NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the Issuer Default Ratings (IDRs) of Caesars Entertainment Corp (CEC) and Caesars Entertainment Operating Company (CEOC) to 'CC' from 'CCC'. In addition, Fitch revised the Recovery Ratings (RRs) on CEOC's issue-specific ratings upwards to more explicitly recognize the benefit of the parent guarantee from CEC. The net effect on the issue ratings due to IDR downgrade and RR revisions was a downgrade of CEOC's first-lien debt to 'CCC/RR2' from 'CCC+/RR3; the second-lien notes' to 'C/RR5' from 'CC/RR6' and the unsecured notes with subsidiary guarantee to 'C/RR5' from 'CC'/RR6'. The unsecured notes without subsidiary guarantee were affirmed at 'C'. The RR for the unsecured notes is revised to 'RR5' from 'RR6'.
KEY RATING DRIVERS
The downgrade of CEOC's and CEC's IDRs to 'CC' reflects the increasing likelihood that CEOC will look to restructure its debt within a year or two. The restructuring could take the form of either a bankruptcy filing or an out-of-court restructuring such as a debt-for-equity exchange, which Fitch would likely consider a default. Fitch's view is supported by CEOC's escalating cash burn; sizable maturity walls in 2015 and 2016; and increasing cost of borrowing including at the first-lien level. CEOC could potentially sell additional assets to get past 2016; however, further asset sales will exacerbate CEOC's already weak free cash flow (FCF) profile and not materially lessen the likelihood of an eventual default.
Per Fitch's base case CEOC runs out of cash in 2015; however, CEOC could potentially make it through 2016 in a more aggressive scenario. The base case assumes no further asset sales, no additional borrowings, that Caesars Growth Partners (CGP) does not set-off or extend the $1.1 billion of CEOC notes that it holds, and that CEOC repays $1.1 billion of first-lien debt with the proceeds from the most recent CGP asset sale.
CEOC's liquidity as of Dec. 31, 2013 pro forma for the asset sale to CGP and net of cage cash (estimated by Fitch at $300 million) is $2.95 billion. The amount available on CEOC's revolver is de minimis.
Pro forma cash includes $1.8 billion of asset sale proceeds from CGP, which are subject to the credit agreement's asset sale covenants. CEOC must use the proceeds to repay first-lien debt or reinvest the proceeds within 18 months. There is no material development pipeline at CEOC and any asset purchases would likely come from CGP as CEOC looks to preserve liquidity. Therefore, the reinvestment options mostly include maintenance capex, which Fitch estimates could be $500 million-$700 million within the 18-month reinvestment window. This suggests that actual pro forma liquidity, net of first-lien debt paydown, could be closer to $1.65 billion-$1.85 billion range.
Fitch forecasts CEOC's FCF burn at approximately $1.1 billion for 2014 and $800 million in 2015. There is a $1 billion maturity wall in 2015, which is all subordinate to first-lien debt and includes $427 million of debt held at CGP, and another $1 billion of junior debt is due in 2016 ($324 million held at CGP).
Fitch believes that CEOC's access to further capital is limited outside of parent intercompany loans. CEOC's first-lien notes trade well below par with yield-to-worst (YTW) of 13%-14%, which Fitch thinks makes the issuance of first-lien debt cost prohibitive. The loan market is also becoming increasingly bearish with CEOC's 9.5% incremental term loan due 2016 now trading at a discount. (Fitch estimates that CEOC has $1.15 billion remaining on its accordion option).
Other potential sources of liquidity that may extend the timing of a liquidity event include cash infusions from CEC via intercompany loans and asset sales. CEOC has a $1 billion intercompany credit facility with CEC which had $285 million outstanding as of Dec. 31, 2013. The facility was extended and expanded in November 2012. The maturity was pushed out three years from 2014 to 2017 and the capacity was increased to $1 billion from $750 million.
