Michael Craig's Journal

I assume most people have heard at least the initial news: Two private equity firms have reached an agreement with Harrah’s board of directors to acquire all the company’s stock for $90 per share. That comes out to about $17 billion, plus they are assuming $10 billion in Harrah’s debt. I started my legal career in deals like this - usually, trying to butt in and break them up or improve the terms for selling shareholders - and wrote a book about business deals, so it’s a subject I can probably tell you a lot about.

It’s going to take me some time to do the homework (plus it may take some time before the documents are available online), though I may speculate a bit in the meantime.

1. This is an Eighties-style deal: all cash. Apollo Management and Texas Pacific Group are coming up with about $17 billion in cash (some raised from their private equity funds, and most, I assumed, borrowed) to buy out the current public shareholders.

2. Apollo Management is the brainchild of Leon Black, one of the most brilliant financiers on the planet. Black cut his teeth in mergers and acquisitions under Michael Milken at Drexel Burnham & Lambert in the Eighties, and lived to tell the tale. In those swashbuckling times, when he was young and chunky, he was nicknamed, among other things, “The Black Prince” and “Pizza the Hut.” He made, I think, billions of the government’s S&L giveaway, which was also the source of one of Andy Beal’s fortunes.

3. There are three ways to make this deal work, and I’m sure Blackpollo and TaxPac are lining up all three: asset sales, operations, and asset redeployment. With twenty-some BILLION dollars in debt to work down, asset sales are the most likely.

Not to ignore the others, Harrah’s (which operates nearly 40 casinos around the U.S. and is starting some operations outside the U.S.) is a cash cow. Casino operations always are. Casinos rarely lose money on operations, Harrah’s generally operates in a very conservative fashion, and therefore generates a lot of cash that can be used toward debt (or at least interest) service. In addition, certain takeover-related changes may allow the new Harrah’s to wring greater cash-flow out of the same operations - tax deductibility of certain interest, accelerated depreciation.

But operations alone won’t come close to cutting it. The new company is expected to have about $21 billion in debt. The documents describing the new capitalization of Harrah’s are not yet on Harrah’s web site, but it doesn’t make sense for them to not come up with ways of reducing the principal. The company is comprised primarily of assets can be sold (e.g., Rio Las Vegas, Harrah’s Rincon-San Diego) without affecting the other assets.

The acquisition is an asset-value play. The new owners think they can package the assets for sale for a greater amount that what they paid, repackage the remaining/core assets, eventually sell those through a final asset sale or a sale of stock to the public. It’s rare for a private equity firm to hold a company for more than 7 years.

The third method of making a deal work is asset redeployment. Harrah’s is making noises like it’s going to continue with its expansion projects, but don’t count on it. Its assets are going to be highly leveraged, so it’s going to be hard to borrow the money to tear down and rebuild its bulk of Strip assets into a Mega Resort. No one’s going to step forward and say, “We’re going to let Harrah’s Las Vegas and the Flamingo get even more decrepit,” but that’s what makes most financial sense. They make a lot of money from those properties and, if you’ve been inside either in recent years, don’t spend much on upkeep.

4. What’s this mean for the World Series? I have three answers: (a) nothing much at first; (b) nothing good immediately thereafter; and (c) something good in the long run.

At first - It’s going to take about a year for this deal to get done. Current operating management is a lame duck.

Immediately thereafter - Top managers who are going to leave or be replaced aren’t going to do anything expensive or ambitious. Top managers who expect to stay have to look for ways to SAVE money, not spend. The World Series was run on the cheap by Harrah’s last year, and a lot of players complained. If Harrah’s wasn’t already planning on ignoring those complaints, they sure will now. If, for example, Harrah’s could run things more competently by spending twice as much on dealers and floor people - either compensating them better, paying for training, or having more of them - there is no constituency inside the company for that.

In addition, don’t count on Harrah’s doing something smart and innovative to replace all those seats that were paid for by online satellite winners. Harrah’s should be running WSOP satellites in every poker room it operates and licensing the right to operate WSOP satellites to other operators. That could cover a lot of the drop in business due to the difficulty of players qualifying online for ‘07 (though it may not be as much of a hit as some people think), but it requires initiative, coordination, and planning. It would be good for maintaining the value of the World Series as an asset but it’s the kind of thing Harrah’s might not have done anyway and now may not pursue because of changes in personnel or orders not to change anything.

The World Series is something that’s easy for the new owners to sell. It’s easily transplantable, makes a lot of money, has potential to make more and lead to other markets and opportunities, and requires little upkeep to run in its current form. It’s not a big-ticket asset compared with selling, say, Caesars Palace, but it’ll fetch a price far in excess of what Harrah’s paid for the whole downtown Horseshoe operation when it acquired that in early 2004. (Harrah’s subsequently sold off at casino property.)

Long-term, new ownership is likely to be positive for the World Series. Several reasons: (1) How much worse would someone do than the current owners? (2) The new owners would not be acquiring the World Series with the idea of cost-cutting to increase profits. Costs are ludicrously small already. Either the price will be sufficiently attractive or, more likely, a new owner will see a way to leverage the World Series brand into further profitability. If that’s the case, the new owner will be motivated to protect the core, having the World Series run well, be popular and well-attended, and be liked by the customers. (I admit that this should have been the motivation for Harrah’s to do better with the Series, but their orientation was different. They paid almost nothing for the Series and had little in the way of plans to operate it or figure out the best way to profit from it. I believe that they eventually would have figured out that they have to spend money to make money and that their actions were positive for short-term profitability but negative for long-term profitability.)

5. What’s this mean for poker otherwise? An upheaval is coming. I can’t even speculate how it will end, but I don’t think we’re done seeing takeovers of the giant Vegas casino owners. Las Vegas Strip land is incredibly valuable, as are profitable resorts. Two companies owned almost all the land and profitable resorts. One of the two, Harrah’s was judged as takeover bait, easy to dismantle and sell for more than the stock-market value, selling for $17 billion. You’d have to be naive to believe that the other private-equity firms - there are tens of billions of dollars in these funds, looking for deals - haven’t put a big target on MGM Mirage.

I emphasize that this is all speculation. Very little has been disclosed about the 2007 WSOP beyond its starting date. Nothing has been said by Harrah’s about the effect the takeover will have on the Series. The regulatory documents detailing the financing of the takeover and the board of directors’ evaluation of the value of Harrah’s and its assets haven’t been made public.

It’s just my opinion that the new owners are going to carve up the company, sell off as much land and as many casinos as they can, sell off the World Series of Poker to someone whose profit will come from growing the brand long-term, and pretty up the remaining assets and take them public again in 5-7 years.

This entry was posted on Thursday, December 21st, 2006 at 10:16 pm and is filed under My favourites:.