In June 2019, Eldorado Resorts (NASDAQ:ERI) announced its plan to acquire Caesars Entertainment (NASDAQ:CZR)-- a bigger casino operator that owns nearly half of the resorts on the Las Vegas Strip -- for $17.3 billion. The purchase would require $7.2 billion in cash, 77 million shares of stock, and assumption of Caesars' debt. It was an ambitious move, but with the backing of Carl Icahn, it seemed like a good idea for everyone. 

What nobody could have anticipated was that all of those resorts and casinos would be shut down by a pandemic just as the merger's closure date was approaching. Both companies say the deal will still get done in the next few months, but there are some risks that investors should be aware of. 

Panoramic picture of the Las Vegas Strip.

Image source: Getty Images.

An acquisition that isn't what it used to be

Like it or not, the value of this acquisition has changed dramatically since the agreement was made in June. The $7.2 billion in cash that Caesars shareholders will receive -- $8.40 per share -- remains the same. But those 77 million shares of Eldorado stock -- to be distributed in a ratio of 0.0899 shares per share of Caesars -- aren't looking nearly as attractive as they were a few months ago when the buyer's stock price was rising. Today, Eldorado's stock is worth 63.5% less than it was the day of the announcement. 

ERI Chart

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The cash portion of the deal should also be questioned. Eldorado was planning on using $3.6 billion in new debt to partially fund the acquisition, and was going to enter into a $1.0 billion revolving debt facility, adding to a $1.0 billion revolver that it's acquiring from Caesars. Here's why that's a problem.

Yields on junk bonds have jumped over the last couple of months as high-risk businesses have become even riskier for investors. According to The Wall Street Journal, CCC rated junk bonds now yield 15.7%, up from a 52-week low of 10.6%. The high-yield constrained benchmark has seen rates of 7.8% recently, up from a low of 5.2%. At the same time, Moody's downgraded Eldorado's debt from B2 to B3, only two marks away from its equivalent of a CCC rating. And Moody's has a negative outlook on the company's debt. 

The bottom line is that Eldorado needs to borrow to get this deal done, and borrowing just got a lot more expensive for it. 

The key to the merger

What investors should remember is that VICI Properties (NYSE:VICI) is the real key to this merger happening. The REIT already owns most of Caesars Entertainment's real estate, but will acquire the real estate of three additional resorts for $1.8 billion and provide $1.4 billion in funds through a lease-modification agreement. This lease modification comes with a $98.5 million increase in rent for Eldorado and Caesars. 

The problem is that Caesars and Eldorado may not be able to pay their rent in full over the next year if the resorts aren't generating any cash. VICI Properties addressed that in a recent press release: 

As of April 16, 2020, we are actively engaged in discussions with our five tenants regarding how best to respond to the COVID-19 pandemic as it specifically impacts each tenant's financial and operating situation. While we have not yet agreed to any lease modifications or other concessions with any of our tenants, if the current environment persists we may ultimately support tenants during the short term in ways that we believe will benefit the Company over the long term.

What might "support" look like for those casinos? Penn National (NASDAQ:PENN) recently got $337.5 million in rent credits from Gaming & Leisure Properties (NASDAQ:GLPI) in exchange for Tropicana Las Vegas's real estate. Free rent isn't actually free, so it could be costly for Caesars or Eldorado to modify the terms of their leases further. At the end of the day, VICI Properties holds the key to this deal getting done. 

A gamble either way

Investors are in a tough position here. If Eldorado closes the Caesars acquisition, it would create an extremely leveraged casino company at a moment when the U.S. economy is heading straight into the teeth of the worst economic downturn since the Great Depression. If the deal falls through, it would be hard not to view Caesars as the loser because its stock price today is being held up by the cash portion of the acquisition offer. As standalone companies, both Eldorado and Caesars are highly leveraged, and could see a sharp downturn in business while the U.S. economy remains weak. 

I have my doubts that Eldorado will be able to close the Caesars acquisition, but no matter what happens these aren't consumer discretionary stocks I would want to own given the uncertainty ahead for the U.S. gambling industry.