Kent State University
Kerrisdale Capital Investment Case Study
Caesars Entertainment Corporation
Evan Gallagher | Daniel Shuster | Shervon Preston
Caesars Entertainment Corporation
Equity Research Report
Kent State University
Highlights
This report is published for educational purposes
only by students competing in the Kerrisdale
Capital Investment Case Study for the Economist
Competitive Landscape: Caesars lags behind its competitors in
terms of profit margin, and lacks a physical presence in Macau, China, the largest gambling hub in the world.
Ticker:
CZR
Bankruptcy Proceedings: Caesars’ primary revenue generating
unit, Caesars Entertainment Operating Company is in the midst of a
Current Price:
$10.95
bankruptcy filing. The proposed restructuring plan calls for a decrease in the operating unit’s debt, however there is significant con-
Recommendation: SELL
troversy surrounding the shifting of assets between Caesars’ various
entities.
Negative Cash Flow: Caesars currently operates with negative free
cash flow and will continue to do so well into 2020.
CZR Daily Adjusted Stock Price
$30
$25
$20
$15
$10
$5
$0
Market Data
52– week High ($)
26.74
52– week Low ($)
8.51
Previous Close ($)
10.93
Market Cap (Millions $)
1,570
EPS (ttm) ($)
-25.00
Company Overview
Caesars Entertainment Corporation
owns, operates, and maintains casino and resort properties across fourteen states and five countries. The
company is headquartered in Las
Vegas, Nevada.
1
Industry Overview
Industry Overview
Caesars Entertainment Corporation operates in the casinos and resorts industry. The industry is competitive, heavily
regulated, 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 called
racinos.
Economic Slowdown
The 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 hard
by the economic recession, and it continues to suffer. An increasing number of states have legalized gambling, which in
turn has led to a decrease in traffic to Nevada, and this lower profits for some of the largest casinos. There are currently
twenty-one states and two U.S. territories that allow commercial casinos in some form.
Macau
Macau, China is the world’s largest gambling hub, which recently saw its first full year decline in revenue since the
early 2000’s. China’s high profile corruption crackdown is to blame, specifically that of Xi Jinping, the President of
China, 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 by
2.6%. The fate of the gaming industry in Macau is largely dependent on how far the Chinese government will take the
war on corruption. While Macau is suffering, Japan is taking steps to legalize casinos. With projections of an increase in
high net worth individuals, Japan may soon be a key destination.
2
Industry Overview (cont)
Regulatory Environment
The 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 Control
Standards (MICS).” The MICS focus on several aspects of casino operations including conduct of games, movement of
cash, and the accounting and record keeping of transactions. Due to the high volume and high denomination of such
transactions, 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 & International
The 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 casinos
and 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 Atlantic
City. Caesars also operates casinos in the United Kingdom, Egypt, South Africa, Canada, and Uruguay. One region that
Caesars lacks a presence is Macau, China. As stated earlier, Macau is the world’s largest gambling hub, and the lack of
a 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 impact
on 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 see
improved 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 gambling
market in the region. The additional revenue has allowed Sands and Wynn to build new properties as the legalization of
gambling 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 out
revenues. Caesars has experienced negative results in regards to expansion. Attempts at expansion in Maryland, New
York, California, and Pennsylvania have had negative impacts on operations in New Jersey. Expansion is critical for
Caesars’ revenue growth and its inability to do so without cannibalizing its existing operations is cause for concern.
3
Company Background
Caesars Entertainment Corporation (NASDAQ: CZR) is a diversified casino-entertainment company. The company is
operated through its wholly owned subsidiary, Caesars Entertainment Operating Company, Inc. Caesars operates fifty
casinos in fourteen U.S. states and five countries. Figure 1, below, outlines Caesars’ domestic operations. Caesars also
owns 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 Entertainment
Resort 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 to
Caesars 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’s
delisting from the New York Stock Exchange and culminated with a leveraged buyout (LBO) by private equity firms
Apollo 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 Blackstone
Group owning a large portion of stock. Although Caesars may have seen this move as beneficial to the company, it
would be the start of a rather grim journey.
