Ceasars Default Notice Alters Shareholder Odds

Caesars Entertainment Corporation's (NASDAQ: CZR  ) recent default notice makes its common stock more of a gamble than the crap tables. As written in the article, "This Casino is Playing Russian Roulette," Caesars' large debt load and equivocal transfer of assets have put a bullet into Caesars' shareholders. Foolish investors should tread lightly given the situation unfolding at Caesars, and look at much more solvent competitors like MGM Resorts International (NYSE: MGM  ) and Penn National Gaming (NASDAQ: PENN  ) to get exposure to the evolving gaming industry.

Event of default
On June 5, 2014, Caesars Entertainment Operating Company, or CEOC, a majority-owned subsidiary of Caesars, received a default notice from holders of CEOC's outstanding 10% coupon bonds due 2018. Below summarizes the default notice:

1. Transfers by CEOC to another one of Caesars' subsidiaries of the following casinos: The Cromwell, The Quad Resort & Casino, Bally's Las Vegas, and Harrah's New Orleans, which were consummated in May 2014, violated the asset sales covenant. The bondholders believe the transfer of assets is not allowable, claiming that CEOC did not get paid fair market value. Essentially, the bondholders, who are supposed to be protected by collateral of the above casinos, are saying that Caesars cannot transfer the casinos like they did.

2. Caesars denied its obligations of the Notes by stating in its May 6, 2014 8K form that, upon the sale of CEOC's common stock to certain investors, Caesars' guarantee of CEOC's outstanding secured and unsecured notes was automatically released.

If the above points are upheld in court, than the event of default will affect CEOC's senior secured bonds. What's more, the "acceleration" clause, which is typical in bond contracts, would force default under CEOC's other bonds and bank debt. This would force Caesars into Chapter 11 bankruptcy, because CEOC's $16 billion of debt is approximately three-quarters of Caesars' total debt.

Balance sheet woes
Caesars debt-load problem is compounded by the fact that it has a negative $10 billion net tangible asset balance. Net tangible assets are simply total assets minus intangible assets minus total liabilities.

March 31 

Caesars

MGM

Penn

       

Current Assets

$3.4 billion

$1.97 billion

$508 million

PP&E

$13.35 billion

$14 billion

$550 million

Total Assets

$24.38 billion

$25.35 billion

$2.25 billion

       

Current Liabilities

$2.84 billion

$2.2 billion

$395 million

Long Term Debt

$21 billion 

$12.9 billion

$1 billion

Total Liabilities

$27.88 billion 

$21 billion

$1.48 billion

Net Tangible Assets

-$10 billion

-$3 billion

 -$95 million

Source: Yahoo Finance

As the table above shows, Caesars is in much worse shape than competitors MGM and Penn National. MGM, which is closest in total asset size to Caesars, has a positive net balance before adjusting goodwill and intangibles. Even after adjusting for goodwill and intangibles, it has $7 billion more of net tangible assets.

Penn National is about one-twelfth the size of its two peers, but has a much stronger net tangible asset balance. As was discussed in the recent "Penn National Gaming Cashes in on the Evolving Gaming Industry" article, Penn National's sizable intangible assets are due to its much younger age and recent spinoff of its real estate assets. With that said, it is striking that Penn National has such a stronger net tangible asset balance than Caesars.

The large debt balance relative to assets at Caesars creates less room for shareholders to maneuver in bankruptcy court, especially as they are last in line in bankruptcy situations. The sheer uncertainty of how a restructuring will play out makes investing in Caesar's a gamble.

Pressure tactic from bondholders?
After the default notice was given, Caesars responded by saying that the note-holders' claims are "baseless and self-serving." While a court will decide if it is baseless, the self-serving is obvious. When is an investment not self-serving? While the response was obvious, it does bring to light that a default notice puts pressure on Caesars, and may provide the bondholders with negotiating leverage. Such leverage hurts shareholders, especially when the bondholders are hedge funds such as Canyon Capital Advisors and Appaloosa Management.

Foolish Takeaway
The recent Caesars default notice has commenced a likely long and messy restructuring battle. The lack of hard assets compared to its liabilities, and the negotiating leverage held by bondholders, make it likely that shareholders could be left holding the bag. Foolish investors should be careful, and look toward more solvent competitors to make bets on the gaming industry.

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