The success of Caesars Entertainment's initial public offering last week reflected the combination of its tiny size and the improved prospects for legalization of online poker following a 2011 Justice Department ruling that removed some obstacles at the state level.
Caesars (ticker: CZR), which has been gearing up for legalization, has one of the leading brands in its World Series of Poker. Yet the shares look overpriced because the debt-laden company has little going for it besides a future in online poker. Its current market value of about $2 billion assumes legalization of online poker at state and federal levels and significant profits from what is likely to be a very competitive business.
Caesars sold only 1% of its outstanding stock in its IPO: 1.8 million shares at $9.00. The stock jumped 71%, to $15.39, in its first day of trading and closed the week at $14.24. The shares are likely to remain volatile until there is greater float. Better domestic gambling plays include Ameristar Casinos (ASCA) and Pinnacle Entertainment (PNK), which don't have the enormous debt of Caesars and carry much lower valuations.
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Caesars is one of the largest gambling companies, with 52 casinos in 12 states and seven countries, including a presence in the key markets of Las Vegas and Atlantic City. What it lacks is a casino in the lucrative gambling mecca of Macau, where Wynn Resorts (WYNN) and Las Vegas Sands (LVS) have valuable franchises.
After being taken private in a top-of-the-market leveraged buyout in 2008, Caesars carries enormous debt of $22.5 billion and has been burning cash after hefty interest expense of almost $2 billion annually. Some of the company's debt trades for 80 cents on the dollar and yields 15%. The company has skimped on capital expenditures, spending just $165 million in the first nine months of 2011 and only $160 million in 2010. Wynn spent around $100 million in 2010 to renovate just one of its Vegas hotels.
There appears to be little or no equity value in Caesars' core business given the ugly financials. Yet the IPO prospectus shows Caesars carved out its online business, including the World Series of Poker, into a separate unit unencumbered by debt. This means Caesars equity holders should get all the online profits; hence the investor focus.
In a January research note, Nomura Securities gaming analyst Harry Curtis wrote that he believes that "by year-end 2012, Internet poker will be live in at least a handful of sizable states, perhaps including California, New Jersey, New York, Illinois and Nevada." State action could pressure Congress to approve online poker nationwide, simplifying regulation and creating a new stream of federal tax revenue. Curtis estimates that national online poker ultimately could generate $6 billion in annual revenues with 30% to 35% profit margins.
"The next big wealth creation will be online," said Gary Loveman, Caesars' CEO, on a presentation posted on the RetailRoadshow.com Website. He cited "a number of encouraging things" that have occurred in the past few months that have raised the odds of legalized online poker. (In 2006, Congress cracked down on online poker played via offshore sites.) The recent, important Justice Department ruling was that the 1961 Wire Act, which has been used to hamper online gambling initiatives, applied to sports betting but not online poker.
Caesars tried to go public in late 2010 at a much higher valuation but pulled the deal amid weak investor demand. Before that happened, Barron's warned that the IPO looked unappealing. Back then, Caesars sought an equity market value of $5.5 billion.
The Bottom Line
Shares of Caesars jumped 71% after last week's IPO. But given the company's huge debt load, the core casino business may have little or no equity value. Don't bet on more big gains.
As Barrons.com reported Monday, this was a very unusual IPO. That's because the shares originated with a group that invested in Caesars' $29 billion leveraged buyout in 2008 alongside the dominant investors, private-equity giants Apollo Global Management and TPG Capital.
These investors, including a trust controlled by actor Michael J. Fox and the California State Teachers' Retirement System, gave a small portion of their shares to Caesars in return for the company doing the IPO and allowing them to sell their total stake of 22 million shares.
The IPO was cleverly handled because Caesars created scarcity value by selling such a small amount of stock. It will take a big move in the stock, however, for the LBO sponsors to come out whole. We estimate that their cost is $40 a share or more.
Caesars, which has only $125 million of debt maturities until the end of 2014, is seeking to renegotiate a portion of its bank loans, to extend the maturity to 2018 from 2015, to buy time for a recovery. The problem is that its debt load is so high and interest burden so significant that the company ultimately may need a financial restructuring.
Caesars' equity is valued at 12 times projected 2012 pretax cash flow, for a company that may continue to burn cash. In comparison, regional gambling companies like Ameristar and Pinnacle trade for about seven times estimated 2012 pretax cash flow. Ameristar, at $20, looks appealing trading for about nine times projected 2012 profits and for about seven times free cash flow.
Also likely to be in on the action is the British parent of the online card room Party Poker, Bwin Party Digital Entertainment (BPTY.U.K.). The world leader in online gambling, it may offer a better play than Caesars. Bwin, hoping to take advantage of potential legalization, is the lead partner in a U.S. online poker joint venture with MGM Resorts International (MGM) and Boyd Gaming (BYD). Its market value, at $2 billion, is comparable to that of Caesars. It's profitable, and trades for 13 times estimated 2012 profits. In the end, its shareholders, not Caesars', might be able to say veni vidi vici.
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