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ANALYSIS-How buyout firms have 'cake and eat it too' in Caesars bankruptcy
October 4, 2016 / 5:21 PM / a year ago

ANALYSIS-How buyout firms have 'cake and eat it too' in Caesars bankruptcy

WILMINGTON, Del/CHICAGO Oct 4 (Reuters) - Caesars Entertainment Corp delivered an unusual bounty to its private equity owners when it struck a $5 billion deal last week to exit its casino operating unit's costly bankruptcy: They keep part of their investment.

Under the proposed agreement, shareholders Apollo Global Management and TPG Capital Management LP could emerge with a 16 percent collective stake in a new restructured Caesars, worth roughly $500 million.

The Sept. 27 deal was previewed in a 2012 internal Apollo memorandum which outlined how the funds would be able to have their "cake and eat it too" if Caesars went belly up.

Typically, in the largest U.S. corporate bankruptcies shareholders are wiped out if creditors are not paid in full. Caesars creditors are receiving billions less than what they are owed.

"This is definitely outside the norm," Israel Shaked, a professor at the Boston University School of Management who has worked as a restructuring advisor, said about the shareholders maintaining a stake.

To be sure, Apollo and TPG are walking away with much less than they would have under prior settlement offers, which were firmly rejected, and they are surrendering their stock in the Caesars parent, which is worth about $950 million.

Caesars and Apollo declined to comment.

GOLDEN AGE

Apollo and TPG gained control of the casino empire in 2008 in a $30 billion leveraged buyout for Harrah's Entertainment, which they then renamed.

Apollo, TPG and co-investors sank $6 billion into the deal, just as the golden age of mega-buyouts peaked and the U.S. economy tipped into a deep recession.

Caesars was soon groaning under around $18 billion in debt. The Las Vegas-based chain refinanced debt and extended maturities on borrowings in a bid to keep creditors at bay in the hopes that the business would recover, according to a 1,787-page report in March by an independent examiner, former Watergate prosecutor Richard Davis.

But four years after the buyout, the casinos continued to struggle. At this point, Davis said the private equity firms began exploring transfers of hotels and casinos within the Caesars corporate family to try to protect their investment in the event of a bankruptcy.

Apollo has a reputation for savvy restructurings. In the 2014 bankruptcy of Momentive Performance Materials, a chemical company Apollo owns, it used an obscure consumer loan ruling from the U.S. Supreme Court to force new terms on lenders.

"We've seen this with Apollo in the past, in the sense they are willing to really test the legal system," said David Tawil, president of Maglan Capital.

Tawil said other private equity firms would not likely follow the unusually aggressive, high-risk strategy.

"It's definitely not a playbook for the faint of heart," he said.

INTERNAL MEMO

Davis, the examiner, said Apollo's Marc Rowan set out to create new Caesars affiliates, partly funded with around $500 million from the private equity firms, to buy projects from Caesars Entertainment Operating Co Inc, or CEOC, the debt-burdened subsidiary.

"We want to strengthen our hand in a potential restructuring with as little capital outlay as possible," Rowan wrote in an internal October 2012 memo that was intended for TPG, but was published by Davis in his report. "A transaction like this is the only way we see it to 'have our cake and eat it too'."

A Caesars spokesman said Rowan would not comment.

The affiliates acquired properties such as the Linq Hotel and Casino in Las Vegas, which includes the world's largest observation wheel at 550 feet, and the nearby Planet Hollywood Resort & Casino.

The private equity firms and the parent company have said these deals were aimed at helping Caesars flourish by providing cash to CEOC. They have denied wrongdoing and dispute the examiner's findings.

But Davis said the internal communications show the strategy explicitly contemplated how the private equity firms could emerge winners if Caesars filed for Chapter 11. Premier assets were acquired at less than fair value and placed beyond the reach of creditors, who were stuck seeking repayment from a hollowed-out CEOC, according to Davis.

Davis said the memo showed that the private equity firms feared losing their entire investment and were trying "to improve their position vis à vis CEOC's creditors in the event of a restructuring."

Davis concluded the private equity firms and the Caesars parent faced up to $5.1 billion in damages for the asset transfers. Creditors, led by deep-pocketed and aggressive hedge funds such as Appaloosa Management called it "looting," and were pursuing $13 billion in damages in several courts.

Appaloosa and its allied creditors agreed to drop those lawsuits as part of last week's deal. The settlement essentially puts the family of hotels and casinos back under one roof by merging the affiliates that Rowan created, including Caesars Acquisition Corp, with the Caesars parent.

The deal is subject to approval from the U.S. Bankruptcy Court in Chicago. One small hedge fund still opposes the proposed deal. (Reporting by Tom Hals in Wilmington, Delaware and Tracy Rucinski in Chicago; Editing by Amy Stevens, Noeleen Walder and Grant McCool)

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