Caesars Holdings (CZR), which is the name of the merged Eldorado Resorts and Caesars Entertainment, couldn't have completed its leveraged buyout at a worse time. The coronavirus pandemic is causing casinos across the country to burn hundreds of millions of dollars a month, and it's not at all clear that a recovery in demand is coming this year.
Official data hasn't been released yet, but estimates from J.P. Morgan and Visitdata.org show that traffic to casinos has been down around 40% since reopening in early June. That doesn't bode well for traffic until a COVID-19 vaccine is released or some other kind of solution is found to bring visitors back to casinos across the country. Yet Caesars is piling on debt in order to grow, and that could lead to the same mistake its legacy company Harrah's made more than a decade ago.
Betting big on U.S. gambling
To finance the acquisition, Caesars Holdings has taken on $15.5 billion in debt. That may have seemed manageable pre-pandemic, when management expected $3.6 billion in property EBITDA, a proxy for cash flow from resorts (which importantly includes $500 million in expected synergies). But that's high leverage in a good economy, and the pandemic could leave the company in a much worse financial position.
The last time an acquisition of this size took place in the gambling industry, it was the $28 billion buyout of Harrah's Entertainment, the predecessor to Caesars. That deal resulted in the bankruptcy of Caesars' largest subsidiary after years of financial struggles and complex financial engineering, although it didn't bankrupt the parent company because of some complicated financial maneuver But that bankruptcy came during a growing economy without a pandemic.
Investors providing debt financing to the latest deal must be confident that the company can return to form once the coronavirus is overcome, but that's a risky bet no matter how you look at it.
A recession may hurt business for a long time
What worries me most about the new Caesars business is the regional gambling markets it's now reliant on. A recovery in Las Vegas is one thing, but regional casinos that dominated Eldorado's holdings and accounted for over half of Caesars' revenue pre-merger will now be the business' engine.
While Las Vegas is driven by partygoers, corporate events, and high rollers, regional casinos aren't as flashy. They count on locals to spend some extra money on the weekend or take a short vacation to their properties. And they aren't all that focused on the high rollers and VIPs that drive the Las Vegas Strip.
The problem with the regional approach is that 51 million Americans are out of work since the pandemic began and a lot of those jobs aren't coming back. Restaurants are closing permanently, service jobs are being cut, and retail jobs will likely drop even after the pandemic is over. And there may not be a stimulus package or boost in unemployment benefits to keep these consumers spending money. I think we're in for a very long recovery for those jobs, and that could have a big effect on regional casino revenue.
Even if revenue is down a modest 5% to 10% from pre-pandemic levels (which I think is conservative), the impact on Caesars' cash flow and EBITDA will be much worse because of leverage in the casino business. And as I noted above, that leverage is high after this buyout, so there's a lot of risk facing Caesars.
Avoid this wager
The fact that Caesars has experience going through bankruptcy after a buyout is a warning sign for me. I think right now, it has taken on too much debt and has too much leverage in its operations to bet on the stock. Even when visitors return to its resorts, Caesars is facing long odds trying to avoid another financial catastrophe.