2013 | 2014 | ||||||
Price: | 61.50 | EPS | $0.00 | $0.00 | |||
Shares Out. (in M): | 87 | P/E | 0.0x | 0.0x | |||
Market Cap (in $M): | 54 | P/FCF | 0.0x | 0.0x | |||
Net Debt (in $M): | 202 | EBIT | 0 | 0 | |||
TEV (in $M): | 0 | TEV/EBIT | 0.0x | 0.0x |
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Background
The full offering documents can be found here
River Rock used to file with the SEC, but ceased doing so after the bond exchange to save money. You can review past SEC filings here.
River Rock continues to produce financial reports which can be retrieved from the casino’s website (https://www.riverrockcasino.com/investors/login.php). You
will need to request a login and then wait perhaps a day or two for it to be activated. All information in those reports is considered confidential, so below I will
rely solely on information that is in the public sphere. For your own cash flow modeling, of course, you will want to get the most recent information.
Debt Structure
Upon completion of the bond exchange, River Rock had the following bonds outstanding:
Issue Par Value Date
Series A 9% 2018 Senior Notes 96,662,000 12/21/11
Series B 8% 2018 Senior Notes 93,302,000 12/21/11
Senior Subordinated 2019 Notes (1) 27,600,000 12/21/11
Subordinated 2011 Notes (2) 3,607,000 12/21/11
TOTAL $221,171,000
(1) The Senior Subordinated 2019 Notes were issued to Merrill Lynch to repay existing debt of the Tribe. These notes pay interest in additional bonds
(Pay In Kind) as long as the combined par value of Senior Notes remains above $100 million, providing additional security to the Senior Notes for a number
of years.
(2) The Subordinated 2011 Notes are holdouts from the exchange and are now at the bottom of the structure and stripped of most of their covenants; all
interest and principal is deferred while the Senior Notes remain outstanding. However, they can be exchanged at any time for Series A Senior Notes, so a
conservative approach would be to assume that they will all be exchanged.
Redemption Notices provide updates to most of this information. $11,014,000 of the Senior Notes were redeemed on 11/1/12, representing 6.08% of the
outstanding bonds (http://emma.msrb.org/EP706596-EP548929-EP949997.pdf).
$1,223,800 of the Senior Subordinated Notes were redeemed on 11/1/12 (http://emma.msrb.org/EP706596-EP548929-EP949998.pdf). It does not specify
the outstanding balance, but if you work through the math on how many bonds would be issued with the PIK and assume that none of the Senior Subs were
redeemed on 5/1/12, you arrive at a maximum estimate of the outstanding par value.
Issue Par Value Date
Series A 9% 2018 Senior Notes 87,253,000 11/1/12
Series B 8% 2018 Senior Notes 82,992,000 11/1/12
Senior Subordinated 2019 Notes (1) max of 28,199,353 11/1/12
Subordinated 2011 Notes (2) 3,607,000 12/21/11
TOTAL $202,051,353
As you can see, 10.4% of Senior Note principal was paid down in the first year after the exchange (total debt decreased by at least 8.6%). This rapid
paydown at par value is what turns an ordinary high yielding bond priced at 62 into a VERY high return bond. If you compare the Series A YTM of 20.9%
and Series B YTM of about 10.0%, it appears that the difference is explained solely by the tax factor; the market appears to be completely ignoring the
early redemptions into the pricing of these bonds!
There are three other off-balance sheet liabilities to note.
“There is a culture of collaboration between the county and the tribal board of directors,” said Sonoma County Supervisor Mike McGuire, whose district includes
the casino. “I heartily appreciate — and sincerely mean this — how accessible the tribal board of directors has been on issues.”
(http://www.pressdemocrat.com/article/20120915/ARTICLES/120919690?p=3&tc=pg)
Covenants
There are two sets of covenants particularly relevant to the cash flows.
2. Paydowns of principal on the Senior 2018 Notes and Senior Subordinated 2019 Notes are determined by River Rock’s “Excess Cash Flow” (essentially
free cash flow less distributions to the Tribe – see full definition in offering docs) as follows.
If trailing four quarter Excess Cash Flow (ECF) is:
Cash Flow Modeling
Other than the general malaise about gaming bonds, why are River Rock’s bonds trading so cheaply? The reason is that a large new competing casino is
expected to open by year end at Rohnert Park, about 30 miles south of River Rock Casino. This casino will be closer to San Francisco and will certainly
draw away some of River Rock’s customers due to the shorter travel distance. In one of Standard & Poor’s last reviews of the defaulted bond, its analyst
anticipated a mid to high 30% drop in EBITDA due to the new casino, while management believed it could be less than 30%.
Despite this, a stress test of River Rock’s cash flows shows that there is still likely to be a comfortable cushion in covering interest payments and paying
down principal. I assume a Base Case 35% drop in EBITDA in the first quarter of 2014. The last full calendar year that River Rock filed with the SEC was
2010, so I will use some historical values from then in combination with known information from other SEC filings to present an illustration of how well
River Rock can handle the drop in EBITDA. CapEx is assumed to be the maximum permissible $5 million each year. Principal payments occur every six
months (5/1 and 11/1), based on financial calculations ending with the preceding quarter.
