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We’re still not sold.

“There appears to be little or no equity value in Caesars' core business given the ugly financials. Yet the IPO prospectus shows Caesars carved out its online business, including the World Series of Poker, into a separate unit unencumbered by debt. This means Caesars equity holders should get - all the online profits; hence the investor focus.”

  • Andrew Barry, Barron’s

In the Barron’s article “Is Caesar’s a Sucker’s Bet”, journalist Andrew Barry suggested that the online carve-out explains the post-IPO stock pop of CZR.  Before suspending disbelief, investors should consider several important points.

  • Barring a massive recovery in its core business, CZR is likely to remain cash flow negative for the foreseeable future.  There is a high likelihood that this company will need to restructure (maybe another bankruptcy) its balance sheet at some point down the road. 
  • Federal legislation now looks a lot less likely than a month ago since the “Barton Bill” did not get tacked on to payroll tax extension as many hoped.  There is still hope that HR 2366 will get tacked onto a piece of must pass legislation this year (e.g. Highway Bill), although the odds look slim.  An online gaming market developed through the State route will take longer to develop and be smaller in size.
  • Barring a spin-off of Caesar’s Interactive, any profits (which are minimal at the current time) coming from this business will go into the general pool of cash used to pay CZR’s massive interest obligations of $1.6BN on debt of $23 billion.
  • A spin-off of Caesar’s Interactive poses material tax consequences for both Caesar’s Entertainment and its shareholders unless they can effect a tax-free spin under Section 355
  • While it is true that Caesar’s Interactive has no debt, that doesn’t mean that it is truly “unencumbered.”  CZR’s secured lenders at the operating company and CMBS entity have upstream guarantees secured by stock in Caesar’s Entertainment Corporation (CEC) and thereby an indirect claim to anything that CEC owns.  If a spin-off occurs, and debt holders don’t receive consideration for their stake, they have a strong case of fraudulent conveyance should CZRs eventually file.  Even if no filing occurs, there are likely to be lawsuits brought by debt holders to either prevent a spin-off or to get a piece of the proceeds.

Since the hope of Federal legislation has begun to fade, the stock has plummeted 40% off its highs.  Still at $10.54 per share CZR is valued at 12x our 2013 EBITDA estimate- a far cry from being reasonably priced.

  • A slight premium to Wynn which has much higher quality assets, an option on Cotai, more development opportunities in Asia, and happens to return a large amount of cash to shareholders
  • A slight premium to LVS which has Sands Cotai Central opening in less than 2 months, much higher asset quality, and more attractive growth opportunities
  • A 2x premium to MGM, which also has better quality Strip assets, a casino in Macau and an option on Cotai, and an option on US online gaming through its Bwin.Party agreement