NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed Caesars Entertainment Corp.'s (Caesars) and Caesars Entertainment Operating Company, Inc.'s (CEOC; OpCo) 'CCC' Issuer Default Ratings (IDR). Fitch also affirmed the 'CCC' IDR of Caesars Linq, LLC & Caesars Octavius, LLC and the 'B-' IDRs of Chester Downs & Marina LLC (and Chester Downs Finance Corp as co-issuer). The Rating Outlook is revised to Negative from Stable on all IDRs. A full list of rating actions follows at the end of this release.
The Outlook revision reflects Fitch's heightened concern regarding OpCo's near-to-medium term cash burn rate and potential covenant compliance pressure. These factors, combined with previously expressed concerns about weakening relative asset quality due to constrained capital reinvestment, more than offset the positive credit impact from recent transactions executed to push out its debt maturities meaningfully.
The Outlook revision also incorporates the increasing possibility that the OpCo could look to execute transactions that Fitch views as a default.
Fitch has reduced its base case EBITDA forecast and now projects negative free cash flow (FCF) for the OpCo persisting beyond 2015. The company's higher cost refinancing activities have also contributed to the weakened near-term FCF profile. CEOC's near-term cash burn rate makes it susceptible to tripping its 4.75 times (x) net senior secured leverage covenant and/or face a liquidity crunch absent support from the parent over the next couple of years.
The affirmation of OpCo's 'CCC' IDR reflects Caesars' available liquidity and pushed out maturity profile, which provides the company with some time for meaningful operating improvements to materialize. Fitch lowered its base case FCF projections for the OpCo following weak second-quarter results and the continuing third-quarter trend of disappointing revenues being reported by states in which Caesars operates. Fitch maintains a circumspect view regarding the prospects for a stronger-than-expected improvement in Caesars' operating results over the next couple years.
In Fitch's base case, cash flow from operations at the OpCo is negative $200 million - $250 million through 2014 and annual capital expenditures are $250 million - $350 million. This equates to negative FCF of $450 million - $600 million per year. In January 2015, $5.75 billion in out-of-money swaps mature, which should have a positive impact on FCF in excess of $150 million. However, absent a sharp uptick in the economy Fitch projects FCF to remain negative, albeit improved, past 2015.
The cash burn's most near-term implication is the impact on the OpCo's 4.75x net senior secured leverage maintenance test, which relies on the substantial cash balances maintained at the OpCo level for compliance. The covenant ratio is at 4.3x as of June 30, 2012, providing the company with about a 10% EBITDA cushion. At the current rate, CEOC may need to obtain a covenant amendment or waiver by late 2013 or early 2014.
Caesars has some flexibility with respect to the covenant. The parent can inject cash into OpCo via intercompany loans ($475 million outstanding as of June 30, 2012) which would count against the debt in the ratio. Also the OpCo's credit agreement allows for equity cures (limited to three quarters in any rolling four quarter period).
The parent has meaningful access to cash. It can upstream from Harrah's BC, which collects interest on $1.1 billion in OpCo unsecured notes held at the entity. Also, the parent collects management fees from the PropCo and has a majority stake in Caesars Interactive, which now generates income. However, Fitch is unsure how the parent will choose to prioritize between the potential uses of cash, which may include debt reduction at the ProCo and growth initiatives outside the OpCo restricted group.
Past 2013, Fitch thinks that the liquidity pressure is now more acute. Pro forma for the August transactions and the sale of Harrah's St. Louis, Fitch estimates that the OpCo will have about $1.9 billion in liquidity. Of this amount, about $730 million is attributed to a revolver maturing in January 2014. Fitch forecasts negative FCF of roughly $600 million in 2013 and $450 million in 2014. Other cash uses include a $125 million maturity of unsecured notes in 2013 and investment contributions towards Caesars' Baltimore and Project Linq developments (about $130 million in aggregate investments).
CEOC's ability to maintain adequate liquidity over the next two to three years will depend largely on the OpCo's ability to access first-lien debt and/or the parent's ability and willingness to downstream cash to the OpCo. Access to first-lien debt could become more questionable as the OpCo nears its 4.75x maintenance covenant.
To date, parent support has been meaningful and mostly came through intercompany loans. Also in 2010 the parent transferred $682 million to CEOC. The transfer came after the parent received $220 million federal income tax refund and approximately $550 million in equity investment from Paulson & Co. Fitch thinks further support from the parent will hinge on the equity sponsors' (Apollo and TPG) perceived prospects for the OpCo to become FCF positive. Absent material improvement in the operating outlook, Fitch believes there is reasonable likelihood that the sponsors may opt to restructure OpCo's debt instead of making further capital infusions.
A spin-off of Caesars' Interactive unit or other means of monetizing the online business could be logical precursors to a restructuring. The parent guarantees OpCo's debt and sponsors, if electing to restructure OpCo, would likely want to extract value out of Interactive and not risk the entity being pulled into the restructuring proceedings. Caesars Interactive is a non-wholly owned subsidiary of the parent outside the OpCo. The unit owns Playtika, the Word Series of Poker brand and online gaming operations in the UK. Fitch believes that most of Caesars' current equity value is attributable to this unit, which would benefit materially if online gaming is legalized on the federal level in the U.S.