THE FOLLOWING ILLUSTRATION IS NOT BASED ON THE MOST RECENT DATA!!!
You will need to review River Rock’s confidential reports over the past year to fine tune your estimates going forward.
ALSO NOTE: THE TABLE BELOW IS HYPOTHETICAL AND IS NOT A PROJECTION FROM RIVER ROCK’S MANAGEMENT.
All values in thousands of dollars
Basis for initial Q1 2013 assumption | Q1 2013 | Q2 2013 | Q3 2013 | Q4 2013 | Q1 2014 | Q2 2014 | Q3 2014 | Q4 2014 | |
Cash Flow | |||||||||
Net Income | quarterly average from 2010 | 6,423 | 6,416 | 6,622 | 6,614 | 2,225 | 2,218 | 2,341 | 2,333 |
+ Interest Expense | using par values from "Debt Structure" section of this write-up | 4,081 | 4,089 | 3,882 | 3,890 | 3,679 | 3,687 | 3,564 | 3,571 |
+ Depreciation | quarterly average from 2010 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 |
+ Sonoma MOA Payments | per current MOA | 875 | 875 | 875 | 875 | 875 | 875 | 875 | 875 |
TOTAL | 13,841 | 13,841 | 13,841 | 13,841 | 9,241 | 9,241 | 9,241 | 9,241 | |
Annual | 55,365 | 55,365 | 55,365 | 55,365 | 50,765 | 46,165 | 41,565 | 36,965 | |
Excess Cash Flow | |||||||||
Net Income | quarterly average from 2010 | 6,423 | 6,416 | 6,622 | 6,614 | 2,225 | 2,218 | 2,341 | 2,333 |
+ Depreciation | quarterly average from 2010 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 | 2,462 |
-Priority Tribal Distribution | per covenant | (2,250) | (2,250) | (2,250) | (2,250) | (2,250) | (2,250) | (2,000) | (1,750) |
- Bellacana Lease Payment | per August 2011 agreement | (696) | (696) | (696) | (696) | (696) | (696) | (696) | (696) |
- CapEx | max allowable under covenants | (1,250) | (1,250) | (1,250) | (1,250) | (1,250) | (1,250) | (1,250) | (1,250) |
+ Deferred Interest on Sub Debt | using par values from "Debt Structure" section of this write-up | 458 | 466 | 457 | 464 | 454 | 462 | 459 | 467 |
TOTAL | 5,147 | 5,147 | 5,344 | 5,344 | 945 | 945 | 1,316 | 1,566 | |
Semi-Annual | 10,294 | 10,294 | 10,492 | 10,689 | 6,290 | 1,891 | 2,261 | 2,882 | |
9% Sr. A Notes Par Value Start | using par values from "Debt Structure" section of this write-up | 87,253 | 87,253 | 82,505 | 82,505 | 77,665 | 77,665 | 74,764 | 74,764 |
8% Sr. B Notes Par Value Start | using par values from "Debt Structure" section of this write-up | 82,992 | 82,992 | 78,475 | 78,475 | 73,872 | 73,872 | 71,113 | 71,113 |
6.5% Sr. Sub Notes Par Value Start | using par values from "Debt Structure" section of this write-up | 28,199 | 28,657 | 28,093 | 28,550 | 27,965 | 28,419 | 28,252 | 28,711 |
9% Sr. A Notes Cash Interest | 1,963 | 1,963 | 1,856 | 1,856 | 1,747 | 1,747 | 1,682 | 1,682 | |
8% Sr. B Notes Cash Interest | 1,660 | 1,660 | 1,570 | 1,570 | 1,477 | 1,477 | 1,422 | 1,422 | |
6.5% Sr. Sub Notes Deferred Interest | 458 | 466 | 457 | 464 | 454 | 462 | 459 | 467 | |
9% Sr. A Notes Principal Paydown | - | 4,748 | - | 4,839 | - | 2,901 | - | 1,159 | |
8% Sr. B Notes Principal Paydown | - | 4,517 | - | 4,603 | - | 2,760 | - | 1,102 | |
6.5% Sr. Sub Notes Principal Paydown | - | 1,029 | - | 1,049 | - | 629 | - | - | |
Portion of outstanding Sr. A Notes paid | 5.4% | 5.9% | 3.7% | 1.6% | |||||
Portion of initial Sr. Notes paid | 5.4% | 5.5% | 3.3% | 1.3% |
As you can see, Excess Cash Flow drops materially from approx. $10.7 mil semi-annually in 2H 2013 to just $2.9 mil in 2H 2014. Still, this means that all cash
interest was paid on the debt and there will be $2.9 million available for retiring Senior Notes (the Senior Sub Note paydown ceases after 5/1/14 because
trailing Cash Flow falls below $50 million). Also, because less interest will be due on the notes in the future, even if operating cash flow is flat going forward,
Net Income and Excess Cash Flow will continue to rise again over time. Thus, assuming business is stable, River Rock should be able to pay down a larger
proportion of debt at each semi-annual coupon period in 2015+.
