Caesars Entertainment (CZR or CEC) is a mispriced special situation following the closing of the bankruptcy restructuring of its subsidiary CEOC (along with its emergence from bankruptcy) and the merger of Caesars Acquisition Corp. (CACQ) and CZR/CEOC. I believe the mispricing is caused by several temporary issues, and two underappreciated longer-term dynamics.
Following the completion of the restructuring, the litigation risk from former CEOC creditors has been removed, and CZR now has more flexibility to pursue growth opportunities (both M&A and greenfield development). CZR trades at a discount to its closest comps, but more significantly, it is discounted without giving any credit to the two underappreciated longer-term dynamics which lead to an even lower effective valuation pro forma for transactions that are either agreed upon (i.e., the three Call Right Properties) or likely to occur (i.e., other properties discussed below on the roadmap of VICI Properties shown during VICI’s roadshow).
CZR is in the process of transitioning to a more asset-light model, with less casino ownership and higher operating leverage, which should improve CZR’s multiple. CZR is shifting its casino asset base from owned and operated casinos towards operating casinos sold to the VICI REIT (and potentially other REITs) and leased back, and CZR is poised to unlock value for shareholders.
Temporary Issues Causing CZR Mispricing
The initial overhang and selling pressure from former CEOC creditors selling CZR stock.
--CEOC creditors—not natural long term CZR holders—ended up with ≈416 million shares (excluding the convert), which represent 69% of the non-Sponsor shares currently outstanding. There were only 149 million CZR shares outstanding prior to the merger/restructuring, 88 million of which were owned by the Sponsors (TPG/Apollo, etc.), so it was not possible for creditors to short out their full CZR exposure prior to the merger. ≈40 million CZR shares were short on the Effective Date (65% of the non-Sponsor CZR shares outstanding prior to the merger/restructuring).
--It took from closing (Oct. 6, 2017) to late November for CZR to trade enough shares for the creditors to potentially get liquid (if you assume all sales were from the creditors, which is unlikely: some other shareholders were also selling during that time period), so there has been a large overhang pressuring the stock for most of the time since the closing of the merger/restructuring.
--In addition, on December 5, 2017, the TPG/Apollo Co-Invest Funds distributed 46.7 million shares pro rata to their members, which may have added some selling overhang.
Complexity of the situation is confusing some analysts. For example:
Capital structure confusion
--The reconsolidated capital structure had been opaque prior to the restructuring, and although it was clarified and finalized with the restructuring, some confusion remains given that the latest 10Q does not reflect the post transaction structure (which closed Oct. 6, after the Q3 close). The final equity capitalization structure is included at the end of this write up.
Longer-term Dynamics Causing CZR Mispricing (more detail for each is below)
1) (Most important)Underappreciated Real Estate Value: a) The cash value embedded in CZR’s real estate, which is in the process of being monetized through sale-leaseback transactions with VICI Properties, and b) the ongoing opportunity to create incremental CZR equity value in M&A transactions using the proceeds from real estate sales, which have a multiple arbitrage that create incremental CZR equity value.
2) Latent pricing power in Las Vegas room rates
Brief Background on the CZR Merger/Restructuring
On January 15, 2015, CEOC filed for Chapter 11 Bankruptcy. On October 6, 2017, CZR/CEOC and CAC completed a merger/restructuring in which CEOC converted its corporate structure into two companies—OpCo (New CEOC) and PropCo (VICI REIT).
Certain domestic properties were contributed to VICI (initially 19 properties, including Caesars Palace), which is now wholly owned by former CEOC creditors. New CEOC (a wholly owned subsidiary of New CEC) continues to own substantially all operations, gaming licenses, personal property and other related interests in the casinos, and leases the properties owned by VICI REIT. CEC does not own any equity interests in VICI REIT. The chart below represents the structure of New CEC after the completion of the merger/restructuring:
Full background on the merger/restructuring can be found in the proxy statement / prospectus from 6/23/17:
More Detail on Longer-term Dynamics Causing CZR Mispricing:
1) Underappreciated Real Estate Value
--Call Right Properties = $1.3 billion of cash value for CZR
--Additional Properties on VICI’s near-term roadmap (which is included in the VICI roadshow and is pasted below) = $6.5 billion of cash value for CZR
--Total Value of properties on VICI’s near-term roadmap = $7.8 billion of cash value for CZR
Following the restructuring, CZR’s property structure is the following (with the modification that after this presentation was prepared, CZR and VICI completed a sale-leaseback of Harrah’s Las Vegas real estate):
VICI and CZR have a Right of First Refusal Agreement which provides both VICI and CZR with ROFRs on future acquisitions of domestic gaming facilities located outside of Clark County, Nevada, or Greater Las Vegas, proposed to be owned or developed by Caesars or VICI. They amended the ROFR Agreement to include a ROFR on a future sale-leaseback of the properties Caesars recently announced it is acquiring from Centaur Holdings, so after the Centaur acquisition has closed, CZR can also sell the Centaur real estate to VICI, which will create additional incremental equity value for CZR.
VICI and CZR also have a Call Right Agreement that specifies the following:
--VICI has a Call Right (for up to five years) to purchase and leaseback three properties from CZR: Harrah’s Atlantic City, Harrah’s Laughlin, and Harrah’s New Orleans.
--The agreed cash purchase price is 10x the initial annual rent for each property.
--The initial rent for each property will be determined based on a rent-to-EBITDAR ratio of 1.00-to-1.67 (i.e., rent ≈60% of LTM EBITDAR for each property at the time of call option exercise).
The three properties on which VICI has a call option represented $130 million of total rent (as of the 6/28/16 CEOC Disclosure Statement, pg. 393; the VICI roadshow in January 2018 still assumes $130 million rent for these three properties), and will be acquired for 10x annual rent: $1.3 billion if rent remained flat since that time. VICI Pro Forma EV/EBITDA (LTM Adjusted) is 15.3x ($10.9 billion EV (pro forma for HLV acquisition, $1 billion equity private placement, and IPO at midpoint of filing range); $711 million LTM adjusted EBITDA), so they should see rapid accretion from buying the rent from these three call properties (which will drop straight to EBITDA for VICI) at 10x.
In addition to the three Call Right properties, VICI states in its prospectus about the rest of CZR’s owned U.S. casinos: “We may seek to purchase additional Caesars properties, similar to our recent acquisition of Harrah’s Las Vegas. Additional owned properties of Caesars include:”
1. Octavius Tower (Las Vegas)
2. Paris Las Vegas
3. Bally’s Las Vegas
4. The Cromwell (Las Vegas)
5. Flamingo Las Vegas
6. The LINQ Hotel & Casino (Las Vegas)
7. Planet Hollywood (Las Vegas)
8. Rio Hotel and Casino (Las Vegas)
9. Harrah’s Philadelphia (Philadelphia, PA)
10. Horseshoe Baltimore (Baltimore, MD) (JV in which CZR holds ≈40.9% interest)