Fair Game: Caesars’ Debt: A Game of Dealer’s Choice

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Business Day |Caesarsâ€™ Debt: A Game of Dealerâ€™s Choice

http://nyti.ms/1q0xLui

Fair Game

By GRETCHEN MORGENSON

The house always wins. Thatâ€™s worth remembering when youâ€™re in a casino. It also seems to be true for some people who hold Caesars Entertainment debt.

Thatâ€™s the message of a tangled tale involving a dispute between Caesars and a group of debt holders. And the spat has troubling implications for corporate-bond investors everywhere.

The story begins in 2008 when Caesars, whose empire includes resorts in Las Vegas, New Orleans and Atlantic City, became the target of a $30 billion, highly leveraged buyout. Apollo Global Management and TPG Capital, two big private equity firms, acquired the company, then known as Harrahâ€™s Entertainment. They continue to control the company.

A Caesars subsidiary â€” the Caesars Entertainment Operating Company â€” incurred most of the $23 billion in debt that financed the deal. That company has since exchanged some of the old debt for new; its current debt load of $19 billion is governed by different terms and rules, and some are tilted in the favor of the parent company.

A poker table at Caesars Palace in Las Vegas. In August, the resort’s parent company, Caesars Entertainment, offered some of its debt holders an attractive deal — and other holders are angry about its possible effects. Julie Jacobson/Associated Press

At the heart of the dispute is a chunk of debt issued before the buyout: $1.5 billion of senior unsecured notes due in 2015 and 2016. Principal and interest payments were guaranteed by the parent company.

Caesars took a beating in the 2008 economic downturn. It is struggling now, and management has begun restructuring talks. Debt issues of Caesars are trading at well below their original value.

In mid-August, Caesars did something remarkable. It quietly offered a delectable deal to a few select investors holding the senior notes of 2015 and 2016. It paid par â€” 100 cents on the dollar â€” for $155 million of notes held by the chosen, as-yet-unnamed investors, more than double the prevailing market price for the debt.

Caesars got something, too. As part of the deal, the parent companyâ€™s guarantee of principal and interest payments for all the remaining notes held by other investors was removed from the senior notesâ€™ governing documents. Under those documents, called indentures, changes can be made to the note terms if holders owning at least 51 percent agree. Caesars offered the premium to just enough holders to meet that threshold.

If this tactic is allowed to stand, deals that disenfranchise some bondholders in favor of others could become common.

Not long after the transaction, a group of holders who were excluded from it sued Caesars in Federal District Court in New York. One plaintiff is MeehanCombs L.P. of Stamford, Conn., whose president, Eli Combs, said: â€œThe bond market needs to know whether or not we have gone back to the 1930s, when valuable rights could be stripped away from individual and smaller investors through backroom deals between issuers and a favored few. Thatâ€™s what we think this case will determine.â€

They argue changes to the indenture canâ€™t override another of its provisions: that all holdersâ€™ rights to principal and interest cannot be impaired.

Caesars has not yet responded to the lawsuit, which argues that the â€œbackroom dealâ€ violates the Trust Indenture Act of 1939, a Depression-era law written to ensure that debt holders were treated fairly.

Richard Sylla, a professor at New York University, said that before the law, â€œTrustees often worked in cahoots with issuers and investment banks to draw up trust indentures that were not really in favor of the people buying the bonds.â€

The dispute over the senior notes affects other Caesars debt: Removing the parentâ€™s guarantee on the senior notes means that the guarantee can be stripped from $11.6 billion of other Caesars debt. Thatâ€™s clear in the governing documents.

Taking a belt-and-suspenders approach to the guarantee on the notes, Caesars sold $135 million of stock this year, a transaction that it says also had the effect of stripping the parent company guarantee from the senior notes. The stock sale meant that the operating company was no longer wholly owned, thus releasing the parent from obligations on billions in debt.

That move has also spurred litigation.

Stephen Cohen, a Caesars spokesman, said the lawsuits were victimizing the company. â€œWe have worked collaboratively and constructively with debt holders in an effort to improve the operating companyâ€™s financial condition while investing in the business and taking steps to enhance operating performance,â€ he said in a statement. â€œDespite the efforts of some speculators to impede our ability to improve the companyâ€™s financial situation, we are continuing to work with responsible creditors.â€

Since the Caesars moves, the price of its debt has fallen. Second-lien notes due in 2018 and yielding 10 percent are trading at just over 25 cents on the dollar.

One reason may be that over the past two years, the company has sold valuable assets owned by the subsidiary to affiliates that are not liable for its debt, according to the note holdersâ€™ lawsuit.

Last March, the operating company sold four properties to Caesars Growth Properties Holdings â€” a Caesars Entertainment affiliate. They are the Cromwell, the Quad and Ballyâ€™s in Las Vegas and Harrahâ€™s in New Orleans. The $2 billion paid gave the operating company breathing room, but that cash flow is no longer paying off its debt. Mr. Cohen said the asset sales were fair and in the operating companyâ€™s interests.

Caesars and its private equity owners may be playing hardball, increasing their leverage with bondholders as they try to restructure the debt. Spokesmen for Apollo and TPG declined to comment. So did a spokesman for the Law Debenture Trust Company of New York, the trustee on the notes that are part of the suit.

But the lawsuits over Caesarsâ€™ actions raise questions for pension funds that own stakes in Caesars through private equity investments with Apollo and TPG. Because of those deals, they are silent partners in what Caesarsâ€™ note holders say is unfair treatment of certain debt holders.

Some institutions are in the awkward position of holding stakes in Caesarsâ€™ battered equity as well as its troubled debt.

The most recent portfolio of the California State Teachersâ€™ Retirement System, an investor in the Apollo fund that bought Caesars, shows that it also holds five Caesars debt issues that stand to lose their guarantees. A spokesman for the pension fund declined to comment.

In the long run, itâ€™s hard to win in a casino. And itâ€™s becoming hard to win as an investor in them. Whatâ€™s troubling is that if the deal is found acceptable by the courts, the house advantage could spread to other companies, too.

A version of this article appears in print on September 14, 2014, on page BU1 of the New York edition with the headline: Caesars’ Debt: A Game of Dealer’s Choice .