NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded Caesars Entertainment Operating Company. Inc.'s (CEOC) senior secured credit facility to 'CCC+/RR1' from 'CCC/RR2' following the finalization of the new guarantee and pledge agreement. The agreement caps the amount of debt that Caesars Entertainment Corp (CEC; Caesars, parent) may guarantee at $8.35 billion.
In addition, Fitch has also affirmed CEOC's first-lien notes at 'CCC/RR2', and the more junior tranches at 'C/RR6', although the recovery rating (RR) on the junior tranches has been revised to 'RR6' from 'RR5'. The Issuer Default Ratings (IDRs) for CEOC and CEC were affirmed at 'CC'. A full list of rating actions follows at the end of the release.
KEY RATING DRIVERS
The upgrade of the senior secured credit facility reflects CEOC's new guarantee and pledge agreement, which caps the amount of debt that CEC may guarantee at $8.35 billion relative to approximately $5.3 billion of term loans and $19 billion of total debt outstanding at CEOC. The new agreement, plus the reduced risk that CEC may attempt to release the guarantee from the credit facility, strengthens the credit facility's recovery prospects with respect to the guarantee. Fitch estimates that in an event CEOC files for bankruptcy the credit facility lenders' recovery will exceed 91%.
The 91% or greater recovery estimate takes into account roughly 70% recovery derived from the CEOC collateral alone and 20% or greater recovery from the parent guarantee. This does not assume any paydown of the term loans using the $2.8 billion of excess cash on hand at CEOC including the $1.8 billion in proceeds from the recent asset sale to Caesars Growth Partners (CGP). CEOC's newly amended credit agreement exempts the CGP asset sale from the paydown requirements but CEOC's secured note indentures still require CEOC to either prepay first-lien debt or reinvest the proceeds within 15 months.
The affirmation of the first-lien notes at 'CCC/RR2' reflects Fitch's recovery estimate for this debt at roughly 70%, which is borderline 'RR2' (71% - 90% recovery) and RR3 (51% - 70%) without the guarantee. The prospect of the first-lien notes receiving a portion of the parent guarantee or CEOC prepaying debt using the CGP asset sale proceeds increases the cushion for the first-lien notes within the RR2 band.
The guarantee and pledge agreement permits CEC to grant the guarantee on up to $3 billion of incremental debt in addition to the $5.3 billion of the term loans outstanding. Fitch believes Caesars may use this capacity as an incentive when negotiating restructuring terms, seeking consents for further amendments or issuing additional first-lien debt (new credit agreement has a $500 million accordion option). The ambiguous nature of the indenture provisions CEC relied on to release the guarantee on CEOC's notes may strengthen the noteholders' leverage when negotiating restructuring or amendment terms or attempting to extract more meaningful concessions in an event of an in-court restructuring. There is also a possibility of a court reversing the guarantee release although putting a probability on this scenario is difficult.
The downward revision of the RRs on the more junior notes reflects increased uncertainty that these tranches will be able to recover 11% or more (RR5 range is 11% - 30%) based on the parent guarantee alone in a bankruptcy scenario now that the B7 term loan is closed and the new credit agreement and the guarantee and pledge agreement are finalized. Fitch estimates 0% recovery for these tranches based on the CEOC collateral alone. These tranches could still realize some recovery based on the guarantee consideration discussed above, but likely no higher than around 20%, which would equate to a weak RR5 recovery rating.
PARENT GUARANTEE RELEASE
Caesars released the CEOC notes' parent guarantee by selling 5% of CEOC to third-party investors. Caesars offered the guarantee to the B7 term loan lenders and kept the guarantee for the existing term loan lenders that agreed to amend the credit agreement. The guarantee release is pursuant to the CEOC's note indentures' provision that states that the guarantee will be released if CEOC ceases to be a wholly-owned subsidiary of Caesars.
Fitch believes that the language that Caesars relied on for the guarantee release is ambiguous and can potentially be challenged by the noteholders (second-lien noteholders' notice of default cited the release as of one of the default triggers). With respect to the pre-LBO notes, 'wholly-owned subsidiary' in the relevant provision directs the readers to SEC's Regulation S-X (17 CFR part 210) definitions, which defines the term as 'subsidiary substantially all of whose outstanding voting shares are owned by its parent'. It is unclear if selling 5% of CEOC's stock meets the 'substantially all' threshold. With respect to the post-LBO notes, the provision that allows the release of the guarantee upon CEOC ceasing to be wholly-owned is adjoined to two other provisions that Caesars did not meet with the word 'and'.