Cash at CEC is limited at approximately $300 million as of Dec. 31, 2013 pro forma for March 2013 equity issuance, and CEC's ability to extract cash from its healthier subsidiaries is also constrained. Caesars Entertainment Resort Properties (CERP) is prohibited from paying dividends as long as its net leverage remains above 6x and Fitch estimates net leverage at CERP will remain above 7x through at least 2016. CGP will have $387 million of cash on hand pro forma for the purchase of assets from CEOC and will generate considerable income from the CEOC notes it owns and its majority interest in Caesars Interactive Entertainment. (Other assets in CGP, including the assets purchased from CEOC, are subject to restricted payment covenants.) However, CEC does not have any voting rights in CGP (100% of voting rights are held by Caesars Acquisition Company [CAC]) and CAC's publicly articulated mandate is to seek growth opportunities, not to pay dividends.
Fitch believes that large -scale asset sales at CEOC are unlikely going forward given the credit agreement's requirement to repay debt or reinvest proceeds within 18 months, especially in light of the recent $1.8 billion asset sale. Further, CEOC is left with few assets that can generate sizable proceeds if sold in piecemeal fashion. Larger assets include Caesars Palace, the company's flagship property on the Las Vegas Strip, and Horseshoe Hammond in the Chicago market. Other sizable assets ($200 million-plus gross gaming revenues) remaining in CEOC include Bally's and Caesars in Atlantic City as well as Horseshoe casinos in southern Indiana and Bossier City, LA.
POTENTIAL DEBT FOR EQUITY EXCHANGE
CEC has publicly articulated the need to address the high debt burden at CEOC but has also hinted that a bankruptcy route is not preferable. Main motivation to keep CEOC out of Ch. 11 is that CEC guarantees CEOC debt and a call on the guarantee by CEOC will likely consume all of CEC's interest in subsidiaries outside of CEOC, which includes 58% economic interest in CGP and full ownership of CERP. Other considerations for avoiding Ch. 11 are the call rights CEC has to acquire CAC at a capped price, as well as the commonplace idea that Caesars is "too complex to fail" given the inter-dependencies between different subsidiaries and high potential cost of going through a bankruptcy process. The call rights, which are exercisable in late 2016, are subject to a condition that there is no event of default under any financing agreement of CEC or its subsidiaries.
Fitch believes that the most likely scenario is that CEC attempts a debt-for-equity exchange in the near term targeting $5.3 billion of second-lien notes due 2018, which trade at around 40-50 cents (other debt in the capital structure trades much higher, at 80 cents or above). However, the economics of such an exchange at current prices would still leave a questionable capital structure even if fully executed, and would significantly dilute Apollo/TPG's share in CEC.
The exchange would not alleviate CEOC cash burn entirely as Fitch estimates that cash burn would remain in the $150 million-$250 million range. Despite these shortcomings, an exchange may allow Apollo/TPG to maintain an influential interest in CEC (especially if new equity has reduced voting rights, e.g. hybrid, class B) while improving CEOC's capital structure to an extent that CEOC can become a viable entity in a more favorable economic environment. Given the cash-burn rate Fitch thinks that CEC may look to execute an exchange in the near term, possibly within the next six months.
CEC guarantees all of the major debt in the CEOC restricted group. Fitch has not given credit to the guarantee in CEOC's recovery analysis up to this point given that CEC lacked meaningful equity in assets outside CEOC until late 2013 and the uncertainty with respect to a potential release of the guarantee. CEOC's post-LBO notes' indentures contain language that may permit CEC to have the guarantee released with the consents from either certain unsecured noteholders or the term loan holders. The revision in the RRs of CEOC's debt reflects Fitch's view that there is a better than 50/50 chance that CEOC creditors will realize value from the guarantee in the event there is a restructuring at CEOC.
