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Kent State UniversityKerrisdale Capital Investment Case StudyCaesars Entertainment CorporationEvan Gallagher Daniel Shuster Shervon Preston

Caesars Entertainment CorporationEquity Research ReportKent State UniversityHighlightsThis report is published for educational purposesonly by students competing in the KerrisdaleCapital Investment Case Study for the EconomistCompetitive Landscape: Caesars lags behind its competitors interms of profit margin, and lacks a physical presence in Macau, China, the largest gambling hub in the world.Ticker:CZRBankruptcy Proceedings: Caesars’ primary revenue generatingunit, Caesars Entertainment Operating Company is in the midst of aCurrent Price: 10.95bankruptcy filing. The proposed restructuring plan calls for a decrease in the operating unit’s debt, however there is significant con-Recommendation: SELLtroversy surrounding the shifting of assets between Caesars’ variousentities.Negative Cash Flow: Caesars currently operates with negative freecash flow and will continue to do so well into 2020.CZR Daily Adjusted Stock Price 30 25 20 15 10 5 0Market Data52– week High ( )26.7452– week Low ( )8.51Previous Close ( )10.93Market Cap (Millions )1,570EPS (ttm) ( )-25.00Company OverviewCaesars Entertainment Corporationowns, operates, and maintains casino and resort properties across fourteen states and five countries. Thecompany is headquartered in LasVegas, Nevada.1

Industry OverviewIndustry OverviewCaesars Entertainment Corporation operates in the casinos and resorts industry. The industry is competitive, heavilyregulated, and very sensitive to economic conditions. Commercial casino gaming takes a variety of forms, the most recognizable of which consists of what are called Las Vegas-style casinos. Other commercial gaming venues include excursion (mobile) and dockside (permanently moored) riverboats, card rooms, and racetrack casinos, commonly calledracinos.Economic SlowdownThe Casino industry is heavily depended on the level of disposable income available to the general consumer. The economic recession brought a fall in consumer discretionary spending which in turn caused the casino industry to suffer,and despite the general market recovery, the casino industry has yet to fully recover. The Las Vegas Strip was hit hardby the economic recession, and it continues to suffer. An increasing number of states have legalized gambling, which inturn has led to a decrease in traffic to Nevada, and this lower profits for some of the largest casinos. There are currentlytwenty-one states and two U.S. territories that allow commercial casinos in some form.MacauMacau, China is the world’s largest gambling hub, which recently saw its first full year decline in revenue since theearly 2000’s. China’s high profile corruption crackdown is to blame, specifically that of Xi Jinping, the President ofChina, who’s crusade against mobsters has deterred ultra-high net worth and VIP gamblers away from the gaming tables. These gamers account for two-thirds of Macau’s casino receipts, and their absence has sent revenues down by2.6%. The fate of the gaming industry in Macau is largely dependent on how far the Chinese government will take thewar on corruption. While Macau is suffering, Japan is taking steps to legalize casinos. With projections of an increase inhigh net worth individuals, Japan may soon be a key destination.2

