Inside Asian Gaming

January 2015 inside asian gaming 29 Feature What remains to its largest unit, Caesars Entertainment Operating Co., is a disparate collection of commercial casinos in 20 regional markets together with the former London Clubs International estate of eight UK casinos and a casino in South Africa. The company has management contracts with casinos owned by Indian tribes in three states, investments and operating deals with two casinos and a racino in Ohio, a casino it runs in Windsor, Ontario, two in Cairo inherited from LCI, and a piece of a casino in Uruguay. This agglomeration generates the majority of parent CZR’s revenues, 61.7% of them, according to the latest available results, down 13% year on year through the first nine months of 2014. CEOC improved its perennial operating loss by more than 60% over this period, but its debt service over the next 12 months will exceed $1.8 billion. The corporation as a whole posted a net loss through 30th September of $1.79 billion after interest payments of $1.95 billion and was looking at forking over another $737.9 million for debt service before the year was out. Arrayed against these obligations was possibly $1.8 billion or so in property EBITDA for the entire year. CZR is looking at more than $2.4 billion in interest payments in 2015, with CEOC, its largest subsidiary, in negative operating cash flow to the tune of $548 million. In 2016, some $1.28 billion of debt is scheduled to mature, $1.22 billion of it belonging to CEOC. This balloons to $7.3 billion in 2017, 99% of it CEOC’s. In 2018, $5.24 billion comes due. PLAYING FOR KEEPS Analyst Chad Beynon of Macquarie Securities, speaking recently to The Press of Atlantic City , called the CEOC restructuring the most complex “that has ever gone on in the gaming world”. Actually, the model was laid out more than a year ago by Penn National Gaming, a listed regional operator (Nasdaq: PENN) with 19 casinos in 12 US states. In November 2013, PENN announced it was spinning off its considerable landholdings as a separate company, Gaming & Leisure Properties Inc., which would trade on Nasdaq as a real estate investment trust. With the completion of the deal early in 2014, GLPI became the landlord for PENN’s casinos, their fixed rents serving as the principal source of GLPI’s income. PENN was out of the property business, which allows it to focus on maximizing operating revenues, and the acquisition, financing and disposition of all that property was vested in a highly liquid subsidiary that can do so at much higher profit margins and generally with cheaper access to capital. What CZR proposes for Caesars Entertainment Operating Co. is almost identical. Of course, real estate investment trusts are nothing new, and there are several types of them. Basically, to qualify, a company must incorporate as a REIT, must hold at least 75% of its assets in real estate, must derive at least 75% of its gross income from real estate and must return 90% of its income to shareholders in the form of dividends. In exchange, the REIT pays no tax on its profits. GLPI defines its strategy as one of “aggressively pursuing opportunities to acquire additional gaming facilities to lease to gaming operators, which may include Penn, and also anticipates diversifying its portfolio over time, including by acquiring properties outside the gaming industry to lease to third parties”. After a year in operation, the company has a market cap nearly three times as large as its parent and trades at more than twice PENN’s multiple on an EV/EBITDA basis. “Overall, we see the GLPI spin-off as a positive for the industry,” says Fitch Ratings Service. Not surprisingly, others are exploring the possibilities, among them, Boyd Gaming Corp. (NYSE: BYD), which operates 21 casinos in eight states, and Pinnacle Entertainment (NYSE: PNK), which recently announced plans to separately list the land under its 14 casinos. “As with PENN’s strategic rationale, PNK sees the separation as a means to a lower weighted average cost of capital, a platform to engage in M&A/consolidation of a maturing industry and other industries, and return its free cash flow to equity holders in a tax- efficient way,” says J.P. Morgan. “The entrance of REITs into the gaming sector will potentially drive up trading EV/ EBITDA multiples, provide new sources of capital (e.g. sales and lease-backs), create better transparency on the value of physical casino assets and the gaming licenses and possibly increase tolerance for higher leverage,” says Fitch Ratings Service.