Arizona
Harrah's Phoenix Ak-Chin
California
Harrah’s Resort Southern California
Illinois
Harrah's Joliet
Harrah's Metropolis
Indiana
Horseshoe Hammond
Horseshoe Southern Indiana
Iowa
Horseshoe Council Bluffs
Harrah's Council Bluffs
Louisiana
Harrah's Louisiana Downs
Horseshoe Bossier City
Harrah's New Orleans
Maryland
Horseshoe Baltimore
Mississippi
Tunica Roadhouse
Horseshoe Tunica
Harrah's Gulf Coast
New Jersey
Bally's Atlantic City
Caesars Atlantic City
Harrah's Resort Atlantic City
Missouri
Harrah's North Kansas City
North Carolina
Harrah's Cherokee
Nevada
Harrah's Laughlin
Nobu Hotel at Caesars Palace
Bally's Las Vegas
Caesars Palace Las Vegas
Harrah's Las Vegas
The Cromwell Las Vegas
The LINQ Las Vegas
Harrah's Lake Tahoe
Harrah's Reno
Harveys Lake Tahoe
Paris Las Vegas
Planet Hollywood Resort & Casino
Rio All-Suite Hotel & Casino
Flamingo Las Vegas
Ohio
Horseshoe Cincinnati
Horseshoe Cleveland
ThistleDown Racino
Pennsylvania
Harrah's Philadelphia
Ontario-Canada
Caesars Windsor
Figure 1: Caesars’ domestic operations
Source: Caesars Total Rewards
4
Pre-Bankruptcy Financial Structure and Performance
It is hard to fathom that Apollo Global Management and Texas Pacific Group (TPG) seriously believed in the financial
position of Caesars Entertainment in the wake of their 2008 leveraged buyout that left the firm with over $20 billion in
debt. Although their combined $6 billion equity stake in the post-Harrah’s company has been substantially impaired in
the wake of Caesar’s 2009 financial troubles, there is ample evidence that Apollo and TPG have netted lucrative cash
flows from the deal. It has been reported that Apollo and TPG collected a $200 million transaction fee in 2008 as part of
the deal. In addition, both companies reap annual management fees of $35 million, fueling controversy among limited
partners that object to such fees being retained by the general partner. In any case, the private equity firms have a vested
interest in perpetuating Caesars’ existence, and they have gone to great lengths to shield the company from creditors by
aiding in the creation of a disturbingly convoluted financing structure. Figure 2 is an organization chart provided by
M&A due diligence consulting firm Xtract Research, shows just how complex Caesars’ corporate structure has become.
Figure 2: Caesars’ corporate structure
Source: Xtract Research
5
Pre-Bankruptcy Financial Structure and Performance (cont)
It is noteworthy that this chart refers to Caesars Acquisition Company (NASDAQ: CACQ), a separate publicly traded
unit that was formed in 2013 by Caesars Entertainment Corporation to shift property holdings away from the original
holding 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 the
name of Caesars Growth Partners, only 34% is owned by CACQ, with the remaining 66% directly owned by Apollo and
TPG (Carey, Keller 2015). Recognizing the need for protecting intangibles from creditors, Caesars formed yet another
L.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 CEOC
through 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 Caesars
Growth Properties Finance, Inc. (CGPF). According to Bloomberg, CGPF routinely deals with creditors in the Cayman
Islands and Bermuda to obtain additional financing (2014).
This complex system of nested companies, subsidiaries, and related parties ought to be alarming to investors in either
CZR 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 with
potential fraud are significant enough to collapse the entire company (CZR, CACQ, CGP, etc.). These possibilities will
be further explored in a subsequent section.
6
Bankruptcy Proceedings and Money Laundering Allegations
Bankruptcy Proceedings
On January 15, 2015, Caesars Entertainment Operating Company (CEOC) filed for Chapter 11 bankruptcy protection
after 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 Entertainment
Corporation (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 would
have been a significant development, as a Chapter 11 bankruptcy for the publicly-traded holdings company would have
given creditors the opportunity to liquidate some of the company’s more lucrative properties, and would have massively
devalued the company’s common stock. In a ploy to avoid this, Caesars motioned to move bankruptcy proceedings to
the Northern Illinois federal district court in Chicago, where the operating company was incorporated. After several
days 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 trust
fund, 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 asset
shifts, and a few name changes. Of course, reduced debt and associated interest payments will alleviate some of the
burden on the operating company. The bottom line, however, is that cash flows will remain unhealthy for the operating
company, and that it is unlikely to survive another economic shock, regulatory change, or major litigation.
