Caesars’ challenge

The saddest thing about Atlantic City is that it’s so damn pretty.

The boardwalk has a view of the glimmering Atlantic Ocean. On a recent August day, the sky reflects the colour of the waves as they crash gently against a crowded beach. Children, families, young couples and revellers lounge on beach towels or underneath their parasols, soaking up the sunshine. Most are travellers staying at one of the many hotels and casinos, whose proximity to the beach and shopping centres provide easy access to everything Atlantic City has to offer.

The counterman at Café Roma in Caesars Atlantic City pours coffee for his late-morning customers. He’s worked for Caesars Entertainment for the last decade.

“I like it here. This was my first place in America,” he says. “We still do ok, you know? We still interact with customers.”

After chatting for a minute, he slides to the other end of the counter to serve the next patron.

For an employee of a troubled company in a fading city, his outlook is bright. The summertime is best, he says. People drive in from Philadelphia, New York or the New Jersey suburbs. They stay for a while, sit at the beach, eat a few good meals – gamble if that’s their thing. Atlantic City is nice in the summer. The boardwalk is, anyway.

The beauty – both natural and manmade – fades fast as you walk inland, away from the ocean and the whirring pings of the slot machines. The palatial casinos give way to cash-for-gold shops and payday loan storefronts; family restaurants become low-level strip clubs and neon-lit adult bookstores. It’s a stark contrast. The resorts that line the boardwalk are fun and glamorous; but it’s not hard to see where the party stops.

One embodiment of the part of Atlantic City where the party is still going is Caesars Entertainment, one of the world’s biggest casino operators. In 2008, buyout firms TPG Capital and Apollo Global Management purchased what was then known as Harrah’s Entertainment for $30.7 billion. The deal included the assumption of $12.4 billion in debt.

Although it’s a high-profile, high-revenue business, the company has struggled to succeed in an economic environment characterised by weak consumer confidence, high unemployment and declining disposable income. Caesars is currently saddled with $23.49 billion of long-term debt, and nowhere are the company’s challenges more apparent than in Atlantic City, which is home to four of its 52 casinos.

“Overall market volume declines in Atlantic City remained steep, but are returning to pre-[Hurricane] Sandy levels,” said Caesars chief financial officer Donald Colvin during a second quarter earnings call this year. “That said, our share has declined slightly there. We are fighting market inefficiencies.”

Hard times 

More than most businesses, casinos suffer on the wheel of economic fortune. In strong economies, when discretionary consumer spending is high, they prosper. In recessions, they suffer. So it’s no surprise that the last few years have been difficult for the gaming industry, particularly in Atlantic City, where a combination of increased regional competition and the effects of Hurricane Sandy in October 2012 led to an 8 percent decline in gross gaming revenue last year, according to an American Gaming Association report.

In the second quarter, net revenue generated by the Caesars’ Atlantic City properties fell to $400.1 million, compared to $436.5 million in Q2 2012 (this includes a casino in Pennsylvania). The properties generated $765.4 million for the six month period ending 30 June, an 11.9 percent drop compared to the previous year.

“That market has struggled a lot for a lot of reasons. Competition, the storm, and on and on. And that said, it actually still performs pretty damn well on weekends as a leisure market,” says one source with knowledge of the business.

The picture remains negative – though certainly less bleak – when one considers how Caesars performed across all 52 of its properties. Overall, net second quarter revenues fell by just 0.25 percent compared to the same period last year. Somewhat strikingly, however, gaming revenues declined by 7.5 percent during that time, according to its second quarter report.

Caesars’ performance has led to a rash of negative coverage over the last year. UNITE HERE – a labour union that represents many Caesars employees – has engaged an aggressive campaign targeting Caesars’ private equity backers.

The employees’ complaints – particularly those pertaining to advisory and management fees levied on Caesars by the sponsors – have already found an audience with some of the firms’ investors.

“Notwithstanding this decline in value and the overall poor performance of the fund over the last five years, [TPG] had drawn $717 million in transaction and monitoring fees. Only $465 million of the collected fees have gone to reduce the management expenses that your limited partners have paid,” wrote Rhode Island General Treasurer Gina Raimondo in an August letter to TPG’s chief investment officer, Jonathan Coslet.