CEC's market capitalization of around $2.5 billion is a good proxy for the value of the guarantee. Fitch believes that Caesars Entertainment Resort Properties (CERP) contributes roughly $700 million of the value and CGP $1.8 billion.
CEOC DEFAULT IS LIKELY NEAR
Fitch believes that CEOC will attempt to execute a debt-for-equity exchange with the second-lien holders in the near term. According to a Bloomberg article Caesars hired Kirkland & Ellis to help in its restructuring talks.
The second-lien's elevated price relative to recovery prospects is hampering CEOC's exchange efforts. At mid-30s the price is likely too high to enable CEOC to execute a meaningful exchange without utilizing CEC's equity in healthier subsidiaries.
Since the sale of 5% of CEOC's equity to unaffiliated investors in May CEC may look to offer equity in CEOC to the second-lien holders. CEOC is about 12x leveraged through the first-lien and therefore equity beyond the first lien is minimal. At current prices CEOC's second-lien notes are valued at $2.1 billion. Second-lien prices could be elevated due to the second-lien holders' positions in 1-year CEOC credit default swaps, which are trading at above 5,000 basis points spread compared to below 2,000 basis points in early May.
In order to execute an exchange CEOC would have to find a way to trigger the CDS without cross-defaulting the entire capital structure ($150 million is the cross-default threshold in most debt documents). Alternatively, CEOC would have to sweeten the exchange by prepaying a portion of second-liens with cash on hand (may require consent from the first-lien holders) and/or offering equity in the parent. Assuming CEC is unable to execute an exchange CEOC may elect to go the bankruptcy route, which could potentially be less dilutive relative to an exchange now that the guarantee has been released on the notes, if the guarantee release is upheld.
Assuming CEOC can execute an exchange Fitch believes that CEOC has enough levers to get through 2016 and possibly 2017. Pro forma for a full exchange, including the 12.5% notes, CEOC will save $550 million in annual interest expense and will have roughly $2.8 billion in excess cash (cash net of cage cash and pro forma for the CGP sale as of March 31, 2014). Annual FCF burn will be reduced to roughly $400 million - $500 million or possibly lower in event operating conditions improve. Maturities below the first-lien include $1.1 billion of unsecured notes in 2016 and $539 million of unsecured notes in 2017. CEOC can potentially refinance the $2.1 billion in 11.25% first-lien notes maturing 2017 using the available parent guarantee capacity as an incentive.
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'.
Fitch takes the following rating actions:
Caesars Entertainment Corp.
--Long-term IDR affirmed at 'CC'.
Caesars Entertainment Operating Co.
--Long-term IDR affirmed at 'CC';
--Senior secured first-lien revolving credit facility and term loans upgraded to 'CCC+/RR1' from 'CCC/RR2';
--Senior secured first-lien notes affirmed at 'CCC/RR2';
--Senior secured second-lien notes affirmed at 'C/RR6'; RR revised to RR6 from RR5;
--Senior unsecured notes with subsidiary guarantees affirmed at 'C/RR6'; RR revised to RR6 from RR5;
--Senior unsecured notes without subsidiary guarantees affirmed at 'C/RR6'; RR revised to RR6 from RR5.
Caesars Entertainment Resort Properties, LLC
--IDR rated 'B-'; Outlook Stable;
--Senior secured first-lien credit facility rated 'B+/RR2';
--First-lien notes rated 'B+/RR2';
--Second-lien notes rated 'CCC/RR6'.
Caesars Growth Properties Holdings, LLC
--IDR rated 'B-'; Outlook Stable;
--Senior secured first-lien credit facility rated 'BB-/RR1';
--Second-lien notes rated 'B-/RR4'.
Corner Investment PropCo, LLC
--Long-term IDR rated 'CCC';
--Senior secured credit facility rated 'B-/RR2'.
Chester Downs and Marina LLC (and Chester Downs Finance Corp as co-issuer)
--Long-term IDR rated 'B-'; Outlook Negative;
--Senior secured notes rated 'BB-/RR1'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Distressed Debt Exchange' (Jun. 30, 2014);
--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (Nov. 19, 2013);
--'U.S. Gaming Recovery Models - First-Quarter 2014' (July 24, 2014);
--'Fitch 50 (Structural Profiles of 50 Leveraged U.S. Credits)' (July 8, 2014);
--'Fitch Rates Caesars B7 Term Loan 'CCC/RR2'; Refi Negative for Existing CEOC Creditors' (May 7, 2014).
Applicable Criteria and Related Research:
Distressed Debt Exchange
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
U.S. Gaming Recovery Models -- First-Quarter 2014
Fitch 50 (Structural Profiles of 50 Leveraged U.S. Credits)