Casino Business Wobbles at High Stakes Debt Table
The gaming industry (casinos), a major employer in the IUF sectors generally thought of as relatively immune to cyclical developments, is showing signs of being hit by the credit crunch afflicting LBOs. Beginning with the 1998 Colony Capital buyout of Harvey's Casino Resorts, buyout funds have moved into the sector in a big way, attracted by the industry's tempting real estate portfolios and stable cash flows.
Colony went on to form Resorts International, a gaming subsidiary which operates the Las Vegas and Atlantic City Hiltons, Resorts Atlantic City, Resorts Tunica and Resorts East Chicago. The buyout rush culminated in last year's $27.8 billion leveraged buyout of Harrah’s Entertainment by Texas Pacific Group and Apollo Advisors.
In February 2007 - the height of the buyout binge - an industry publication touted the virtues of "alternative" financing for the gaming industry in the following terms: "Today, the massive liquidity of the capital markets has embraced the gaming industry, and that love affair has driven an unprecedented level of deal activity in the industry, including: leveraged buyouts (LBOs), mergers and acquisitions, recapitalizations, new builds and expansions. If a hedge fund or private equity investor is comfortable with the credit (i.e., the borrower), that investor is capable of pricing each security in the capital structure based on risk/return profile of that security. This mode of thinking is highly typical of today’s competitive marketplace and is a far cry from the manner in which federally regulated commercial banking institutions have operated in the past. In the end, it is this aggressiveness of capital market investors that has benefited companies in the gaming industry (http://www.theinnovationgroup.net/maint/docs/AlternativeFinancing.pdf).
In January 2006, Aztar Corporation was acquired in a USD 2.75 billion LBO by Columbia Sussex in a tough bidding war which pushed up the price and saw it taking on Aztar's 676 million in debt. Aztar owns the Tropicana casino-resort properties in Las Vegas and Atlantic City, NJ and other casinos.
Following its assumption of ownership, Columbia Sussex laid off 1,000 union workers at the Atlantic City Tropicana- a quarter of the workforce. The establishment is now understaffed and filthy, according to the official investigative report undertaken as part of the casino's relicensing procedure. "Numerous patron complaints from Tropicana Atlantic City's own files evidence the impact that the layoffs have had on the condition of the property and shown that there is true concern about Tropicana's ability to create and maintain a successful, efficient casino operation," said Yvonne G. Maher, acting director of the Division of Gaming Enforcement.
Revenues have declined sharply, and Columbia Sussex 17% yield debt issues are currently trading at 68 cents on the dollar.
Falling real estate values, continuing credit contraction and weakening consumer demand are all reflected in the falling value of buyout debt generally as the spectre of default and possible bankruptcy looms over the most vulnerable leveraged buyout deals. A November 7 article in the US Business Week notes that "Half of the dozen US companies that defaulted on their debt this year were owned by private equity firms", citing Standard & Poors.
"Leverage", observes Barron's in a December 3 article, "unfortunately cuts both ways. When markets get rocky and financial results suffer, private equity investments can generate big losses. Looking ahead to 2008 and '09, private equity firms could be in the uncomfortable position of telling their investors about impaired equity investments or complete wipe-outs."
Barron's cites the case of the real estate brokers Realogy, bought by Apollo Management for USD 2 billion in April this year. Annual cash flow this year is predicted to barely exceed the 650 million in annual interest charges. Staggering under its burden of debt, and with no real estate upturn in sight, the company's senior unsecured loans are trading at 75 cents on the dollar, while the riskier, higher yielding notes due in 2015 are trading at 62 cents on the dollar. At current trading, Realogy has USD 4 billion in bank debt and 1.7 billion in senior notes outstanding.
Another Apollo buyout, the retailer Linens 'n Things, lost 79 million last quarter, with its debt now trading at just over 50 cents on the dollar. "Unless the retailing environment improves", notes Barrons, "Apollo and its partners could lose all of the $600 million equity investment. Apollo paid USD 1.3 billion for the chain in November 2005, when credit was abundantly cheap.
That the market has turned should come as no surprise - for those whose memories are sufficient to recall that the LBO business is by nature cyclical, and that collapsing junk bond prices in the wake of an LBO bubble are predictable and inevitable. We've been there before, and workers pay the price.