Industry Overview (cont)Regulatory EnvironmentThe casino and resort industry is subject to a variety of federal, state, foreign, and local regulations. Most states, including Nevada, require casinos to adhere to a set of state procedures typically known as the “Minimum Internal ControlStandards (MICS).” The MICS focus on several aspects of casino operations including conduct of games, movement ofcash, and the accounting and record keeping of transactions. Due to the high volume and high denomination of suchtransactions, casinos must meet many of the same requirements as banks including anti-money laundering regulations.The Bank Secrecy Act, which pertains to anti-money laundering requirements, amongst others, requires banks to document every transaction above 10,000 USD.Competitive Situation – Domestic & InternationalThe casino and resort industry is highly competitive, with competitors varying in size, quality of facilities, brand, amenities, and a number of other factors. In some locations, such as Las Vegas, Caesars competes directly with other casinosand resorts in the immediate area. In other locations, there is competition from the immediate area as well as surrounding markets.Caesars currently operates casinos and resorts across the country, with a large concentration in Las Vegas and AtlanticCity. Caesars also operates casinos in the United Kingdom, Egypt, South Africa, Canada, and Uruguay. One region thatCaesars lacks a presence is Macau, China. As stated earlier, Macau is the world’s largest gambling hub, and the lack ofa physical presence puts Caesars at a severe competitive disadvantage. Caesars did purchase land in Macau in 2007 for 525 million, however the company was unable to receive permission to begin construction of a new property. In November 2013 it sold property to Pearl Dynasty for 438 million.Despite the relative slow down in Macau, we believe that the lack of a presence in the region will have a serious impacton Caesars’ revenue growth. Macau is the premier gambling destination for ultra-high net worth individuals who provide large streams of revenue and high profit margins. As the economy continues to improve, casinos in Macau will seeimproved business from the ultra-high net worth consumer, business that Caesars will not have access to.Las Vegas Sands Corp and Wynn Resorts International continue to be major players in the casino and resort industry.Both companies have also expanded into Macau and have taken advantage of the growing and high margin gamblingmarket in the region. The additional revenue has allowed Sands and Wynn to build new properties as the legalization ofgambling improves both domestically and abroad.Many casino operators, including Caesars, are reinvesting in existing markets, adding amenities to attract new customers, and intensifying competition in regional markets. Operators are also looking to expand to other markets to even outrevenues. Caesars has experienced negative results in regards to expansion. Attempts at expansion in Maryland, NewYork, California, and Pennsylvania have had negative impacts on operations in New Jersey. Expansion is critical forCaesars’ revenue growth and its inability to do so without cannibalizing its existing operations is cause for concern.3

Company BackgroundCaesars Entertainment Corporation (NASDAQ: CZR) is a diversified casino-entertainment company. The company isoperated through its wholly owned subsidiary, Caesars Entertainment Operating Company, Inc. Caesars operates fiftycasinos in fourteen U.S. states and five countries. Figure 1, below, outlines Caesars’ domestic operations. Caesars alsoowns an online gaming venue, bingo, poker games, and has alliances with gaming operators in Italy and France.The company’s resorts operate primarily under the Harrah’s, Caesars and Horseshoe brand names. Caesars Entertainment Corporation is comprised of the subsidiary Caesars Entertainment Operating Company, Caesars EntertainmentResort Properties, and Caesars Growth Properties.In 2005, Harrah’s Entertainment Corp, founded by William Fisk Harrah in 1937, completed its takeover of Caesars Entertainment Inc. and chose to operate under the Harrah’s brand. Shortly thereafter in 2010, Harrah’s changed its name toCaesars Entertainment Company which is the current publicly traded entity.2008 was a volatile period for Caesars, which at the time still maintained the Harrah’s moniker. It began with Harrah’sdelisting from the New York Stock Exchange and culminated with a leveraged buyout (LBO) by private equity firmsApollo Global Management, LLC and TPG Capital, LP. Harrah’s assumed around 20 billion in debt when acquired.Caesars Corp currently has a joint venture with Apollo Global Management, with TPG Capital and the BlackstoneGroup owning a large portion of stock. Although Caesars may have seen this move as beneficial to the company, itwould be the start of a rather grim journey.ArizonaHarrah's Phoenix Ak-ChinCaliforniaHarrah’s Resort Southern CaliforniaIllinoisHarrah's JolietHarrah's MetropolisIndianaHorseshoe HammondHorseshoe Southern IndianaIowaHorseshoe Council BluffsHarrah's Council BluffsLouisianaHarrah's Louisiana DownsHorseshoe Bossier CityHarrah's New OrleansMarylandHorseshoe BaltimoreMississippiTunica RoadhouseHorseshoe TunicaHarrah's Gulf CoastNew JerseyBally's Atlantic CityCaesars Atlantic CityHarrah's Resort Atlantic CityMissouriHarrah's North Kansas CityNorth CarolinaHarrah's CherokeeNevadaHarrah's LaughlinNobu Hotel at Caesars PalaceBally's Las VegasCaesars Palace Las VegasHarrah's Las VegasThe Cromwell Las VegasThe LINQ Las VegasHarrah's Lake TahoeHarrah's RenoHarveys Lake TahoeParis Las VegasPlanet Hollywood Resort & CasinoRio All-Suite Hotel & CasinoFlamingo Las VegasOhioHorseshoe CincinnatiHorseshoe ClevelandThistleDown RacinoPennsylvaniaHarrah's PhiladelphiaOntario-CanadaCaesars WindsorFigure 1: Caesars’ domestic operationsSource: Caesars Total Rewards4

