Eldorado seals a risky Caesars deal with echoes of Apollo


Well it happened. Carl Icahn got his way again, and Caesars is merging with Eldorado Resorts. Got to give it to the guy—he really knows how to hammer a deal through, and not through Trumpesque style BS. The world would definitely be better off with Carl Icahn negotiating a U.S. trade deal with China and sitting down with Iran.

When rumors of an impending deal first started surfacing 4 months ago, I said that an Eldorado offer for Caesars would have to be $12-13 billion at a minimum. It ended up being $17.3 billion. I probably would have lost on the Price is Right if we were doing a Caesars Showcase Showdown, but at least I didn’t go over. Bob Barker would have tried to comfort me, so at least there’s that.

eldorado-seals-a-risky-caesars-deal-with-echoes-of-apolloBut with all due respect to Carl Icahn and Bob Barker, whose names have never been juxtaposed before according to Google so I guess I invented something new here, Eldorado/Caesars is going to struggle under its own weight, hopefully not as badly as Caesars sank following Apollo’s leveraged buyout of Harrah’s in 2008. I do not know how long it will take and I am not recommending immediate shorting. Just keep the option on your radar. This new combined company, now the largest casino firm in the United States, could become one of the best short targets in the U.S. gambling industry come the next recession and market decline.

That’s not to say that everything about the deal is bad. There are some smart moves here, but I doubt they will be enough if and when the business cycle turns. One thing that was commendable was Eldorado turning around and selling real estate acquired from Caesars to VICI Properties, its triple net lease REIT partner. The financial engineering here also involves a put/call spread on rent multiples that should serve to hedge against rising rents somewhat. In total, it brings down the total net money changing hands in the deal down to $14.1 billion. If we want to get technical about it then, maybe I would have won the Showcase Showdown.

The other nice part about the deal is that the first major repayment of principle is out to 2024. That gives Eldorado about five years to figure out what in the world it is going to do when its commitments start coming due. In the meantime, its forecast of $500 million in synergies and cost savings may come to fruition and put the stock on track for one more rally before things start to go south again as they did late in 2018.

But the bigger problems are just too obvious to ignore. Caesars is still in the hole, pooling together all financing obligations, to the tune of about $49.5 billion (page 34). Meanwhile, Eldorado is just above treading water under the additional weight of the Tropicana acquisition for $1.9 billion that closed in April. This has already caused a 135% increase in quarterly interest expense. GLPI owns Tropicana’s real estate and now Eldorado is paying rent to GLPI and booking it as interest expense even though the assets are listed on its balance sheet as Eldorado assets. In reality every dollar of that real estate can simply be flipped to the debt side.

Eldorado’s presentation on this deal is full of back-patting and self-congratulations. To a degree it’s deserved. Eldorado has done very well in this bull market. But the presentation is way too stacked with eye-catching statistics about Eldorado now being the biggest, the best, proven track record, largest global gaming database, etc. That’s all true, but there is not enough on its long term plans for paying all this down. It’s fun being the biggest when things are going well and you can refinance on a whim. It’s not fun being the biggest when things are not. It’s a lot easier to deliver value to shareholders when money is being thrown at you in record quantities to finance anything you want for almost any reason. It’s a lot harder to deliver returns to shareholders when you’re already leveraged and the kaleidoscope turns.

Assuming nothing cataclysmic happens over the next few months, like a U.S. war with Iran erupting or China and the U.S. upping the self-harm trade competition to extremes, then Ceasars/Eldorado shareholders can run with this for a little bit longer. Wall Street looks like it’s going to get over the summer monetary lull without any serious problems, and nothing particularly alarming is coming across on the dollar supply charts. The danger now is not a sudden decline in equities primarily, though this could happen, but a quick rise in price inflation and sudden decline in the dollar. The rise in gold prices to six-year highs today looks like the first step in this direction. A new global money-printing cycle is beginning without the last one ever ending, rate cuts are priced in already, Europe is joining the next round of partying, and bond yields are continuing their Twilight Zone trend into deeper and deeper negative territory. Even nominally positive rates are negative. The 10Y yield now is down to 2%, and inflation rates are above that.

Investors seem OK with the deal so far, taking the companies at their word, though it’s only been a day. Eldorado lost about $422 million in market cap, and Caesars gained $900 million, so markets are pricing in the $500 million in savings that the two are promising, so far, but no more of a boost than that, so there’s no extreme exuberance here. More like an “OK, let’s see,” reaction.

Things could get interesting though by the time the deal goes through officially, scheduled for sometime in the first half of next year. That could be a very different time than we are in now, considering everything happening in the world on both a monetary and geopolitical front. There is a chance that the macro picture could turn by the time the deal is set for a final vote, and it could be called off.

In the event it does go though, which is more probable, how will we know when to establish shorts? The trigger will probably be consumer price inflation, which is likely to spike higher on the next round of global stimulus after a 12-year hiatus. Once the official inflation rate hits 4% annual, there will be no stopping it. 3% will be attributed to “symmetrical” goals, and excused as a brief overshoot to help compensate for when inflation was below 2%. But once it hits 4%, the central bankers won’t be able to ignore it anymore. They’ll have to raise rates and chase it regardless of where the economy is, and it won’t work anyway. Gamers will stop patronizing casinos, leaving the new giant dealing with a huge multi-billion dollar mortgage, rising debt service costs, and floundering growth. But, at least, they’ll be the biggest struggling casino firm in the country.