The sponsors’ role 

Although they do not manage the now-public company in the strictest sense (it went public in February 2012), senior executives or advisors directly affiliated with TPG, Apollo or their subsidiaries hold a majority of the seats on Caesars’ board of directors. That board is “the ultimate decision-making body of the company and advises and oversees management, who are responsible for the day-to-day operations and management of the company”, according to its charter.

In that capacity, the firms have worked with Caesars on issues relating to its balance sheet – an area in which it has taken some rather notable steps of late. Last month, the company initiated a refinancing of $4.4 billion in CMBS facilities, according to an 18 September US Securities and Exchange Commission filing.

Of course, simply buying back the entirety of its outstanding CMBS facilities would be remarkable at this stage, given the size and scope of the company’s debt. Caesars will syndicate $3.27 billion of new senior secured credit facilities to finance the repurchase, a total that includes a $3 billion term loan and a $269.5 million revolving credit facility. The company will also offer $500 million of first lien notes and $1.35 billion of second lien notes.

Terms of the new facilities were not available as the transaction had not been finalised at press time, a Caesars spokesperson told Private Debt Investor.

The refinancing, along with other repurchases and maturity extensions, has had an effect. Prior to the announcement of its CMBS refinancing, the company had only $5.5 billion of its debt load coming to maturity in 2015. Most of its debt, $13.6 billion, reaches maturity in 2018 or later, according to Q2 presentation materials made available to Private Debt Investor.

TPG and Apollo have also taken a more direct approach to improving the company’s prospects as well. In April, Caesars announced that the firms would invest $500 million combined into a growth-oriented venture called Caesars Growth Partners. The new venture is intended to help the company pursue growth opportunities through a “less levered and more flexible vehicle than its existing operating subsidiaries”, the company said in a statement.

There is still more work to be done, however. Caesars will pay in excess of $1 billion in interest this year alone. For the years 2014 through 2017, those totals increase to $2 billion, $1.67 billion, $1.52 billion, and $1.26 billion respectively, according to its second quarter earnings report.

Caesars Entertainment management did not respond to request for comment. TPG and Apollo both declined to comment.

Building your way out 

Despite the ongoing effort to control its debt load, Caesars has continued to build and renovate existing properties to broaden its customer base, as well as expand its operational focus beyond gaming. In fact, the second quarter casino revenue losses were offset by positive developments in food & beverage and other segments, according to the second quarter earnings call.

Caesars expects $1 billion to $1.1 billion in capital expenditures for the year, with a focus on the casinos in Las Vegas and newer markets such as Baltimore. And although New Jersey remains one of its weakest markets, Caesars is in the process of constructing a 250,000 square foot convention centre located on the southwest corner of its Harrah’s Atlantic City property, a move that could improve its regional market share.

The new facility is intended to serve as something of an anchor for its other holdings on the boardwalk, one market source said. The plan is to draw in audiences from the Northeast’s $16 billion convention and meetings market, which should attract new visitors, particularly mid-week, as well as absorb hotel room and restaurant capacity.

Spending money to develop non-casino revenue streams appears apt, as several sources indicate that food, beverages and entertainment may be where the company focuses moving forward. Anything to offset the declines in gaming revenue must be viewed positively, particularly when one considers how Moody’s downgraded the company’s corporate rating from Caa1 to Caa2 earlier this year due to negative
gambling trends . 

The convention centre, along with the company’s general efforts to improve its health by tapping into new markets, is a move its critics in the labour movement applaud.

“This market hasn’t zeroed in on the convention business like Las Vegas did many, many years ago.” says C. Robert McDevitt, president of Atlantic City’s chapter of UNITE HERE. “When Harrah’s built the 3000 hotel rooms, in their mind, those rooms were going to be filled by gamblers from Pennsylvania, New York and North Jersey. It wasn’t built with the idea of, ‘We need to build 3000 rooms to have a big convention centre’.”

McDevitt’s UNITE HERE office is located two and a half blocks from the rear of Caesars and Bally’s (another of the company’s properties). He has decorated his office with a framed “Great Day in Harlem” poster and collages of antique union flyers and newspaper clippings. He’s a big man, prone to using his hands to describe casino table configurations or to convey frustration.

Even as he concedes Atlantic City’s many faults, he refuses to let TPG and Apollo off the hook for the state of Caesars’ local properties. UNITE HERE has been sending its members to public pension meetings over the last few months to protest about how private equity ownership has affected its labour force, particularly in relation to how the balance sheet issues have put the company in a position to initiate cutbacks.