In my actual base case cash flow model (not shown due to inclusion of confidential data), I assume the 35% drop in EBITDA in 2014 followed by a
conservative assumption of zero operating cash flow growth through maturity. The following table shows the anticipated principal paydowns. As noted in
the previous paragraph, the principal paydowns fall substantially in 2014, but then begin to rise again as interest costs decline.
% of outstanding principal paid down |
% of initial principal (as of 3/1/13) paid down |
|
5/1/2013 | 6.7 | 6.7 |
11/1/2013 | 7.5 | 7.0 |
5/1/2014 | 5.4 | 4.6 |
11/1/2014 | 3.0 | 2.5 |
5/1/2015 | 3.8 | 3.0 |
11/1/2015 | 4.3 | 3.3 |
5/1/2016 | 4.7 | 3.4 |
11/1/2016 | 5.6 | 3.9 |
5/1/2017 | 6.9 | 4.5 |
11/1/2017 | 7.7 | 4.7 |
5/1/2018 | 8.1 | 4.6 |
Total | 48.3 |
The total of 48.3 implies that of every 100 bonds you buy prior to the 5/1/13 paydown, approximately 48 of them will be redeemed prior to the debt’s maturity
date; 14 are estimated to be redeemed before the end of this year. Keen observers will notice that these paydowns are more rapid than the outdated cash flow
illustration above (hint, hint).
Last but not least is the question, “How bad can it get?” Based on my cash flow modeling, the Bear Case EBITDA could drop about 52% before there is any
risk to the coupon payments on the Senior Notes. This is a very unlikely scenario and demonstrates how strong the cash flows and covenant protections are
on this bond. Realistically, it would have to get even worse than -52% because River Rock would be able to cut CapEx to boost Excess Cash Flow.
Risk and Return Summary
In my opinion, the biggest risk here is that the cash flow is generated by a single facility. Stressed-test forecasts notwithstanding, there is always a risk of
the unexpected that could derail the investment thesis. Clearly, I do not believe this is a reason to avoid these bonds, but it does argue for a modest
weight in a portfolio.
Despite an expectation for a dramatic decline in cash flow in 2014, it appears likely that River Rock will have little trouble meeting its interest payments and
will most likely retire a substantial portion of the Senior Notes prior to maturity. The interesting thing about the Base Case, Bear Case, and Bull Case (which
assumes only a 30% EBITDA drop and Operating Cash Flow growth of about 2% in 2015+) is that the IRR is not that sensitive to changes in outlook. The
reason is that in all three scenarios, you get the high current yield of 14.5% and you should get fairly good principal paydowns for at least the next 3 coupon
periods. Thus, even a bear on this casino should be long! My IRR estimates are:
Bull Case: 29.0%
Base Case: 28.1%
Bear Case: 25.4%
Note that the Bull Case does not even include the most bullish scenario – an early call of the bonds if River Rock can find financing to restart its expansion
plans, requiring the Senior Notes and their restrictive covenants to be retired. I can’t place a probability on this happening, but considering that they
announced the expansion plans in June 2007 and already spent $67 million in planning, there is likely to be a strong preference to get back on track sooner
rather than later if they can access the money to do so.
Since River Rock’s bonds are likely to be purchased by investors who normally buy corporate debt, a concern is likely to be the matter of default
recovery, whether due to an actual weakness in cash flow or an inability to refinance at maturity. Despite the first lien on casino assets, it is not clear what
capital and collateral can be recovered and there is no way for bondholders to take over the casino and collect future cash flows since only a Native
American tribe can run the casino.
As we know from our book learning days, there are “4 C’s of Credit”: Character, Capacity, Capital, and Collateral. While there is a potential weakness in the Capital and Collateral
areas, I believe I have shown that River Rock has more than enough Capacity. So what of the Character? History provides our first clue as the previous
bond exchange was very investor friendly.
On a forward-looking basis, there are two key factors that lead me to believe that River Rock will remain on good terms with bond investors. First is
that they would still like to go ahead with their expansion plan if financing is available, which means they can’t stiff current lenders and expect new ones
to give them money. Second, whatever the probability may be, the Tribe will be extremely reluctant to take any risk that a creditor could have the casino shut
down or cash flows to the Tribe halted. The payments the Tribe receives from the casino are simply too important; as of 2005, 38% of the tribe was
unemployed and of those employed, 1/3 were below poverty levels. Tribal members over 18 get a monthly payment of about $600, which is significant
income for many of them. Thus, I believe that River Rock’s Character to meet their debt obligations is high. (Source for various points in this paragraph are
from this September 2012 article.
Similar to most sovereign bond issues, this is primarily a bet on cash flow, not collateral. Given the impressive cash flow at River Rock, I believe it is a bet
that is likely to pay off to the tune of an IRR just under 30%.
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