This Casino is Playing Russian Roulette

On April 17, 2014, an affiliate of Caesars Entertainment Corp (NASDAQ: CZR  ) completed a $675 million debt offering as part of a strategy to transfer certain casinos. Transferring these assets is unlikely to materially help Caesars, as it was unable to cover interest payments in 2013. Foolish investors should place their bets on competitors such as Penn National Gaming (NASDAQ: PENN  ) , MGM Resorts International (NYSE: MGM  ) , and Boyd Gaming Corporation (NYSE: BYD  ) instead, as they have managed their debt more effectively through the rough casino environment catalyzed by the most recent recession.

Caesar's casino transfer
On March 3 Caesars announced that it entered into an agreement to sell Bally's Las Vegas, The Cromwell, The Quad, and Harrah's New Orleans to affiliate Caesars Growth Partners, for a purchase price of $2.2 billion. The transaction is expected to close in the second quarter of 2014, as a part of ongoing efforts to address Caesars' solvency issues. 

 

2014

2015

2016

2017

2018

Thereafter

Total

Caesars Debt

 $197 million

 $1.2 billion

 $1.8 billion

 $2.3 billion

 $8.5 billion

 $9.5 billion

 $23.6 billion

Source: Caesar 2013 10-K

As you can see above the company's debt has been a drag, and begs the question of how transferring assets is going to help the company pay down the large debt-load. Fellow Fool Sean O'Reilly's statement "They are shuffling chairs on the titanic" appears accurate, since it is unlikely this maneuver will help the company pay it's debt.

Interest coverage
The interest coverage ratio measures ability to meet interest payments. A higher ratio indicates that the company is more capable of meeting interest payments from operating earnings. A ratio less than 1 would indicate that a company can't meet debt obligations from earnings, leaving no income for the common shareholders or to repay the principle piece of the debt.

Interest coverage = earnings before interest & taxes (EBIT) / interest expense

 

EBIT

Interest expense

Interest coverage

Caesars

 $(2.2) billion

 $2.25 billion

-0.97

Penn 

 $(818) million

 $97 million

-8.4

MGM

 $945 million

 $857 million

1.10

Boyd

 $228 million

 $344 million

0.66

Source: Yahoo! Finance

As the table above shows, the casino industry is having a tough time meeting its obligations. Caesars had approximately negative $2.2 billion in EBIT, while its interest expense was $2.2 billion. It is difficult to understand how transferring assets through affiliates will help Caesars sustain it's interest payments.

MGM and Boyd Gaming both had reasonable levels of interest coverage. MGM was able to cover interest expense by a thin margin, while Boyd came up slightly short. Penn National's interest coverage appears the worst, but this is a bit misleading. EBIT and interest expense are both income statement items, which are based on the 2013 fiscal year. Penn National wrote-down a large amount of goodwill, which lowered it's EBIT by approximately $1.1 billion. Furthermore, Penn National's debt has decreased significantly since the company spun-off it's real estate assets in November 2013.

Casino Leverage
Debt-to-equity indicates what proportion of equity and debt the company uses to finance it's assets, with a high ratio indicating that a company has financed itself primarily with debt. If the cost of debt financing outweighs the return that the company generates on the debt, it can lead to bankruptcy, which could leave shareholders with nothing.

 

Caesar

Boyd

Penn

MGM

Total liabilities

$26.6 billion

$5.1 billion

$1.36 billion

$18.1 billion

Shareholder equity

$(3.1) billion

$0.65 billion

$0.758 billion

$7.8 billion

D/E

-8.58

7.85

1.79

2.32

Source: SEC 2013 10-K's

Caesars has a negative shareholder equity position, which makes it difficult to compare. With approximately $26.6 billion in total liabilities, if Caesars does file for bankruptcy, it will likely wipe shareholders out and cause debt holders to fight for the assets in bankruptcy court.

Boyd is highly levered compared to Penn National and MGM. This is good news for MGM and Penn National shareholders since there is lower risk if the casino industry faces stress like it did in the recession years. Since the balance sheet is a snapshot of the companies overall financial position at a specific point in time, Penn national's liabilities and equity in the above chart represents the post-spinoff position. Unlike Boyd and Caesars, MGM and Penn National have the capacity to take on more debt if management is able to spot good opportunities.

Foolish Takeaway
The casino industry has been a tough environment, causing some of the top players to take on excessive debt. Caesars certainly fits this description, as it was not even close to covering it's interest payments by earnings in 2013. Caesars' most recent maneuver to transfer four casinos is a game of Russian roulette, with shareholders likely to take the bullet. Foolish investors interested in casinos should look at Caesar's competitors, and specifically the post-spinoff Penn National.

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