The reality is a spin may only be a split/sale which could benefit enterprise value but not necessarily shareholder value.
Despite the fact that roughly 95% of CZR’s EBITDA comes from its core casino operations, most of the focus remains on the company’s interactive division. This division currently comprises online gaming operations in the UK and social gaming through Playtika’s platforms. Speculation (dare we say “spin”?) is that CZR’s unencumbered interactive assets will be spun off to shareholders. Under this scenario shareholders would hold stock in 2 companies – “bad company” consisting of highly leveraged core gaming operations and “good company”, essentially an option on a huge growth business comprised of online and social gaming. Sounds good, but doesn’t really mesh with reality.
As we wrote about in “SPIN-OFF OF CAESARS INTERACTIVE? NOT SO FAST….” on 2/28, a spin-off of CZR’s interactive assets presents several challenges:
- A spin-off poses material tax consequences for both Caesars 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 or get a piece of the proceeds.
- Federal legislation now looks a lot less likely than a few months 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), but the odds look slim. An online gaming market developed through the State route will take longer to develop and be smaller in size.
- Without the exciting growth opportunity of social gaming and the option on US online gaming legalization, the core business is a collection of a over-leveraged Regional/ Las Vegas/AC assets with a lot of deferred cap ex and a sky high interest expense bill where every cent of FCF will go towards interest service for the foreseeable future.
We recently obtained some clarification to some of these issues. The company confirmed to us that if they decide to monetize CZR’s interactive assets in a separate entity it would likely have to be in form of a split-off or sale where the proceeds would go back to Caesar’s Entertainment. While this may seem like a subtle clarification, for an entity that is over 11x leveraged, an accrual of proceeds from any sale back to the enterprise vs. shareholders makes huge difference. Essentially, with a monetization of Caesars Interactive, shareholders would be left holding the bag of a highly leveraged portfolio of Caesar’s casino holdings where proceeds of any sale would likely go towards debt reduction. This is not necessarily a bad thing but on a $22BN pile of debt, it’s hard to move the needle enough to create material equity value.
CZR’s also needs to consider the synergies of keeping the company intact:
- State by state legislation will likely require having physical assets in each state in order to get a license. This means keeping CZR Interactive in-house maybe a necessary reality for the foreseeable future
- Co-branding opportunities for the social gaming site
- Question of whether a split-off of the assets would create value in excess of what investors are currently assigning to the interactive business. A split-off of the interactive company would also introduce a second set of reporting and public company expenses as well as a fee payable CZR’s would also diminish the standalone entities’ value.
We believe that the vast majority of CZR’s $1.6BN equity cap largely reflects the value of the Interactive division and an option value of a major recovery on the core. Without a tax free spin, the equity value of the Interactive division may be less than investors perceive.