Pre-Bankruptcy Financial Structure and PerformanceIt is hard to fathom that Apollo Global Management and Texas Pacific Group (TPG) seriously believed in the financialposition of Caesars Entertainment in the wake of their 2008 leveraged buyout that left the firm with over 20 billion indebt. Although their combined 6 billion equity stake in the post-Harrah’s company has been substantially impaired inthe wake of Caesar’s 2009 financial troubles, there is ample evidence that Apollo and TPG have netted lucrative cashflows from the deal. It has been reported that Apollo and TPG collected a 200 million transaction fee in 2008 as part ofthe deal. In addition, both companies reap annual management fees of 35 million, fueling controversy among limitedpartners that object to such fees being retained by the general partner. In any case, the private equity firms have a vestedinterest in perpetuating Caesars’ existence, and they have gone to great lengths to shield the company from creditors byaiding in the creation of a disturbingly convoluted financing structure. Figure 2 is an organization chart provided byM&A due diligence consulting firm Xtract Research, shows just how complex Caesars’ corporate structure has become.Figure 2: Caesars’ corporate structureSource: Xtract Research5

Pre-Bankruptcy Financial Structure and Performance (cont)It is noteworthy that this chart refers to Caesars Acquisition Company (NASDAQ: CACQ), a separate publicly tradedunit that was formed in 2013 by Caesars Entertainment Corporation to shift property holdings away from the originalholding entity (NASDAQ: CZR). The logic behind this maneuver was clearly to create another layer of separation between Caesars Entertainment Corporation’s (formerly Harrah’s) most valuable holdings and aggrieved creditors. Caesars did not stop there however. As the chart depicts, most of the properties are actually owned by an L.L.C. under thename of Caesars Growth Partners, only 34% is owned by CACQ, with the remaining 66% directly owned by Apollo andTPG (Carey, Keller 2015). Recognizing the need for protecting intangibles from creditors, Caesars formed yet anotherL.L.C. that constitutes a joint venture between the now-bankrupt Caesars Entertainment Operating Company (CEOC),CZR, and CACQ.While shifting assets away from CZR and CEOC, the company shifted a considerable portion of its debt into CEOCthrough a complex series of internal transactions and refinancing in 2014, the year leading up to the January 2015 bankruptcy. These transactions are facilitated by a dedicated financing subsidiary of Caesars Growth Partners called CaesarsGrowth Properties Finance, Inc. (CGPF). According to Bloomberg, CGPF routinely deals with creditors in the CaymanIslands and Bermuda to obtain additional financing (2014).This complex system of nested companies, subsidiaries, and related parties ought to be alarming to investors in eitherCZR or CACQ. Legal games such as this can protect assets from creditors for a time, but they cannot shield the company from the raw market forces that will ultimately drive Caesars to failure. Furthermore, the nature of the internal transactions poses serious questions of whether or not substantial corporate fraud is occurring. The legal risks associated withpotential fraud are significant enough to collapse the entire company (CZR, CACQ, CGP, etc.). These possibilities willbe further explored in a subsequent section.6

