When Caesars Entertainment (NASDAQ:CZR) late last month announced it was being acquired by Eldorado Resorts (NASDAQ:ERI), it was a bit of a shock for the gambling industry. Eldorado was a relatively minor player until it began its acquisition spree a few years ago, and Caesars is just starting to get back on its feet after the bankruptcy of its biggest operating unit.
It should come as no surprise that Caesars investors cheered the buyout, but shareholders on other side of the deal haven't been so happy. Eldorado's shares have dropped nearly 10%, and VICI Properties (NYSE:VICI), which is the Caesars-related REIT that will acquire $3.2 billion of real estate, has fallen slightly as well. If investors' distaste deepens, it could put the deal in jeopardy. Here's what could go wrong.
The market could reject a deal
Eldorado isn't coming to this acquisition flush with cash, nor is it looking to buy out a smaller company. Caesars is significantly larger, and comes with $6.3 billion of its own debt. To swing the deal, Eldorado needs to come up with $7.2 billion in cash and issue 77 million new shares -- it's offering 0.0899 shares plus $8.40 in cash per CZR share. This could go wrong in two ways.
First, it's possible that the banks involved could back out of the deal. Lenders have "fully committed" to providing $2.7 billion in new financing for Eldorado, and made a $1.0 billion increase in the company' revolver. However, if markets freeze up, the economy slows, or any flaws in the deal are found, the lenders could still withdraw their support.
The second group that could rebel? Current Eldorado shareholders. If the stock price continues to drop, the deal will be worth less for Caesars shareholders, and could unravel. For now, as the chart above shows, the buyer's stock is holding steady after that initial dip. But if Eldorado shareholders sour on the acquisition and the stock sells off, a lower stock price could make the deal unpalatable for both sides.
I can't overstate how important financing is to this deal. In a move that illustrates just how desperate Eldorado was to find financing, it agreed to a $98.5 million increase in rent payments to VICI in exchange for $1.4 billion of the $3.2 billion in REIT financing. It's literally mortgaging its future to get the deal done, and that may not sit well with the market.
Economic growth is required
According to Eldorado's projections, the company will be saddled with $21.8 billion of debt once the deal is closed, and $3.1 billion of EBITDAR, excluding $500 million of "synergies." That's a hefty debt load for any company, but particularly for one in the casino industry. Operations are highly leveraged, so a small blip in the economy would be felt at nearly every point of operations for the new company.
The 2008 financial crisis presents a cautionary tale for gambling companies on the topic of leverage. After it struck, several large resort operators and some regional casino companies went bankrupt. There are still half-completed construction projects on the Las Vegas Strip from those dark days. If economy growth slackens, or worse, if there's a recession, and consumer spending at casinos and resorts does not increase, this deal will be in trouble.
Regulators give a thumbs down
Regulators have a voice in any acquisition, and the gambling industry brings its own added layers of complexity. Casinos get state licenses to operate, and too much consolidation, or the prospect of one company owning multiple casinos in close proximity to each another, can lead regulators to insist that companies planning to merge sell assets.
Eldorado says it expects $385 million in asset sales, but there could be more. If too many properties need to be sold off, and the company can't find buyers willing to pay premium prices (like the premium it's paying for Caesars' assets), the deal may cease to make sense.
Recognize the risks
It's unlikely, but Eldorado could ultimately back out of the acquisition of Caesars Entertainment for a number of reasons. It may find something it doesn't like when it does its due diligence; it may determine that there would be fewer synergies than it originally thought; or a falling share price could pressure leadership to change course.
Eldorado has been extremely successful at leveraging low interest rates and steadily growing gambling revenue to grow over the past five years, but this deal may turn out to be a step too far.