Besides entering into Chapter 11, Caesars may elect to execute debt exchanges, possibly for equity since the company is now public. However, Fitch thinks exchanges are less likely now than in 2009 when the company reduced debt by $3.8 billion by exchanging a bulk of its unsecured notes with subsidiary guarantees into second-lien notes with lower par amounts. Fitch believes there is little recovery if any beyond OpCo's first-lien as Fitch's analysis shows first-lien holders recovering less than 90% of value in an event of default. This shows in the yields of the longer dated second-lien notes, which are in excess of 20%. Fitch thinks that Caesars will maintain its first-lien capacity to fund its cash burn while the company's thin market capitalization of less than $1 billion would make meaningful debt-for-equity exchanges extremely dilutive.
With respect to equity-for-debt exchanges, Fitch generally considers exchanges that result in debt reduction to be events of default. In case of an equity-for-debt exchange, Fitch may maintain the 'CCC' IDR if the agency determines that the exchange (in of itself) is not meant to avert a liquidity crunch or some other more blatant event of default.
Chester Downs and Marina LLC (Chester Downs)
The Negative Outlook on Chester Downs' IDR reflects the weak recent performance of Harrah's Philadelphia and the Pennsylvania Gaming Control Board's announcement that the board will be receiving license applications for casino license designated for the city of Philadelphia. The deadline for application is Nov. 15, 2012.
Chester Downs' operating declines through the six-month period ending June 30, 2012 were greater than Fitch's previous forecasts. Annualizing first-half results, the pro forma FCF profile is positive but provides limited cushion for a meaningful increase in competitive pressure. In addition to the potential for a new casino, existing operators in the areas have discussed expansions.
Fitch may downgrade Chester Down's IDR to 'CCC' when the additional license is awarded and Fitch has more specifics on the new casino's development plans. Fitch may also revise the Outlook back to Stable if Chester Downs' operating profile improves significantly from the first-half 2012 level in the interim.
Chester Downs owns and operates Harrah's Philadelphia in Chester, PA and is 99.5% owned by the OpCo. Chester Downs is not a guarantor of the OpCo's debt and vice versa and there are no cross defaults. Fitch does not firmly link the IDRs, however the agency believes there is moderate linkage between the OpCo and Chester Downs since the OpCo (which is weaker) has the ability to pull cash from Chester Downs to the extent permitted by the restricted payment carveouts.
Caesars Linq, LLC & Caesars Octavius, LLC (NewCo)
Fitch revised the Outlook on NewCo's ratings to Negative as Fitch links NewCo's ratings with OpCo. NewCo's credit profile largely relies on lease payment that OpCo is or will be making to the NewCo. Credit support for NewCo's $450 million term loan will be provided by the retail lease income generated by the redeveloped area between Flamingo and Imperial Palace on the Las Vegas Strip; income generated by an observation wheel that will be anchoring the redeveloped area and $50 million in lease payments from the OpCo. CEOC will pay $35 million to lease Octavius Tower once the hotel expansion is fully functional (the villas component is not yet fully opened) and $15 million to lease O'Sheas casino once Project Linq is operational.
There is a chance Fitch may de-link NewCo's ratings from OpCo's in the event that the OpCo is downgraded. This may occur if Fitch feels that the OpCo will maintain its leases through a restructuring and/or the income generated by the retail/entertainment segment of Project Linq is sufficient to service NewCo's debt service.
An Outlook typically has a one to two year time horizon. A downgrade to 'CC' would indicate that Fitch feels that an OpCo default is probable. This could be precipitated by the following drivers:
--Parent monetizing or spinning-off Interactive with proceeds or new shares going to equity holders;
--Free cash flow drain persisting at levels currently envisioned by Fitch;
--More imminent risk of OpCo violating its 4.75x maintenance covenant; and
--Liquidity excluding 2014 revolver availability declining to a less comfortable level (likely below $500 million).
A downgrade below 'CC' is also possible if Caesars executes a transaction that Fitch views as a default.
Fitch may revise the Outlook on the IDR back to Stable if Caesars' operating prospects improve meaningfully over the next one to two years such that a path to being FCF positive at the OpCo level is more evident.
Fitch has affirmed the following ratings:
Caesars Entertainment Corp.
--Long-term IDR at 'CCC'.
Caesars Entertainment Operating Co.
--Long-term IDR at 'CCC';
--Senior secured first-lien revolving credit facility and term loans at 'B-/RR2';
--Senior secured first-lien notes at 'B-/RR2';
--Senior secured second-lien notes at 'CC/RR6';
--Senior unsecured notes with subsidiary guarantees at 'CC/RR6';
--Senior unsecured notes without subsidiary guarantees at 'C/RR6'.
Chester Downs and Marina LLC (and Chester Downs Finance Corp as co-issuer)
--Long-term IDR at 'B-';
--Senior secured notes at 'BB-/RR1'.
Caesars Linq, LLC & Caesars Octavius, LLC
--Long-term IDR at 'CCC';
--Senior secured credit facility at 'CCC+/RR3'.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' (Aug. 14, 2012);
--'Distressed Debt Exchange' (Aug. 8, 2012);
--'U.S. Gaming Recovery Analyses -- First-Quarter 2012' (June 28, 2012);
--'2012 Outlook: Gaming -- Market Exposure the Differentiating Factor' (Dec. 13, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Distressed Debt Exchange
U.S. Gaming Recovery Analyses -- First-Quarter 2012
2012 Outlook: Gaming -- Market Exposure the Differentiating Factor