There are certain Orwellian terms that are thrown around in the world of finance that are meant to confuse the uninitiated, and to some extent even the experts. One of those terms is “leverage,” as in “leveraged buyout”. Leverage is a whitewashed term for debt. Or risk. Or “You pay a little money now but you owe a lot more later.” The term “leverage” brings to mind loosening a nut with a torque wrench, or something else totally benign in people’s minds. “Heavy debt” though, people know is risky, so big moves are not described that way. It would take out too much of the sexiness.
But imagine if, instead of the term “leveraged buyout,” finance buffs used the term “very risky debt-filled buyout”. That might add a sense of realism to the current connotation of the term leveraged buyout, which is “a huge deal just happened and a lot of money is involved, think of torque wrenches, so invest.”
As long as interest rates remain low and business is good, or in other words as long as you execute a debt-filled deal wrought with risk during the boom phase of the business cycle, you’re good. You can pass on the debt to someone else as long as you can pay it off during the boom phase. But if you don’t understand the boom-bust business cycle and what causes it and you execute a “leveraged buyout” right on the cusp of a bust, you’re pretty much screwed.
In so many words, that’s exactly what happened to Station Casinos in 2009. Lorenzo Fertitta executed a $3.5B leveraged buyout of Station Casinos, filled with debt in November 2007 of all times, just in time for the financial collapse. At the time of its bankruptcy in July 2009, Station had $6.5B in debt on its balance sheet, $3B more than the actual cost of the buyout. That’s “leverage” for you. One month after the bankruptcy, Frank Fertitta Jr., founder of Station Casinos and head of the Fertitta family, died of a heart attack.
At the time of its bankruptcy, Station was suffering from $2.92B in goodwill impairment charges due to collapsing real estate values especially in Nevada where Station is situated, reduced cash flow from the recession and other bad things you can probably imagine. But the worst part was timing. $2B of the $3.5B “leveraged buyout” came due in 2009, at the pit of the depression. Yeah, good luck with that.
We saw the same thing with Harrah’s $20B buyout of Caesars in 2008, also with impeccably bad timing, but the inertia due to Caesars’ much larger size compared to Station meant that it could keep doing business thanks to economies of scale that Station never had. Ultimately, Caesars buckled, too, or at least is in the process of doing so.
(If you’re wondering why banks are affected almost immediately by a bust whereas other companies take years or more to succumb, it’s because banks are automatically levered 9:1 due to the 10% fractional reserve centralized banking system.)
Since 2011, Station is back in business with much less debt to show for it. Thank goodness for bankruptcy proceedings I guess. And it is showing some healthy signs of growth, too. $83M in earnings for 2014 compared with a $104M loss in 2013 is a nice turnaround, if indeed it can be sustained. And it looks like it can, barring any systemic financial shocks, at least until 2020.
Having looked at the details of Station’s balance sheet, it seems there is no serious amount of debt due until that year. On top of that, $1B of the principle debt is protected by swaps to a tight range of fixed rates until 2017. Come 2020 though, the casino has $1.625B all coming due at once.
Though this is not an immediate danger and there is still time to deal with it, debt coming due at the wrong time is exactly what drove Station into bankruptcy in the first place. Given that station is still private though, what can traders look for, potentially, in the event it goes public once again?
First of all, a deal to bring the company public again could involve Zuffa, owned by Fertitta, which owns Ultimate Fighting Championship at an estimated worth of $3.5B. Given Mayweather Pacquiao was such a disappointment and the best current boxer in the world (Mayweather) is a defensive bore who put on a “brilliant stinking performance” in the words of Larry Merchant, more people are likely to put their money into the UFC as time goes on. Given current earnings, the market cap of Station, if it were today publicly traded, would be around $800M assuming a P/E ratio of 10, giving a theoretical combined company a value of $4.3B give or take more money than most of us could spend in several lifetimes.
One thing Station is doing right is keeping the Culinary Union out of its way by keeping its workforce happy. This can be done in two ways, mainly. Either treat them nicely by being pleasant, which costs nothing, or pay them more. Station’s SG&A expenses are routinely around 22% of gross revenue. Compare that to a union casino like MGM which pays 12% (SG&A divided by gross revenue), and it gives a clue as to how Station has kept the unions at bay so far. Though this is not a scientific comparison and mixes with it executive pay, it’s a rough measure. Walmart, also non union, pays 19% of its revenue in SG&A, higher than unionized MGM.
The takeaways, then, are four:
- Station is growing again after bankruptcy, but 2020 will be the year that determines its long term future. It needs to have the money to pay off $1.6B or suffer the same fate it did in 2009.
- Unions will stay out of Station but at the expense of higher labor costs.
- Unionized workers don’t necessarily get more money than non-unionized workers for similar work.
- Don’t execute “leveraged buyouts” on the threshold of a bust. Or in other words, make sure the money supply is increasing fast before you take on a lot of debt.