Today, I have a somewhat unusual recommendation for you.
It springs directly from the private equity fiasco I’ve written about before – but it’s not a short. It’s actually a long play that will take some time to mature.
But I expect it to pay off big-time….if you’re patient.
In order to understand this play, you have to understand the looting of Caesars Entertainment Corp. (NASDAQ:CZR) by its private equity sponsors Apollo Global Management, LLC (NYSE:APO) and TPG Capital (formerly Texas Pacific Group). I’ve been following this sorry tale for quite a while in my Credit Strategist newsletter, and I’ve decided I don’t want Sure Money readers to miss out, either.
Sadly, this is not the only situation in which APO and TPG have been accused of abusing the people who lend them money for their LBOs. Both firms have a history of this type of behavior; Caesars is just the most appalling example.
Here’s Why Caesar’s Is Going Straight Up
But like everything in life, trouble brings opportunity. In this case, investors who play this situation correctly stand to make big profits.
Negotiations are ongoing to resolve this case and nobody is talking numbers, but based on my knowledge of the parties involved, it seems reasonable to expect that APO and TPG will ultimately pay something in the range of the $3.6 to $5.1 billion of damages that the Bankruptcy Examiner targeted in his report. They will likely do this through a combination of cash payments, forgiveness of Caesars debt that they own, and other consideration.
The settlement will determine the value of Caesars’ distressed debt at the time the company exits bankruptcy. The biggest and most widely traded piece of subordinated debt is the company’s 10% Second Lien Notes due 2018. These bonds dropped to as low as 10 cents on the dollar around the time that Caesars filed for bankruptcy in early 2015. At that time, I recommended that readers of The Credit Strategist buy this debt based on my belief that APO and TPG had committed serious breaches of the law and would be forced to make substantial payments to bondholders that would cause the bonds to rise in value. Since then, these bonds have rallied and recently traded in the mid-40s. But I still expect them to rise further. Let me explain why.
The company’s subordinated debt is likely to be exchanged for stock in a restructured Caesars. The exchange of the 10% Second Lien Notes alone will reduce the company’s interest payments by about $450 million a year. Other debt will also be exchanged for equity, further reducing the drain on the company’s resources of debt service.
And, freed of the burden of paying over $1 billion a year in interest as well as the pernicious influence of APO and TPG over the business, a deleveraged Caesars should prosper.
There is a long history of companies emerging from bankruptcy with deleveraged balance sheets whose stocks have skyrocketed in value. I believe that Caesars stock will do the same thing over the next few years. While the stock may initially drop in value due to the fact that a large number of new shares will be issued to creditors in exchange for their debt, a greater portion of the company’s value will be reflected in the stock rather than in the remaining debt. As the new unleveraged Caesars moves forward, the stock should rise significantly.
This means that the stock received by creditors should make a great investment in the years ahead. As one of the premier gaming companies in the world before private equity got its hands on it, Caesars owns trophy properties.
Further, a deleveraged Caesars will be able to reinvest in its business instead of paying all of its free cash flow in interest to creditors and in egregious fees to its private equity owners.
Over time, I expect Caesars stock to rise sharply as the company’s value is shifted from creditors to equity holders.
That means that if you buy and hold Caesars Entertainment Corp (NASDAQ: CZR) now – and if you’re patient – you should see a sizeable payday down the road. At under $7.00 per share, it is a cheap way to invest in one of the great gaming companies that can now finally move forward without the albatross of LBO debt.