“If you run this gigantic company of 50 casinos, you’ve got to decide where your capital goes. When you’re as cash-strapped as they are, when you’re $21 billion in debt… You can’t just let it sit there. Because what will happen is they will lose market share,” he says.

The union’s own agenda in the story should not be overlooked. Collective bargaining agreements with employees located in the Atlantic City properties expire at various times throughout 2014 and 2016, and agreements with Las Vegas-based employees run out throughout 2013, according to Caesars’ annual report.

One specific example McDevitt cites is the cleaning staff at Caesars’ Bally’s property in Atlantic City, where he claims a reduced number of employees has been tasked with cleaning acres of casino and public floor space.

“There were only 16 people there for day shift at Bally’s to clean this enormous property,” he says. “A couple years ago, there would have been 60 people at the pre-shift meeting. It’s filthy, it’s been undercapitalised for years.”

While there’s no denying the company has reduced staff – salary and wage expenses in domestically-owned properties fell 3 percent and full time employees declined by 6 percent year-on-year in the second quarter – the cost reductions have had an effect in improving Caesars’ expenses.

One initiative, known as Project Renewal, has permanently lowered Caesar’s cost structure and benefits through a greater concentration of specified talent and “quicker decision making”, according to a 2012 full year report. Caesars estimates that Project Renewal and other cost-savings programmes produced $56.3 million and $190.8 million in incremental cost savings for the fourth quarter and full year 2012, respectively, according to fourth quarter and year end results.

The case for the programmes’ success has been strengthened by the negligible effect they have had on customer satisfaction – though McDevitt might contest this assessment. Through the first half of 2012, Caesars generated top-level internal customer satisfaction scores on approximately 57 percent of those surveyed, and this total has trended upwards since the first quarter of 2009, according to documents made available by a company spokesperson. More recent statistics were unavailable at press time.

From McDevitt’s perspective, it’s unclear how Caesars is allocating resources among its properties. While Caesars Atlantic City and Harrah’s seem well run, the employees he represents in The Showboat and Bally’s complain of being overworked or improperly utilised, according to McDevitt. He also insists the ownership group lacks a unified front when it comes to handling such issues. This, he claims, has resulted in certain cost-saving programmes being implemented differently across the four properties.

“It’s extremely frustrating. It’s much more productive for everyone if you have an ongoing dialogue and you understand each other and what your positions are. They don’t really have a position. If I pick up the phone, I don’t know who to talk to right now,” he says.

It seems as though those complaints are being heard. The pushback from LPs on fees has also begun to extend to labour issues as well. In June, Oregon State Treasurer (and member of the Oregon Investment Council) Ted Wheeler sent duplicate letters to TPG and Apollo urging the firms to “create opportunities and … treat employees fairly. This is an opportunity to show how private equity is a positive catalyst for both the economy and for the beneficiaries of institutional investors”.

The note was bold, particularly coming from a limited partner. Still, whatever the disappointment Wheeler and his colleagues at the Oregon Investment Council may have had with the firm’s handling of Caesars, it did not prevent them from re-upping $300 million to Apollo’s latest buyout fund earlier this year. Wheeler personally seconded the motion to approve the investment staff’s commitment recommendation.

“The Treasurer as member of the OIC is concerned about long-term value, which includes alignment of interest and headline risk. Management practices can be a factor to both,” an Oregon spokesperson told PDI. The spokesperson declined to say if Caesars played any role in the OIC’s negotiations for its latest commitment.

The Showboat 

The Showboat sits on the northern end of the boardwalk, past an underdeveloped stretch of candy shops, arcades and restaurants. In the bar adjacent to its casino floor, almost every seat has video poker and the bartenders move quickly to service their customers, many of whom are taking advantage of the lax public smoking laws.

It’s 5 o’clock in the afternoon and the casino floor seems to be quieting down. The senior citizens who populate the gaming areas during the mornings and afternoons are retiring to their rooms or to one of the Showboat’s many restaurants (steak, New Orleans-style buffet, Italian, to name a few).

Asked whether he expects another wave of customers later, of if this is it for the day, one of the bartenders responds:  “There’s a flow to it. In a half hour, half of these people may be gone. But people come back in from the beach.”

Keeping this flow going and seeing it grow will be paramount if Caesars and its current owners are to fully overcome their post-LBO challenge.  ?