The professional gamblers of private equity pride themselves on being comfortable playing a higher risk game than most investors. When Apollo Global and TPG bought Caesars Entertainment for $31bn in 2008, they soon found themselves holding a giant losing bet, as the financial crisis swept through Las Vegas and beyond.
Yet they stayed at the table, grinding through a lengthy and ultimately bitter capital restructuring that shuffled assets like playing cards between different parts of the group’s corporate structure, sparking claims from outraged creditors of asset stripping.
Last week, however, they suddenly folded.
As recently as last month, Apollo and TPG were arguing that responsibility to settle claims relating to the bankrupt Caesars Entertainment Operating Company (CEOC), lay with its publicly listed parent, Caesars Entertainment Corp (CEC). An investment banker for CEOC told a bankruptcy court that the private equity groups believed it was a “CEC problem”.
His message was clear: the casino company behind Caesars Palace in Las Vegas had collapsed under the weight of its debts, but Apollo and TPG wanted public investors to share the burden.
Last Wednesday, in a dramatic reversal, Apollo and TPG announced they would instead surrender their 60 per cent stake in CEC to settle the claims, which could have cost them as much as $5bn.
What prompted the change of heart was a threat from the bankruptcy court two weeks earlier to force senior executives — including Apollo co-founder Marc Rowan and TPG co-founder David Bonderman — to disclose their personal income and tax information.
Apollo and TPG had structured the Caesars empire such that their economic interest was held at the parent CEC. The group’s resorts from Atlantic City to Reno, its intellectual property and, importantly, its debt were retained at CEOC, the operating company that filed for Chapter 11 bankruptcy protection in January 2015. The separation facilitated the alleged asset-stripping that antagonised creditors.
Apollo and TPG, which deny any wrongdoing, agreed last week to hand CEOC creditors nearly $1bn of their shares in CEC and $100m in cash, funded by insurance, on top of the $4bn CEC had already agreed to inject.
The revised offer had been due to expire on Friday night, but CEC said on Monday that negotiations towards a final resolution continued as “significant progress towards reaching an agreement with all parties” had been made.
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Several people involved said the risk of leaks of executives’ personal details was what prompted the private equity firms to offer such deep concessions. “It is hard to imagine a more punitive result for the sponsors. This deal is clear, undeniable punishment,” one of these people said.
Once the financial crisis and recession hit just after the buyout was completed, Caesars engaged in dozens of asset sales and transfers of casinos and intellectual property to affiliates controlled by Apollo and TPG. The company claimed that the transactions were designed to buy time for a turnround.
Some other buyouts of the era, such as that of Hilton Hotels, successfully used financial engineering to make money for their owners. At Caesars, however, creditors objected, accusing Apollo and TPG of self-dealing and “brazen corporate looting”.
They denied this but by the time CEOC filed for bankruptcy, interest expense exceeded cash flow. Still, after intensive negotiations and a steady recovery in the US gaming industry, the company and its largest owners had by this summer convinced holders of $14bn of its $18bn of total debt to agree to a consensual restructuring.
The plan would allow senior creditors to recover essentially all of their claims, including accrued interest for some. But about a quarter of one junior creditor class, “second lien” bondholders who hold debt with a face value of $5bn, objected to the original proposal that would have returned only 40 cents on the dollar. They now stand to collect more than 60 cents.
The second lien’s legal campaign won crucial sympathy from two legal heavyweights. First, Richard Davis, a former Watergate prosecutor, found in an independent examiner’s report in April that fraudulent transfers and breaches of fiduciary duty by Apollo, TPG and Caesars could be worth $5bn in liability.
In an August trial in bankruptcy court, his report caught the attention of Judge Benjamin Goldgar. He asked how it was fair for Apollo and TPG to be released from personal liability when CEC and its public shareholders were making a $4bn contribution.
“Particularly disturbing is that none of the targets of the claims arising from the disputed transactions [including] Apollo and TPG are making any financial contribution to the reorganisation,” he said.
The firms’ concession may not resolve the situation, however, as it still requires a $400m contribution from senior first lien creditors. That “is not a foregone conclusion,” said Angelo Thalassinos, senior legal analyst at Reorg Research.
Apollo and TPG meanwhile retain a 66 per cent stake in another listed Caesars entity, Caesars Acquisition Corp, worth nearly $1bn. That affiliate had controversially bought some of the CEOC properties that the holdout junior creditors are still eyeing. Should Apollo and TPG pull their settlement offer, CEC would withdraw its
contribution. Creditors would then be forced to pursue their claims through litigation.
But if the private equity firms’ gambit works, they will still have a seat at the table, albeit with a much shorter stack of chips.