Money Laundering Allegations
Caesars 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 for
Caesar’s to overcome as fines for such violations often total in the tens of millions of dollars. An important note is that
Caesars currently does not have provisions on its balance sheet to cover such legal fines. If found guilty, such fines as
imposed 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 Overview
In looking at the financials for Caesars, we began with a ratio analysis of Caesars and its peers, Las Vegas Sands and
Wynn Resorts, using data from year-end 2013. As can be seen from Figure 3, Caesars lags far behind its competitors
with a negative ROA (-11.9%), a negative debt-to-equity (-8.9), and a negative profit margin (-34%). Of chief concern
is Caesars’ times-interest-earned ratio of -1.0, indicating that the company is earning less than it requires to service its
debt, let alone earn a profit. Despite the proposed bankruptcy restructuring and subsequent debt write down, we believe
that 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 Resorts
ROA
-11.9%
10.1%
8.7%
ROE
94.2%*
30.1%
-394.1%*
D/E
-8.9
2.0
-46.3
Profit Margin
-34%
17%
13%
Current Ratio
1.5
1.8
2.0
Times Interest
-1.0
12.6
4.3
Earned
*high % due to negative income and/or equity
Figure 3: Comparative Margin Analysis
Source: Morningstar, Kent State University
Caesars Monthly Adjusted Close
$250
Adjusted Close
$200
$150
$100
$50
$0
2012
Caesars Entertainment
2013
2014
Las Vegas Sands
Wynn Resorts
2015
S&P 500
Figure 4: Market Performance
Source: Yahoo! Finance, Kent State University
From a market standpoint, Figure 4 shows the performance of Caesars’ publicly traded stock against that of Las Vegas
Sands, 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 market
valuation will be short lived as is discussed in the subsequent section.
8
DCF Analysis
In examining Caesars from a valuation standpoint, we performed a discounted cash flow analysis (DCF) out to the year
2020 under what we believe are optimistic assumptions. Using Bloomberg estimates, we anticipate revenue growth of
3% 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 project
short-term debt to grow at ~3% annually, however we feel that this is a wildly optimistic assumption as Caesars may
face 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 capital
expenditures 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 bankruptcy
cost of debt of ~7% (Bloomberg), resulted in a weighted average cost of capital (WACC) of 5.73% (Figure 6). Terminal
value was calculated using an exit multiple of -15x which we derived from dividing current enterprise value by
EBITDA as of year-end 2013 (Figure 7). In discounting Caesars’ projected cash flows and terminal value using the
above-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 experience
continued growth both in terms of revenue and in issuance of new debt. With a slow down in Las Vegas, a lack of a
presence 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 per
share. Based on our projections, we believe that Caesars is a strong candidate for a short sell strategy that will pay off
well within the next five years.
Figure 5: Free Cash Flow
Source: Kent State University
Figure 6: WACC
Source: Kent State University
WACC Calculation
Cost of Equity
Weight of Equity
Cost of Debt
Weight of Debt
Effective Tax Rate
WACC
Figure 7: Exit Multiple
Source: Kent State University
19.58%
6.2%
7.5%
93.8%
36.0%
5.73%
Enterprise Value Calculation
Market Value of Equity
1,557
Total Debt
23,449
Cash
2,771
Enterprise Value
22,235
2013 EBITDA
(1,493)
Implied Exit Multiple
(15)
9
Summary
With a shrinking presence in the largest gambling market, an ongoing bankruptcy of its chief operating unit, a complex
and somewhat questionable corporate structure, legal issues, and deteriorating financials, we recommend that a short
sell position be taken against Caesars Entertainment Corporation (NASDAQ: CZR) with realized returns before the year
2020.
10
References
Allen, 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. Retrieved
from http://www.bloomberg.com/news/articles/2015-01-28/caesars-judge-hands-20-billion-reorganization-to-chicagocourt
Hals, Tom. "Caesars Details Plan as Restructuring Deadline Nears." Reuters. Thomson Reuters, 29 Dec. 2014. Web. 17
Feb. 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.
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