Although credit is now given to the guarantee, Fitch recognizes that CEC may look to execute a release of the guarantee. In the event there is a debt-for-equity exchange, considerations around the guarantee may play a role in the terms of the exchange. A more onerous process to release the guarantee would favor the creditors, while posturing by CEC that the guarantee could be more easily released could pressure the prices of the second-lien notes, improving a debt-for-equity exchange execution for CEC.
Fitch's base case view that CEOC creditors will realize the value of the guarantee is mainly supported by the fact that the language specifying the conditions for the release (i.e. that the guarantee be released first from the term loans or certain unsecured notes) also specifies that the release would only occur "upon the election of CEOC". Given CEOC's questionable solvency, CEOC's board fiduciary duty extends out to its creditors and electing to release the guarantee could be viewed as breach of this duty. Should CEOC seek to execute the release of the guarantee, CEOC's creditors could potentially claim that CEOC's board members violated fiduciary duty and/or possibly claim that the release amounts to fraudulent conveyance if CEOC is not properly compensated for the release.
Aside from the considerations above, CEC could have difficulty obtaining the necessary consents from the relevant unsecured noteholders or the term loan holders. The language dealing with the guarantee release provisions in the first-lien, second-lien and 10.75% unsecured notes indentures requires CEOC to first release the guarantee from either "Existing Notes" (about $2 billion of unsecured notes) or the term loans. The unsecured notes' indentures allow consent with a majority vote. The guarantee and pledge agreement accompanying CEOC's credit agreement does not specify mechanics for the release of the guarantee but supposedly CEOC can amend the agreement and repay the non-consenting lenders with cash on hand. Either route presents unique challenges.
Receiving consents from the term loan holders could be problematic, since there is now a heightened perception that the first-lien is not fully covered in event of a default at CEOC without the parent guarantee, which is a view that Fitch held since initiating ratings in 2010. With respect to the "Existing Notes", a majority of these notes is held at CGP, which is controlled by Apollo and TPG via CAC. Hence Apollo and TGP can provide consent to release the guarantee. However, Fitch believes that Apollo and TGP could be reluctant to do so, since voting to release a guarantee in absence of fair value compensation (such as CAC receiving increased stake in CGP) could potentially violate fiduciary duty to other CAC stockholders.
The release of the guarantee per the indentures could potentially be open to debate based on the ambiguity.
The last sentence in the section dealing with the release is arguably ambiguous. An alternative read of the sentence is that CEOC would have to seek consents from both the unsecured noteholders and the term loan holders. Fitch believes that this read is intuitive given it is more restrictive and that allowing other creditors in the capital structure to determine the release of a guarantee is fairly obscure.
Another section that is arguably ambiguous is the one stating that the parent guarantee can potentially be released if CEOC ceases to be a wholly-owned subsidiary. The wholly-owned condition is adjoined in the relevant section to two other conditions by the word 'and'. One of the conditions in the section is that the relevant notes be defeased. Although it is not intuitive that any condition should be attached to a defeasance condition with the word 'and' Fitch takes a literal view of the language.
Fitch adjusted its recovery assumptions for CEOC and now calculates recovery for the first-lien in the 71%-90% range and recovery for the more junior debt at 11%-30%. These ranges are consistent with 'RR2' and 'RR5' RRs, respectively. Key assumptions include a $1.1 billion first-lien paydown using CGP asset sale proceeds (see above for rationale) and giving credit for the parent guarantee. Fitch assigns $2.5 billion of value to the guarantee, which includes roughly $1.8 billion of value assigned to CEC's equity in CGP and $700 million for CEC's equity in CERP. Since the guarantee is not part of any collateral, the value of the guarantee will be distributed pro rata to CEOC's unsecured claims, which in Fitch's analysis includes a portion of the first-lien debt outstanding and all of the second-lien notes.
Fitch-adjusted recovery assumptions for CEOC include a blended EV/EBITDA multiple of 7.9x on $1 billion EBITDA, which is Fitch's base case 2015 forecast for CEOC excluding Harrah's Philadelphia. The multiple is a weighted average of multiples in the 6.5x-10.0x range assigned to CEOC's regions. Fitch assigns a 10x multiple to Caesars Palace, which will be CEOC's only remaining major asset on the Las Vegas Strip. Fitch assigns a 7x multiple to the Other U.S. segment (mostly regional assets) and 6.5x to the Atlantic City segment.