Bankruptcy Proceedings and Money Laundering AllegationsBankruptcy ProceedingsOn January 15, 2015, Caesars Entertainment Operating Company (CEOC) filed for Chapter 11 bankruptcy protectionafter months of asset shuffling and negotiation with first-lien creditors, spearheaded by Apollo and TPG. In a December,2014 press release, Caesars Entertainment Corporation announced that 80% of creditors backed the restructuring plan,effectively making Caesars’ bankruptcy plans “pre-packaged” in nature. This press release failed to tell the entire story,however. Three days prior, on January 12, a group of second-lien creditors had sued to force Caesars EntertainmentCorporation (as opposed to its operating subsidiary) into what legal experts describe as a “free-fall” Chapter 11 proceeding in the U.S. bankruptcy court in Wilmington, Delaware, where Caesars is incorporated (Church, 2015). This wouldhave been a significant development, as a Chapter 11 bankruptcy for the publicly-traded holdings company would havegiven creditors the opportunity to liquidate some of the company’s more lucrative properties, and would have massivelydevalued the company’s common stock. In a ploy to avoid this, Caesars motioned to move bankruptcy proceedings tothe Northern Illinois federal district court in Chicago, where the operating company was incorporated. After severaldays of argument, a federal judge sided with Caesars’ attorneys, moving the Chapter 11 to Chicago where only the severely indebted (and asset deprived) operating company would be affected.Caesars restructuring plan will transfer what real property CEOC retains to a publicly traded real estate investment trustfund, or REIT. This REIT will likely be merged with the property holding entity CACQ, which will then lease properties back to a newly formed operating subsidiary of Caesars Entertainment Corporation. A comparison of the prebankruptcy organization with the proposed structure shows that there is actually little difference, beyond more assetshifts, and a few name changes. Of course, reduced debt and associated interest payments will alleviate some of theburden on the operating company. The bottom line, however, is that cash flows will remain unhealthy for the operatingcompany, and that it is unlikely to survive another economic shock, regulatory change, or major litigation.Money Laundering AllegationsCaesars has also been fighting allegations of money laundering being brought against it by the Financial Crimes Enforcement Network (FinCEN). FinCEN alleges that Caesars’ Desert Palace division violated the Bank Secrecy Act,which pertains to money laundering and the documentation of large transactions. We view this as yet another hurdle forCaesar’s to overcome as fines for such violations often total in the tens of millions of dollars. An important note is thatCaesars currently does not have provisions on its balance sheet to cover such legal fines. If found guilty, such fines asimposed by FinCEN would add to the stress of Caesar’s low cash and high leverage position. In addition, criminal findings against Caesar’s may discourage potential creditors.In an attempt to mitigate any future legal implications, Caesars has hired one of Wal-Mart Inc.’s senior compliance officers, Benjamin Floyd, to focus solely on anti-money laundering practices. Even if Floyd proves successful in mitigating any future money laundering issues, Caesars still operates with negative cash flows as can be seen in a later section.7

Financial OverviewIn looking at the financials for Caesars, we began with a ratio analysis of Caesars and its peers, Las Vegas Sands andWynn Resorts, using data from year-end 2013. As can be seen from Figure 3, Caesars lags far behind its competitorswith a negative ROA (-11.9%), a negative debt-to-equity (-8.9), and a negative profit margin (-34%). Of chief concernis Caesars’ times-interest-earned ratio of -1.0, indicating that the company is earning less than it requires to service itsdebt, let alone earn a profit. Despite the proposed bankruptcy restructuring and subsequent debt write down, we believethat a negative profit margin coupled with a weak position in terms of assets will cause any reprieve from such a restructuring to be short lived. These ratios outline how poorly Caesars performs compared to its peers; and given its disadvantage from a competitive standpoint, we believe there is little chance for improvement.Caesars Entertainment Las Vegas Sands Wynn -8.92.0-46.3Profit Margin-34%17%13%Current Ratio1.51.82.0Times Interest-1.012.64.3Earned*high % due to negative income and/or equityFigure 3: Comparative Margin AnalysisSource: Morningstar, Kent State UniversityCaesars Monthly Adjusted Close 250Adjusted Close 200 150 100 50 02012Caesars Entertainment20132014Las Vegas SandsWynn Resorts2015S&P 500Figure 4: Market PerformanceSource: Yahoo! Finance, Kent State UniversityFrom a market standpoint, Figure 4 shows the performance of Caesars’ publicly traded stock against that of Las VegasSands, Wynn Resorts, and the S&P 500 (NYSEARCA: SPY) from January 2012 through January 2015. As can be seen,Las Vegas Sands and Wynn resorts have generally moved with the market whereas Caesars has remained flat to negative. We expect a slight improvement should the bankruptcy be resolved successfully, however such an uptick in marketvaluation will be short lived as is discussed in the subsequent section.8

