Caesars Entertainment (NASDAQ:CZR), which is known best for its large presence on the Las Vegas Strip, may soon be the latest in a long line of cautionary tales of leverage and greed in the gaming industry. The company's $30.7 billion leveraged buyout in 2008 was made at the peak of the market and after a long battle to stay alive it may soon succumb to its own massively debt load.
Against all odds, the company did make it through the financial crisis thanks in part to a number of clever financial deals that kept the company afloat. An IPO followed in 2012 and the company was a market darling for a short time after selling assets to new subsidiaries intended to stave off bankruptcy and retain some value for shareholders. Unfortunately, financial engineering can only go so far and Caesars is now fighting with bondholders who think they've illegally moved assets out of their reach. In the mean time, the stock has tumbled and is now closing in on an all-time low.
What has bondholders so riled up
Since becoming public again, the core problem for Casesars Entertainment has always been debt. As of the end of last quarter, the main company and its subsidiaries had a total of $26.7 billion face value in liabilities. That's unsustainable given the fact that operating cash flow was negative for the first half of the year. The dire position can be stated best by Caesars Entertainment itself in its most recent 10-Q.
"We experienced negative operating cash flows of $386.8 million for the six months ended June 30, 2014 , and we expect to experience negative operating cash flows for the remainder of 2014 and the foreseeable future, and do not expect that our cash flow from operations will be sufficient to repay our indebtedness in the long-term and we will ultimately seek a refinancing, amendment, or restructuring of our debt, or if necessary, pursue additional debt or equity offerings." -- CZR Q2 2014 10-Q filing.
The financial situation caused Caesars Entertainment and its controlling private equity interests (Hamlet Holdings) to create a dizzying array of subsidiaries to salvage some value before going bankrupt. Caesars Acquisition Company (NASDAQ:CACQ) went public with some of the higher value assets and Hamlet Holdings retained its proportional stake in the spun off business.
Below is an illustration of the structure from a presentation in December 2013. Since then, even more casinos have been sold to Caesars Growth Partners and CEOC has sold shares to private investors as well.
The problem is that debt holders are unhappy about the transfer of assets out of entities they can't collect from. In March the lawsuits started flying. Some bondholders sued claiming the transfer of assets to these new subsidiaries wasn't legal and that the company was insolvent. At least six more lawsuits of varying forms have been filed since then with the latest being a claim by bondholders that Caesars Entertainment is in default after giving more senior bondholders and loan investors the right to potential proceeds from other lawsuits and not giving more junior debt the same deal.
Meanwhile, shareholders of both Caesars Entertainment and Caesars Acquisition Company are left in limbo not knowing how the lawsuits will work out. What we do know is that the company as a whole has little chance to survive if it's forced to combine into one company as it once was. Over the last twelve months, adjusted EBITDA -- a proxy for cash flow -- was just $1.8 billion and interest expense was $2.4 billion. To make matters worse, EBITDA is falling while interest costs are rising.
There's just not enough cash flow to pay for all of the company's debt and bankruptcy would only be a matter of time.
Why investors should stay far, far away
Of the two companies as they stand today, Caesars Acquisition Company holds the best assets and balance sheet, which was the design of the transaction that created the company. But we don't know if it will be forced to unwind the acquisitions it made at its creation now that bondholders are suing.
At the end of the day, Caesars Entertainment is deteriorating by the day and eventually at least one of its subsidiaries -- or the entire company -- will have to go through bankruptcy to clean out its balance sheet. But we won't know how that transaction could look until we know the result of this series of lawsuits.
It's that uncertainty that makes this a company worth avoiding for investors. When the core business is in as bad a shape as Caesars Entertainment there's only so much financial engineering you can do. This business is in severe trouble and if the bondholders have their way Caesars Entertainment's days could be numbered.