Caesars Entertainment Operating Company (CEOC)
Distressed Debt: Credit Review
January 3, 2015
- Corp Structure: CEOC is the operating subsidiary of publicly-traded Caesars Entertainment (NASDAQ: CZR)
- Senior Secured 2017 11 & 1/4s: $73.06
- Second-Priority Senior Secured 2018 12 & 3/4s: $13.93
- Total Debt: $18,394 million
- Cash: $1,480 million
- Net Current Assets: $186 (Cash + Adj. CA – Non-Debt CL)
(This is my first foray into distressed debt analysis, so welcome to the 17 Mile Distressed Debt Training Camp – it will be ugly.)
The defining characteristics of distressed debt investing – forced selling, asset coverage, hard catalysts, short- to medium-term timelines, etc – make the strategy a natural addition to the Special Situation portfolio. While opportunities are scarce at present due to a strong economy and easy monetary conditions, due to a confluence of events I am laying the groundwork now for future implementation of the strategy. I do not anticipate a large-scale distressed debt opportunity for a number of years, as I am medium-term bullish on financial markets, but the recent stress within the O&G HY market has created some potentially interesting opportunities that I would like to explore, in addition to select non-O&G distress names such as CZR.
I began poking around CZR as an equity idea and came across a credit note that recommended the CEOC 2018 12 & 3/4s. With the bonds trading below $15, down from over $50 at FYE13, I expected to find a pretty big margin of safety with limited analysis. Far from it. According to my initial work, not only do the Second Priority Senior Secured 2018 12 & 3/4s appear to have very little chance of recovery, the Senior Secured Notes look to be approximately 45% overvalued.
- Term Loans: $5,360
- Senior Secured Notes: $6,675
- Second Priority Senior Secured Notes: $5,252
- Sub-Guaranteed Debt: $496
- Unsecured Senior Debt: $611
- FACE VALUE TOTAL DEBT: $18,394
- Gross Debt/EBITDA: 18.69 times
- EBIT Interest Coverage: .39 times
Enterprise Value to Debt Holders
While CEOC is not publicly traded, given the relatively independent nature of the entity and the egregiously over-leveraged capital structure, it would not be a surprise to see an IPO-based debt restructuring with the goal of an eventual total consolidation of the Caesars Entertainment empire. But again, I am far from an expert here (yet) – CEOC creditors may hold a hard line in negotiations and look to maintain a highly levered post-reorganization capital structure. So while likely overly conservative, I calculate the Enterprise ‘fair value’ under the assumption the CEOC entity becomes publicly traded.
To calculate the Enterprise FV for CEOC, I assume a: normalized capital structure of 4 times EBITDA, pro forma interest rate of 6%, 40% tax rate and equity FV PE of 17.5 times. According to the CZR 3Q14 Earnings Release, Adjusted LTM CEOC EBITDA, pro forma for the recent asset sale to Caesars Growth Partners, was ~$984 million, and annualized D&A ~$309 million. As such, the estimated Enterprise Fair Value is approximately $8,540 million. The implied EV/EBITDA at this valuation is 8.68 times.
With Net Current Assets of $186 – calculated as Cash + Adj. Current Assets – Non-Debt Current Liabilities – EV available to debt holders is approximately $8,727 million.
In the best-case scenario, I value the enterprise at 10 times EBITDA, or $9,840 million, and add Cash of $1,480 to arrive at an EV to debt holders of $11,320 million.
In the base-case scenario, backing out Term Loans of $5,360 from EV to Debt of $8,540 affords Senior Secured debt holders approximately $3,367. With a face value of $6,675, this means the Senior Secured Notes are fairly valued at $50.44 per $100 of par value versus a recent closing price of $73.06.
In the best-case scenario, using the same methodology as above, the Senior Secured Notes are fairly valued at $89.29.
While there is a large valuation gap between the base-case and best-case valuation scenarios, it is a fairly moot difference, as it proves that at best the Senior Secured Notes have little upside from a recent $73 closing price and that the Second Priority Senior Secured Notes are essentially worthless. The best-case assumes a FV EV/EBITDA multiple of 10 times and ignores the negative non-cash working capital balance; both of which are extremely unrealistic in my opinion.
Unless further research reveals sources of value currently unaccounted for, the Second Priority notes are worthless. For the Senior Secured notes, I am not interested – outside of finding additional value – above $40 at the highest, and more likely $30.
I will continue to use CEOC as training ground, but for right now, the Senior Secured Notes are a pass from an investment perspective.