ASCA: TOEING THE COVENANT LINE

ASCA’s liquidity situation reminds me of the U.S. women’s gymnastics team performance at the Olympics. They were in great shape heading into the floor routine when everything fell apart. Facing a much younger competitor in China, they couldn’t even stay in bounds, costing them the Gold. With Ameristar East Chicago about to taking a pounding from a new and improved Horseshoe, ASCA will struggle to stay in the bounds of its credit facility covenants. Of particular concern is the senior leverage covenant restricting the company to 5.25 to 1.00 debt to EBITDA until Q2 2009 when the ratio drops to 5.00 to 1.00. As the chart indicates, ASCA will toe the covenant line and could cross it in any of the next 3 quarters. A Q2 2009 violation is almost a mathematical certainty.

I’ve commented in the past that ASCA has been over earning due to its low but unsustainable cost of borrowing. The company’s entire debt structure is comprised of borrowings off the credit facility currently paying only LIBOR plus 1.625%. Although they did recently fix some of the debt through interest rate swaps. EPS is about to be deflated as ASCA will need to refinance a portion of the credit facility with fixed rate bonds. The rate they pay will be dictated by the proximity to the covenant restriction and the credit environment. Brunswick recently issued $250 million of 9.75% bonds. With that as a proxy, ASCA could experience a 5% higher incremental rate on whatever they borrow, presumably at least $200 million. That’s a 10% hit to EPS at minimum. Remember that the credit facility matures in 2010 and will need to be renegotiated in its entirety before then. I maintain that ASCA could be over earning by 50-100% in terms of EPS.

I believe the company is making a big push internally to cut costs and capex to stay in bounds. The long-term danger of this strategy is declining service levels and deteriorating facilities. Indeed, through termination, attrition, and scheduling cuts, ASCA has reduced its workforce by about 5%. More disconcerting is the dramatic drop-off in maintenance capital expenditures. The company should and has historically spent 5-6% of its revenues on maintenance capex. I estimate that percent has declined sequentially since Q1 2007 and was only 1.7% of revenues in Q2 2008. These levels of cuts will be noticed quickly by customers.

Ameristar may be the first gaming company to fall off the balance beam because of the the credit crunch, but it won’t be the last.


ASCA trying to stay in bounds the leverage restriction of its credit facility

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