DCF AnalysisIn examining Caesars from a valuation standpoint, we performed a discounted cash flow analysis (DCF) out to the year2020 under what we believe are optimistic assumptions. Using Bloomberg estimates, we anticipate revenue growth of3% annually and held all other balance sheet and income statement items as a percentage of revenue. In regards to Caesars’ debt levels, the analysis takes into account the proposed bankruptcy restructuring and subsequent write down of 10 billion in debt for Caesars Entertainment Operating Company (Reuters). This write-down allows Caesars to continue to operate with a positive cash balance to sustain ongoing operations. An important note to make is that we projectshort-term debt to grow at 3% annually, however we feel that this is a wildly optimistic assumption as Caesars mayface difficulty in acquiring short term financing should its chief operating unit emerge form bankruptcy.Despite modest growth in revenue and restructured debt, Caesars remains unable to bring its cash flow levels into positive territory as can been below in Figure 5. We calculated Caesars’ free cash flow as cash from operations less capitalexpenditures yielding consistently negative results through 2020. It is for this reason that we believe Caesars will ultimately be worthless within the next five years.The capital asset pricing model (CAPM) yielded a cost of equity of 19%, which when coupled with a post bankruptcycost of debt of 7% (Bloomberg), resulted in a weighted average cost of capital (WACC) of 5.73% (Figure 6). Terminalvalue was calculated using an exit multiple of -15x which we derived from dividing current enterprise value byEBITDA as of year-end 2013 (Figure 7). In discounting Caesars’ projected cash flows and terminal value using theabove-mentioned WACC, we determined Caesars’ equity to be worth well below zero.As stated previously, we performed our analysis under optimistic assumptions that allowed for Caesars to experiencecontinued growth both in terms of revenue and in issuance of new debt. With a slow down in Las Vegas, a lack of apresence in Macau, and an ongoing bankruptcy, it seems impossible that Caesars will be able maintain sustainable revenue growth and find creditors willing to accept any new debt. Currently, Caesars trades on the NASDAQ at 10 pershare. Based on our projections, we believe that Caesars is a strong candidate for a short sell strategy that will pay offwell within the next five years.Figure 5: Free Cash FlowSource: Kent State UniversityFigure 6: WACCSource: Kent State UniversityWACC CalculationCost of EquityWeight of EquityCost of DebtWeight of DebtEffective Tax RateWACCFigure 7: Exit MultipleSource: Kent State University19.58%6.2%7.5%93.8%36.0%5.73%Enterprise Value CalculationMarket Value of Equity1,557Total Debt23,449Cash2,771Enterprise Value22,2352013 EBITDA(1,493)Implied Exit Multiple(15)9

SummaryWith a shrinking presence in the largest gambling market, an ongoing bankruptcy of its chief operating unit, a complexand somewhat questionable corporate structure, legal issues, and deteriorating financials, we recommend that a shortsell position be taken against Caesars Entertainment Corporation (NASDAQ: CZR) with realized returns before the year2020.10

ReferencesAllen, Lisa. "Caesars Makes Another Move to Insulate Healthy Subsidiaries." TheStreet. TheStreet, 23 May 2014. Web.17 Feb. 2015.Bloomberg Business. "Caesars Growth Properties Holdings, LLC: Private Company Information." Bloomberg.com.Bloomberg, 2015. Web. 20 Feb. 2015.Caesars Entertainment Corp. Form 10-K For Period Ending 12/31/13. Rep. no. 10-K. Las Vegas: Caesars Entertainment, 2014. Print.Church, S. (2015). “Caesars Wins Bid to Move 20 Billion Bankruptcy to Chicago”. BloombergBusiness. Retrievedfrom hicagocourtHals, Tom. "Caesars Details Plan as Restructuring Deadline Nears." Reuters. Thomson Reuters, 29 Dec. 2014. Web. 17Feb. 2015.Keller, Laura, and David Carey. "Caesars Letting Apollo, TPG Keep Stake Fuels Creditor Anger." Bloomberg.com.Bloomberg, 15 Jan. 2015. Web. 18 Feb. 2015.Trefis Team. "Trends In The Casino Industry." Forbes. Forbes Magazine, 7 Jan. 2015. Web. 17 Feb. 2015.Wolf, Brett. "Exclusive: Amid U.S. Probes, Caesars Poaches Top Money Laundering Expert." Reuters. Thomson Reuters, 03 Feb. 2015. Web. 17 Feb. 2015.Xtract Research. "Caesars Growth Partners LLC: Capital Growth Structre." (n.d.): n. pag. Xtract Research. Mergermarket Group, 2012. Web. 19 Feb. 2015.11

Equity Research Report 26.74 8.51 10.93 1,570 -25.00 . LLC and TPG Capital, LP. Harra