Caesars Entertainment Corp: Accretion Scenarios on Reported Merger Talks

 

The NY Post reported that CZR could put itself up for sale imminently, and is said to have given interested parties ERI and Golden Nugget access to a "data room." We assess hypothetical deal scenarios, incl. synergies, asset sales & accretion/dilution; most scenarios imply upside for CZR.

Conclusion: As we noted in our 10/23/18 CZR initiation, Unappreciated Optionality and 4Q Upside; Initiate Overweight, CZR's large shared services program and sophisticated loyalty program potentially position it well for M&A. The NY Post reported on Wednesday night that Caesars may be preparing to announce a sale process. The article highlights two potential suitors, Tilman Fertitta (private, owns Golden Nugget casinos) and Eldorado Resorts (ERI, not covered). Fertitta reportedly made a $13 bid for CZR before (CNBC), but CZR Board rejected it, citing leverage concerns. On this basis, we see ERI as potentially the more plausible acquirer, also benefitting from a public track record of exceeding synergy targets that investors may be willing to underwrite. There are concerns however around the potential of a large-scale merger this late in the cycle, ERI's ability to extract its historical level of synergies on a much larger acquisition, and around deferred capex at CZR. In February 2019, Bloomberg reported Fertitta bought ~4 million shares of CZR (NY Post article, and we have no knowledge of any deal beyond what has been reported.

Key deal considerations. We estimate Tilman Fertitta's company and ERI both have enterprise values of ~$7-8B, smaller than CZR at $20B. As a result, the hypothetical deals would have to be reverse mergers, with the offer a mix of stock and cash. ERI has a stated leverage cap of ~5.5x gross debt, which limits the cash portion of an offer. However, in the event of a deal, the companies would a) likely divest assets given forced sales from geographic overlap, potentially a willingness to lower Las Vegas exposure, and to lower leverage, and b) look to find synergies.

Potential asset sales in the event of a deal. Both ERI and Golden Nugget have geographic overlap with CZR that they would likely have to work out. For ERI, we believe it would potentially have to divest in Reno/Tahoe, Atlantic City, Kansas City, Laughlin, Illinois, Indiana, and Shreveport due to clear ownership restrictions (such as Indiana) or concentration concerns (such as Atlantic City). For Golden Nugget, there could be forced divestitures in Atlantic City and Laughlin. We believe it is likely that divestitures would be worked out in advance of any hypothetical deal closing, similar to PENN/PNK, providing investors confidence that the transaction can close. Any hypothetical buyers of legacy CZR assets would likely look for a discount to historical market multiples given Caesars Rewards loyalty program typically adds 8-10% incremental revenue to properties. However, Gaming REITs would likely be willing to purchase the underlying land of properties at high multiples (historical average 12x), and pro forma CZR-ERI EBITDA currently sitting at 3.5x corporate rent coverage, compared to PENN ~2x, suggesting room for more sale-leasebacks. On its 4Q18 earnings call, ERI said it would look at REITs as a component of future deals, but we do not believe it would like to become a pure OpCo. VICI and GLPI could also likely benefit if leases needed to be modified as they could demand improved economics.

Synergies. ERI has a strong track record of achieving targeted synergies. The company acquired Tropicana from Carl Icahn on 10/1/18 and already expects to "significantly exceed" its $40m synergy targets. Similarly, ERI exceeded synergy targets in its 5/1/17 purchase of ISLE, originally guiding to $35m and highlighting an expectation of at least $100m on its 4Q18 earnings call. In addition, a hypothetical acquirer's existing properties should benefit from revenue synergies from being integrated into Caesars Rewards (8-10% lift discussed earlier).

CZR-ERI accretion / dilution sensitivity. We have analyzed hypothetical scenarios of ERI acquiring CZR using publicly available data and trading multiples (we analyzed a hypothetical CZR/Fertitta combination in our initiation). Our analysis suggests potential upside - downside of 64%-(21)% depending on the price paid, synergies generated, pro forma trading multiple, and disposition multiples. We lay out our analysis inside. We assume ~$400m of total EBITDAR divested based on where we see regulatory overhangs and ability to achieve ERI's leverage target. We show scenarios of $150-600m of synergies. ERI's transactional history could suggest a >$500m cost opportunity, while revenue synergies could add to this, but we've shown a lower range given the relative scales of CZR vs. ERI's prior transactions, CZR's prior ownership, where we are in the cycle, and our historical synergy targets of 75% of corporate overhead.

Tweaking estimates. Note we are lowering our 1Q19e EBITDAR slightly to $529m from $543m as we update our model for published 1Q19 regional GGR