Private equity: Render unto Caesar – despite bankruptcy and $18 billion of debt

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How can Caesars Entertainment have an equity value of $2 billion while its bankrupt operating subsidiary owes creditors $18 billion?

Private equity firms have a long-standing and richly deserved reputation for looking out for themselves. But the financial engineering (or in the words of the complaint filed by first lien bondholders "unimaginably brazen corporate looting") employed by struggling US gambling firm Caesars Entertainment’s private equity owners to preserve value for themselves and push losses onto bondholders is certainly breathtaking. 

Since their ill-fated $30.7 billion LBO of the firm in 2008, TPG and Apollo have tried to shore up the $25 billion of debt still sitting on its balance sheet through more than 40 different deals. Despite, or more likely because of, this the firm has ended up facing a lawsuit from its second lien creditors, and has now placed its operating unit, Caesars Entertainment Operating Company (CEOC) into Chapter 11 bankruptcy.

The restructuring plan for Caesars is essentially this: split the existing company into casino operating company CEOC and a separate publicly-traded real estate investment trust (Reit). If this looks reminiscent of a good bank/bad bank corporate structure that’s because it is. Debt is held at the operating company level (CEOC), which protects the rest of the business from its creditors.

At the crux of the dispute is the allegation by the second lien creditors that in order to preserve value for the parent company, Caesars Entertainment Corporation, management has transferred operating assets worth around $3.6 billion out of CEOC and into other affiliates – essentially asset stripping. 

Unavoidable bankruptcy

This has left CEOC with $18 billion of debt, overall leverage of 20 times earnings and unavoidable bankruptcy. However, CEOC – in which Apollo and TPG have a 64% interest – bafflingly still has an equity market value of $2 billion. In perhaps the most brazen move of all, however, Caesars management has also terminated the parent guarantee on CEOC debt by selling a 5% stake in the subsidiary, thereby rendering it no longer wholly-owned.

This has left the holders of second lien debt in CEOC facing cramdown. The restructuring plan would reduce CEOC’s $18 billion of debt by around $10 billion by simply wiping them out. 

Among them are Appaloosa Management, Oaktree Capital and Tennenbaum Capital, who were behind an involuntary bankruptcy filing made in Delaware on January 12, which demanded the appointment of an examiner to review the intra-company transactions between CEOC and other affiliates.

The company itself countered with its own voluntary filing in Chicago on January 15, having missed a $225 million interest payment on its second lien debt just days beforehand. 

The restructuring plan offers a par recovery for bank lenders and around 94% recovery for first lien bondholders, while cramming down junior lenders. By late January the plan had the support of 80% of first lien bondholders but only 19% of bank lenders and 5% of second-lien lenders. Investors in the bank loans include GSO Capital Partners and Fortress Investment Group.

By mid-January CEOC’s 8.5% February 2020 first lien bonds were trading at around 74c and its first lien bank debt at 90c. Its 10% December 2018 second lien bonds were trading at 14.75c.

The fate of the gambling firm now rests on whether the asset transfers out of CEOC are shown to be illegal and must be unwound or whether the restructuring agreement can stand and the junior creditors be crammed down. 

Whatever happens, the situation at Caesar’s is a case study in the lengths to which private equity firms will go to protect their own interests against those of bondholders that should rank ahead of them in the corporate structure.