How Caesars’ Bankruptcy Plan was Shot Down

how-caesars-bankruptcy-plan-was-shot-downCaesars (CZR) almost got away with it. But as of yesterday, it looks like they were caught just as they were about to get in their getaway car. They tried to sneak all their assets into an untouchable shell, away from the justifiably grabby arms of second lien creditors, to which Caesars owes $5.24B. On January 19, Judge Shira Scheindlin (not to be confused with Judge Judith Sheindlin of “Judge Judy” TV fame, though it would be awesome if it were Judge Judy who issued the ruling) issued a rather logical ruling as rulings go, saying that Caesars cannot sneak all its assets into a steel shell out of the hands of second lien creditors without their consent.

Scheindlin cited the “Trust Indenture Act of 1939,” which, while it probably contains a bunch of needless regulations and other legislative and bureaucratic gauntlets with some goodies and kickbacks for FDR’s cronies, does at least say one thing that makes sense – no out-of-court restructuring of debt agreements without 100% consent of noteholders.

Says Bloomberg:

The judge found that the company’s alleged elimination of the guarantees was “an impermissible out-of-court restructuring” that is “exactly” what a provision of the 1939 law “is designed to prevent,” according to her ruling.

Here’s how it went down. Caesars was trying to move all of its goodies into Caesars Entertainment Corporation, the tradable entity, which would not go bankrupt. If you’re wondering why CZR was only a little bit down on Friday despite the “Caesars Declares Bankruptcy” headlines, that’s why. It would cover first lien creditors to the tune of 92% and be thus placated, or in other words an 8% haircut. The second lien creditors, however, would only get $549M out of $5.24B, for an insulting 90% haircut on their bonds, 10 cents on the dollar, peanuts really.

The second lien creditors, understandably, were livid. They filed suit, and Caesars attempted to defend itself by saying that since there has been no technical default yet, and all debt payments have been remitted so far, that the second lien creditors have no right to complain about what Caesars is doing under the table. Judge Scheindlin didn’t buy it.

The only problem left was that the bankruptcy was still in process, freezing all other rulings in the meantime, including Scheindlin’s. She got around that by saying that while her ruling does not apply to the bankrupt Caesars Entertainment Operating Company – the entity where Caesers Entertainment Corporation stuck all its bad debt – her ruling does apply to Caesars Entertainment Corporation, the tradable CZR, because it is not bankrupt according to the restructuring.

Scheindlin caught them in their own scheme.

So where do we go from here? It depends what is agreed upon now that Scheindlin has put a monkey wrench in the hood of Caesars’ getaway car. Theoretically, the second-lieners, if they’re united, can gut the company. Caesars has just over $4B in current assets including $3.24B in cash, and its $13B in real estate will end up going into the newly formed REIT anyway, so that’s off the table. A full gutting probably won’t happen though. There will be some compromise where the second lien creditors are paid off in some way, perhaps through a higher equity share in the new reorganized entity or some other way.

However it ends up being worked out though, CZR is going to take a big hit Tuesday morning when Martin Luther King Jr. Day is over. The 52 week low is still 28% away, so there is plenty of downside left. My short call on Caesars at $12.58 on September 30th is still in the green. There I said,

I recommend a combination of near the money and way out of the money 2016 puts, 2017’s when they become available if the stock is still at or near current prices by then. Near the money will cost more but protect you in the event that a successful Caesars restructuring will only damage but not destroy the stock. Way out of the money puts will cost almost nothing and have leverage up the wazoo (2016 $2.50 puts are only $0.36 a contract as of today, 9/30/14) and will only work out if the company cannot restructure successfully following an inevitable bankruptcy. A responsible combination leaning more heavily towards near the money strikes and a small sum for a $2.50 put jackpot chance is the way to go here.

That advice still stands here, but the near-the-money puts look a bit expensive right now. Outright shorting, if you can borrow to do it, looks safer in the long term.

And of course, a small 2016/2017 put position way out of the money will do spectacularly if second lien creditors are angry enough to try and gut the company. Just keep it to 1 or 2% at most. Say 1% in 2016 and 1% in 2017.