An upgrade of CEOC's IDR is unlikely at this point without a meaningful reduction in debt burden, which in Fitch's view cannot be accomplished without some sort of a restructuring transaction. A downgrade to 'C' would signify that Fitch believes that a default at CEOC is imminent. This could potentially follow solicitations for a debt-for-equity exchange, which if executed would result in a downgrade to 'RD'. Shortly after the exchange is completed, the IDR will be re-visited and raised to a level consistent with the pro forma capital structure. A bankruptcy filing would result in a downgrade to 'D'.
Due to the parent guarantee, Fitch will likely keep CEC's IDR linked to CEOC's unless the guarantee is released. In the event the guarantee is released, Fitch would withdraw CEC's ratings since there is no debt at CEC.
Fitch has downgraded the following ratings:
Caesars Entertainment Corp.
--Long-term IDR to 'CC' from 'CCC'.
Caesars Entertainment Operating Co.
--Long-term IDR to 'CC' from 'CCC';
--Senior secured first-lien revolving credit facility and term loans to 'CCC/RR2' from 'CCC+/RR3';
--Senior secured first-lien notes to 'CCC/RR2' from 'CCC+/RR3';
--Senior secured second-lien notes to 'C/RR5' from 'CC/RR6';
--Senior unsecured notes with subsidiary guarantees to 'C/RR5' from 'CC/RR6';
Fitch affirms CEOC's senior unsecured notes without subsidiary guarantees at 'C/RR5'.
Fitch rates the other CEC entities as follows:
Caesars Entertainment Resort Properties, LLC
--IDR 'B-'; Outlook Stable;
--Senior secured first-lien credit facility 'B+/RR2';
--First-lien notes 'B+/RR2';
--Second-lien notes 'CCC/RR6'.
Caesars Growth Properties Holdings, LLC
--IDR 'B-'; Outlook Stable;
--Senior secured first-lien credit facility 'BB-/RR1';
--Second-lien notes 'B-/RR4'.
Corner Investment PropCo, LLC
--Long-term IDR 'CCC';
--Senior secured credit facility 'B-/RR2'.
Chester Downs and Marina LLC (and Chester Downs Finance Corp as co-issuer)
--Long-term IDR 'B-'; Outlook Negative;
--Senior secured notes 'BB-/RR1'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (Aug. 5, 2013);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' (Nov. 19, 2013);
--'Distressed Debt Exchange' (Aug. 2, 2013);
--'Fitch: Caesars CGP Related Transactions Positive for Equity Holders and CERP; Negative for CEOC' (Mar. 3, 2014);
--'U.S. Gaming Recovery Models - Third-Quarter 2013' (Jan. 29, 2014);
--'2014 Outlook: U.S. Gaming (Deleveraging Potential) (Dec. 16, 2013);
--'Caesars Entertainment Corp. (Parent Guarantee and Potential Debt for Equity Exchange Considerations)' (Nov. 18, 2013);
--'Fitch 50 -- Structural Profiles of 50 Leveraged U.S. Credits' (July 11, 2013);
--'U.S. Leveraged Finance Spotlight Series: Caesars Entertainment Corp.' (Sept. 5, 2012).
Applicable Criteria and Related Research:
U.S. Leveraged Finance Spotlight Series: Caesars Entertainment Corp.
Fitch 50 -- Structural Profiles of 50 Leveraged Credits
Caesars Entertainment Corp. (Parent Guarantee and Potential Debt for Equity Exchange Considerations)
2014 Outlook: U.S. Gaming (Deleveraging Potential)
U.S. Gaming Recovery Models -- Third-Quarter 2013
Distressed Debt Exchange
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage