CAESARS ENTERTAINMENT CORP CZR
September 11, 2013 - 2:56pm EST by
Astor
2013 2014
Price: 26.25 EPS -$6.60 -$4.50
Shares Out. (in M): 125 P/E NA NA
Market Cap (in $M): 3,292 P/FCF NA NA
Net Debt (in $M): 23,200 EBIT 775 1,150
TEV ($): 26,492 TEV/EBIT 34x 23x

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  • Highly Leveraged
  • Gambling
  • Hotels
  • Rights Offering
  • Short squeeze
  • Off Balance Sheet Liabilities

Description

I am recommending a long position in CZR with a price target of $38 in the next 1-2 months. I believe CZR is severely misunderstood and very poorly analyzed, so much so that the recent move in the stock has simply confounded people. Not only is the recent move justified, in my opinion, there is more to go. Here is why I believe the stock will trade to $38 in the short term:

 

CZR is a very out of consensus idea. It is heavily shorted (almost unborrowable at this point), every analyst that covers it either has a hold or a sell rating and the shorts are constantly in the press, pitching it as a bankruptcy candidate. Not only do I think CZR is not going bankrupt, I believe there is significant upside in the stock.

 

The reasons to dislike CZR are obvious. It is levered over 12x EBITDA, they burn almost $500M in cash/year and they have a 2015 $4.5B maturity that the shorts believe they can’t get past. It is easy to believe that there is no equity value under all this debt so CZR is not only technically bankrupt, it will run out of cash in 3 years. None of that will matter, according to the shorts because CZR won’t be able to refinance its $4.4B PropCo CMBS maturity for 2/15, which will push the company into bankruptcy even earlier.

 

I believe this thought process to be very wrong. One cannot look at CZR as one levered company. It has many component parts that are in fact bankruptcy-remote to each other. There is a HoldCo, a PropCo, an OpCo and now a SpinCo. CZR is spinning off (through a rights offering) many interesting and attractive properties into CAC (Caesars Acquisition Co). This company will trade under the ticker “CGP”. It will be very under-levered, generate a lot of cash, and will be CZR’s growth vehicle. It will be a very attractive stock to own and at the rights offering price of $9.43/share, I believe very cheap.

 

The entire PropCo structure has traded up significantly in the last few weeks as Debtwire is reporting that CZR is in the market to refinance this entity. I believe this process will soon be finished and take near-term bankruptcy risk off the table. The next time the company will have potential issues is going to be 2017 (3 years away). But I believe even that is fixable.

 

PropCo currently has $4.4B of debt and will do about $515M of EBITDA in 2014. I believe that this debt burden will be reduced to $4B through negotiation and improving the collateral pool at PropCo (I would explain further but then it would become a very long pitch. Once you start to work on this, it is easy to see how this is possible). The refinanced structure will have many component pieces probably, including a PIK note (possibly) so that while PropCo credit doesn’t trap real liquidity in the structure, it accretes value while CZR doesn’t de-lever. I believe the blended rate on this structure will be about 7% and PropCo is worth about $8.5/share.

 

PropCo

 

EBITDA

515

Interest

(280)

CapEx

(85)

  Free Cash Flow

150

Multiple

7.0x

Equity Value

1,050

Equity Value/share

$8.4

 

Further there is cash and some receivables at HoldCo worth about $3.75/share. Together PropCo & HoldCo are worth about $12/share.

 

This brings us to OpCo, the ugly stepchild. OpCo is levered 13x EBITDA and arguably drains equity value from the rest of the entities. I believe this is incorrect. There is a set of parent guarantees at OpCo that link it to the rest of the entities. However, these guarantees can be removed, making OpCo its own animal. OpCo could be worth zero but I don’t believe it has negative value to CZR.

 

The Parent guarantee reads:

 

In addition, the Parent Guarantee is automatically released upon the election of the Issuer and notice to the Trustee if the guarantee by Caesars Entertainment of the Credit Agreement, the Existing Notes or any other Indebtedness which resulted in the obligation to guarantee the Notes has been released or discharged.

Definitions:

“Existing Notes” means the Issuer’s 5.375% Senior Notes due 2013, 5.625% Senior Notes due 2015, 6.500% Senior Notes due 2016, 5.75% Senior Notes due 2017, 10.75% Senior Notes due 2016 and 10.75%/11.50% Senior Toggle Notes due 2018.

“Credit Agreement” means (i) the credit agreement, dated as of January 28, 2008, entered into in connection with the consummation of the Acquisition, among the Issuer, the pledgors named therein, the financial institutions named therein, and Bank of America, N.A., as Administrative Agent and Collateral Agent, as amended, restated, supplemented, waived, replaced (whether or not upon termination, and whether with the original lenders or otherwise), restructured, repaid, refunded, refinanced or otherwise modified from time to time, including any agreement or indenture extending the maturity thereof, refinancing, replacing or otherwise restructuring all or any portion of the Indebtedness under such agreement or agreements or indenture or indentures or any successor or replacement agreement or agreements or indenture or indentures or increasing the amount loaned or issued thereunder or altering the maturity thereof and (ii) whether or not the credit agreement referred to in clause (i) remains outstanding, if designated by the Issuer to be included in the definition of “Credit Agreement,” one or more (A) debt facilities or commercial paper facilities, providing for revolving credit loans, term loans, receivables financing (including through the sale of receivables to lenders or to special purpose entities formed to borrow from lenders against such receivables) or letters of credit, (B) debt securities, indentures or other forms of debt financing (including convertible or exchangeable debt instruments or bank guarantees or bankers’ acceptances), or (C) instruments or agreements evidencing any other Indebtedness, in each case, with the same or different borrowers or issuers and, in each case, as amended, supplemented, modified, extended, restructured, renewed, refinanced, restated, replaced or refunded in whole or in part from time to time.

 

I believe the easiest way for CZR to remove the parent guarantees is to pay down or refinance the “Existing Notes” or Senior Unsecured Notes. These are $2.1B worth of paper trading at 70 cents. CZR already owns $1.1B of this paper and is contributing it to CAC so they only need to get rid of another $1B worth. With $1.8B of cash, $1B of potential new debt capacity, $800M of cash coming in from the Macau land sale and the CGP rights offering, CZR has plenty of liquidity to remove the guarantee from OpCo. (While I believe the guarantee language is clear, it is a good idea to get legal advice on it when you begin doing serious work)

 

This completely makes OpCo bankruptcy-remote to the rest of the structure, allowing us to value the other businesses separately. However, even though OpCo can’t mess things up, there are plenty of interesting assets at OpCo. I believe after removing the guarantee CZR will go to the 2nd liens, who will sit under 7x of debt ($5.5B of paper at 10%, trading at 60 cents) and negotiate with them to equitize their stake. Since there is a high likelihood that the 2nd liens wont be the fulcrum security in bankruptcy, it is in their interest to negotiate with CZR to get a piece of the now, very interesting equity. Not only will this move de-lever OpCo significantly, it will allow OpCo to generate cash and de-lever naturally, making the equity position very attractive. I believe the market is totally missing CZR’s ability to restructure their debt in this manner. (I am happy to lay out what I think this deal will look like and why the 2nd liens would do it but again, it would make for a really long writeup right now)

 

There is potentially lots of value at OpCo but for now, let’s just assume that it’s worth zero and move on to CAC. CZR (sometime in the next 4 weeks probably) will do a rights offering to give its shareholder the rights to purchase 1 share of CAC for every share of CZR they hold.

 

The Sponsors (who own 70% of the equity) have committed to excersising $500M worth of rights. There will be a pro-rata over-subscription for un-exercised rights. For our purposes, we will assume that all the rights will be exercised by someone. Post the offering, CZR will own 57% of CGP and CAC (publically owned piece) will own 43%.

 

Here are the assets that will sit in CGP:

 

Planet Hollywood Casino & 50% of the management fee of PH

Horseshoe Baltimore Development & 50% of the management fee of HB

$1.1B of CEOC (OpCo notes, yielding over 9% at contributed value)

Over $900M of cash

Caesars Interactive Entertainment (CIE)

 

CAC will have 125.4M shares outstanding (recall that this will be 43% of the ownership of CGP)

 

Here’s what I think these assets are worth:

 

   

Metric

Amount

Multiple

Debt

Owned

Equity

Discount

PV/ Fair Value

Planet Hollywood

2014 EBITDA

90

10.0x

515

100%

385

 

385

PH Management Fee

2014

18

15.0x

0

50%

135

 

135

Horseshoe Baltimore

2016 EBITDA

100

8.0x

365

52%

226

80%

181

HB Management Fee

2016

15

15.0x

0

50%

113

80%

90

CEOC Notes

   

1,100

   

100%

1,100

68%

748

Cash (will be deployed accretively)

 

950

1.5x

 

100%

1,425

70%

998

CIE (ex real-money online gambling)

2014 EBITDA

85

12.0x

50

75%

728

 

728

real-money online gambling (to be discussed later)

       

 

 

 

  Total

           

4,111

 

3,264

CAC Share (43%)

         

1,768

 

1,404

Per Share of CAC

         

$14.1

 

$11.2

                   

CZR Share (57%)

         

2,343

 

1,860

Per Share of CZR

         

$18.7

 

$14.8

 

Real-money online gambling is a key part of the thesis here and there are varying views on how big this market will be. One thing to remember here is the CZR has about 30% share of the total gaming market in the U.S. and with their partner 888, they will be a formidable force in this market and are set up to be the market leader. I would recommend reading some of the Morgan Stanley pieces on market sizing.

 

CGP’s S1 estimates this market to be about $9.6B (online poker when it was illegal to operate in the U.S. was already a $2B market) so this number is not crazy. Other sources have numbers ranging from $6B to $20B. We will value each scenario:

 

     

CZR Branded Sites

 

888/Partner Sites

     

Bear

Base

Bull

 

Bear

Base

Bull

Total Addressable Market

6,000

9,600

20,000

 

6,000

9,600

20,000

Market Share

 

20.0%

15.0%

10.0%

 

10.0%

7.5%

5.0%

Potential Revenues

 

1,200

1,440

2,000

 

600

720

1,000

  EBITDA Margin

 

15.0%

15.0%

15.0%

 

25.0%

25.0%

25.0%

EBITDA

   

180

216

300

 

150

180

250

Multiple (using midpt of comps)

13.0x

13.0x

13.0x

 

13.0x

13.0x

13.0x

  TEV/Equity Value

 

2,340

2,808

3,900

 

1,950

2,340

3,250

Ownership

   

75.0%

75.0%

75.0%

 

36.8%

36.8%

36.8%

  Total Potential value to CGP

1,755

2,106

2,925

 

717

860

1,194

                   

Total Combined

 

2,472

2,966

4,119

       
                   

CAC Share (43%)

 

1,063

1,275

1,771

       

Per Share of CAC

 

$8.5

$10.2

$14.1

       

PV (50% Discount at least)

$4.24

$4.58

$4.94

       
                   

CZR Share (57%)

 

1,409

1,691

2,348

       

Per Share of CZR

 

$11.2

$13.5

$18.7

       

PV (50% Discount at least)

$5.62

$6.07

$6.55

       

 

So when we add this together, I believe that CAC will be worth between $23-$28 without any future growth projects. On a PV basis, CAC is worth between $15.4-$16.1. Lets just call it $15.5, i.e. When a CZR shareholder purchases the right to buy 1 share of CAC (ticker CGP), he will pay $9.43 for something that is worth $15.50. I believe this will be a very popular no-brainer trade. Moreover, CZR has a potential project in Boston and the recently announced potential projects in Japan, that will eventually end up in CGP as well. CGP is after all Caesar Growth Partners, it will be the growth vehicle for the combined entities. It is very well capitalized and has a great management team, setting it up for a lot of success.

 

When CGP trades at $15.5 (potentially is worth $28 ex Boston & Japan), CZR’s stake (57%) is going to be worth $20.5/share. Recall that we have already determined that PropCo & HoldCo are worth $12/share. This makes CZR worth $32.5/share currently. However, since we stand to make almost $5.5/share on CGP (which I think a lot of people would want to get long), I expect that CZR shares will trade through intrinsic value and reflect the potential in CGP and should trade at $32.5+$5.5 = $38, about 45% upside in the near future.

 

However, this is really the gift that keeps on giving, I do believe that there is equity value at OpCo post a friendly debt restructuring given that the 2nd liens should be happy to convert once the stripping of the parent guarantees leave them out in the cold. Plus, we have Boston and Japan and the potential allocation of current growth projects underway at CZR (LINQ and Gansevoort, which should be very attractive).

 

There is one other interesting wrinkle to be aware of. CZR is a heavily, heavily shorted stock. There is a very low float. If you are short CZR, a few really bad things can happen to you. First, you have to be a registered holder of CZR to exercise your right (per the S1). The rights are non-transferrable and non-tradable!

 

I believe that owners of CZR who want to exercise their rights (like any rights offering, if you don’t exercise, you get diluted) will recall their shares in CZR compelling shorts to cover. This may not occur since banks can synthetically create rights to force shorts to provide you fair value of the right. However, you don’t benefit from the over-subscription feature if this is the case so you will recall anyway in order to potentially get more than 1 share of CGP for every share of CZR. It is a very scary dynamic.

 

Not only are the shorts going to be potentially recalled, they are also short CGP as they can’t cover the right in the market. I understand if you want to be short CZR but it makes no sense to be short CGP. CGP will have similar technical dynamics on its first trading day. Lots of short interest, low float, lots of real new buyers who want exposure to this growth story at a very attractive price.

 

If I am correct in valuing CZR at $32.5, then CZR shorts stand to lose $12/share on CZR and CGP combined from the current price. This is why I believe the stock will trade at $38 pre the rights offering (which should happen in the next 4 weeks).

 

However, that is just current intrinsic value. Las Vegas trends are improving dramatically as evidenced by MGM stock. 2014 and 2015 are setting up to be very good convention years (40% of CZR is Vegas). PropCo CMBS debt is currently in negotiation to be refinanced and should take the near-term 2015 maturity out of the equation. This gives CZR 3 years of run-way before they have a liquidity problem. In the meantime, they burn $500M/year. However, I believe that very soon, they will negotiate with the 2nd lien holders by removing the Parent guarantee (requires refinancing or paying off of Senior Unsecured Notes). The interest expense on the 2nd liens incidentally is $550M. Once you cross that hurdle, this becomes a levered structure that can actually de-lever where this is massive amounts of value in the component parts. This is one of Apollo’s biggest deals. I don’t believe they will allow this company to go bankrupt so easily and I believe that the equity market has been very wrong in realizing how fixable this situation is and how dangerous the technical dynamics of the short thesis are, especially as CZR owners begin to recall their shares for the rights offering.

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

PropCo refinancing (imminent)
CGP Rights offering (imminent)
 
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