMFFlushDraw.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (1) | Recommend This Article (2)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 22, 2012, at 3:53 PM, cp757 wrote:

    Travis great article. I think you have nailed the main points with CZR and the problems they face in the market. I do find a big problem with the long term debt payments of $1.45 billion which you bring up in the article. What bothers me the most is how they represent the Goodwill and Assets on their books at such high amounts,but you have talked about that before. I also think anyone that has invested in this stock has been told that it is not a good investment but you can lead a horse to water but you can't make them drink . I think from February 23 rd to March 9th we will see this stock drop below the 9 dollar IPO..JMHO Travis you said "Caesars Entertainment certainly isn’t worth buying" and that was the truth.

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