An innocuous three-letter conjunction in an 80,000-word legal document helped enable more than $450 million of losses for bondholders at a Caesars Entertainment Corp. (CZR) unit.
The casino operator, taken private in 2008 by Apollo Global Management LLC (APO) and TPG Capital for $30.7 billion, said May 6 it would sell a minority interest in its largest subsidiary, removing creditor claims on assets held at the parent. Whether that transaction is legal may depend on an interpretation of the word “and” in a contract of more than 100 pages that governs some of the company’s bonds.
“This reminds investors to be diligent about reading indentures and making sure that they understand the implications of the way they’re drafted,” said Alex Bumazhny, an analyst at Fitch Ratings, who believes bondholders can challenge the action. “That’s going to be a major focal point.”
Caesars was taken private at the tail-end of a leveraged buyout boom, and a collapse in yields following the Federal Reserve’s unprecedented stimulus to counter the last recession has helped the company carry out more than 45 transactions to reduce debt and extend maturities. Josh Harris, who co-founded Apollo with Leon Black and Marc Rowan in 1990, highlighted in a May 8 earnings call how overvalued credit is, saying “illiquid, more idiosyncratic” markets provide the the best returns.
Creditors have already begun to push back against Caesars, which has said it’s received letters protesting its plan to shift casino properties away from its Caesars Entertainment Operating Co. unit. Removing the so-called parent guarantee last week -- which weakens bondholders’ claims -- is just the latest maneuver in a saga that may lead to a broader restructuring of its unsustainable debt load.
“This was a guarantee of convenience included in the indentures at Caesars’ request, so that consolidated financials could be filed” said Stephen Cohen, a spokesman for Caesars. “Our creditors knew from the beginning that we always had the power to terminate the guarantee. The language of the indentures clearly provides that the guarantee terminates upon the sale of CEOC stock, and there is overwhelming market agreement on that point.”
Indentures linked to most of the operating unit’s debt, such as $1.5 billion of 9 percent, first-lien notes that plummeted 9.25 cents last week to 78 cents on the dollar, say the parent guarantee evaporates if the borrower is no longer wholly owned, if substantially all its assets are transfered to another entity that assumes the obligations and if the issuer sets aside enough cash to cover its debt payments.
Caesars’ recent transaction, which includes a new $1.75 billion term loan to refinance shorter-term debt, shows the company interprets the document in a way that allows it to strip the guarantee if only one of those scenarios is satisfied -- in this case, the sale of a 5 percent equity stake to undisclosed investors.
Bondholders may argue that because two of the actions are linked by “and” in the document, extinguishing the guarantee requires Caesars to satisfy all three clauses, according to Fitch’s Bumazhny.
“We would view this as something that could be contested,” John Kempf, an analyst at RBC Capital Markets, wrote in a report last week. “The company could argue that this was simply a ‘drafting error,’ and the actual intention was not the literal interpretation.”
Caesars said May 6 that lenders for its new term loan required the parent guarantee to be limited to bank debt owners who consent to a credit amendment, plus no more than $2.9 billion of additional debt. It’s unclear how that excess will be allocated, according to Bumazhny.
The operating unit had more than $18 billion of debt at year-end, according to a March regulatory filing.
Leaving bondholders with a potentially reduced claim to other parent assets has swelled the ranks of Caesars debt trading at distressed levels, or yielding at least 10 percentage points more than Treasuries.
The 9 percent notes due 2020 traded at 99 cents on the dollar in January, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Its recent plunge to 78 cents has left the securities yielding 14.8 percent at 9:34 a.m. in New York.
Caesars has been grappling with its debt load with U.S. consumers restraining discretionary spending since its buyout. After reporting a widening $386.4 million loss for the three months through March, Chief Executive Officer Gary Loveman signaled the company was looking for ways to reduce capacity in the struggling Atlantic City, New Jersey, market.
Billionaire hedge-fund manager David Tepper’s Appaloosa Management LP, Canyon Capital Partners LLC and Oaktree Capital Group LLC hold some of the junior notes and have hired law firm Jones Day as an adviser, according to a person familiar with the matter, who asked not to be identified because they aren’t authorized to speak publicly. Dave Petrou of Jones Day didn’t return an e-mail seeking comment.
Representatives for Appaloosa and Canyon declined to comment.
Second-lien creditors have alleged that Caesars’ operating unit, which is raising cash by selling properties including the Bally’s, Quad and Cromwell casino-hotels in Las Vegas to an affiliate, is insolvent and that a transfer of assets is fraudulent and a breach of fiduciary duty, according to a March filing from Caesars.
The company hasn’t said whether it’s received any letters challenging the removal of the parent guarantee.
“In this context, we think it may make more sense to read the ’and’ as an ’or,’ which would allow for this type of release,” said Justin Forlenza, an analyst at independent credit-research firm Covenant Review LLC who has researched Caesars’ covenants. “It speaks to the importance of bond investors really digging into the documents and reading them very carefully.”