Vancouver Casino Dangles Higher Bond Payout, But There’s a Catch

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Great Canadian Gaming Corp. is asking debt holders to gamble that boosting leverage to reward shareholders will keep the company in the black.

To sweeten the offer, the owner of betting parlors and the River Rock Casino Resort near Vancouver is giving investors the chance to receive higher interest-rate coupons over time. The risk is that the odds of a credit-rating upgrade diminish and even a threat of default is likely to rise if more cash flow is directed to shareholders.

Great Canadian asked debt holders for permission to rewrite restrictions on C$450 million ($374 million) of bonds it sold in July 2012 that limit shareholder distributions, according to a consent solicitation document filed Monday. Approval would allow the already below-investment grade rated casino operator to increase leverage to reward shareholders with either stock buybacks or dividends.

“They want to throw off the shackles so they can better manage their own return on capital and their capital allocations than they are currently allowed to do,” Kenric Tyghe, a Toronto-based equity analyst at Raymond James Securities, said Tuesday by phone. “They want to be in a position to buy back shares more aggressively” and start paying dividends.

Leverage Ratios

Great Canadian’s free cash flow soared to C$148.3 million last year, from C$79.1 million in 2011, the last full year before the company sold its bonds in July 2012, according to data compiled by Bloomberg.

As of the end of last year, Great Canadian’s total debt was 3.3 times its earnings before interest and taxes, the lowest level for the measure since 2004, the data show.

By Moody’s Investors Service’s calculation, the ratio is 2.6 times, which would have put the casino operator in line for a higher rating, were it not for concern earnings are too dependent on the River Rock Casino, according to Peter Adu, a Moody’s analyst in Toronto.

The proposal follows an outcry over companies from the architect of the Keystone XL pipeline Enbridge Inc. to coffee chain Tim Hortons Inc. forsaking bondholders to fund growth and dividends.

The Great Canadian request, which needs the consent of holders of a majority of outstanding notes by May 8, promises a consent fee equal to 0.5 percent of the amount held. It also dangles the possibility of a bigger coupon as risks rise.

Coupon Increments

The coupon step-ups use a leverage grid, rare for Canadian high-yield bonds while common in U.S. leveraged loans. The coupon grows in 12-basis-point increments, to as much as 7.375 percent, as leverage doubles, according to the filing.

Great Canadian Chief Financial Officer Kiran S. Rao didn’t immediately respond to a request Tuesday for comment.

The securities were priced three years ago with a 6.625 percent coupon, and were rated B1 by Moody’s, four steps below investment grade, and three levels higher at BB+ by Standard & Poor’s.

The casino operator could increase leverage up to 4.5 times and maintain its current rating, Adu said. “There’s room for them to increase their debt and repurchases,” he said.

Bondholders have been burned in the past as companies borrow to make acquisitions or pay dividends. Tim Hortons succumbed to pressure from activist shareholders for share buybacks last year, issuing C$900 million of bonds to finance the purchases. The debt triggered ratings cuts. In December, Enbridge moved C$17 billion of Canadian liquids pipelines to the Enbridge Income Fund and out of bondholders’ reach to boost its dividend 33 percent.

Driving Terms

Amid a freeze in Canadian junk bonds this year, investors who were snubbed before may be gaining the upper hand. The collapse in crude prices has made a high-yield market comprised 40 percent of the debt of energy companies a tough sell. Not a single company issued high-yield bonds denominated in Canadian dollars this year, even after the central bank lowered borrowing costs on Jan. 21, according to data compiled by Bloomberg.

“Smaller companies aren’t getting the same access to the bond market as they used to, therefore bondholders have more leverage in driving terms on these deals,” Gregory Kocik, a managing director of TD Asset Management which oversees about $3.7 billion in high-yield funds, said by telephone from Toronto. “Within Canada, gaming isn’t closely followed or understood. People are going to demand more compensation.”

Great Canadian has benefited from a duopoly in the Great Vancouver area, where regulatory obstacles deter new competitors, according to Tyghe at Raymond James. Recent upgrades to the River Rock are attracting more high-limit gamblers, he said. The company’s main rival is privately-held Gateway Casinos & Entertainment Ltd.

“They have been under some considerable pressure from major shareholders for an extended period of time to initiate a dividend,” Tyghe said. “Clearly this would give them the flexibility. There’s nothing worse than on the one side having somebody punching you in the teeth” and being unable to defend yourself.

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