The Caesars Palace Coup: A Private Equity Cautionary Tale — Corporate Raiders Masquerading as Benevolent Investors

This one is for Edward, who I know would never do any of these things because he’s far too kind hearted and far too talented to not create shareholder value. Let’s call him one of the good ones.

In late 2006 Apollo Global Management and TPG Capital pulled off what one commentator calls “perhaps the most audacious deal in American gaming history” – a $27.8 billion leveraged buyout of Harrah’s (renamed Caesars) . They bid nearly 40% above the market, winning a fierce auction by offering $90 per share . Behind the scenes, the buyout was financed on a mountain of new debt: about $20.5 billion of freshly underwritten loans on top of $4.6 billion Caesars already owed . The loan documents were virtually covenant-lite – the only test was a debt/EBITDA leverage ratio . In the credit bubble of 2006–07, lenders were eager, selling high-yield debt with almost no protections. As the Apollo/TPG pitch deck cheerfully noted, Harrah’s “historical performance” survived 9/11, SARS, and even war – and the sponsors projected its EBITDA would skyrocket by 40% by 2012 . Armed with this rosy script, they coaxed dozens of co-investors into the deal – big names like Goldman Sachs, Blackstone, Oaktree and Credit Suisse . Even celebrities joined: Bob Kraft and the Michael J. Fox Foundation put money into the buyout . All told, Apollo and TPG themselves put up just about $2.65 billion, with the syndicate shouldering the rest.

Yet the smiles in late 2006 masked a brewing storm. Critics had noted that the $90 price tag was over 10 times Harrah’s 2006 EBITDA – an eye-popping multiple . And by early 2008 the music would stop: a few months after closing, Lehman Brothers collapsed and the U.S. fell into the worst recession since the 1930s . The highly leveraged Caesars was suddenly vulnerable. As one retrospective account observes, “the party would end just a few months later… [and] the private equity firms loaded Caesars with debt to make their purchase, leaving the casino operator vulnerable when the economy crashed”.

Financial Engineering or Fraud? (2012–2015)

Once the economy soured, Caesars’ operating company (OpCo) began bleeding cash. Rather than inject equity, Apollo/TPG embarked on a series of convoluted internal transactions that stripped Caesars of its crown jewels while shielding value in affiliates they controlled. In 2013 they carved out two prime Las Vegas casinos (The LINQ and Octavius Tower) into a new “PropCo” called Caesars Entertainment Resort Properties (CERP). Shockingly, no cash or stock changed hands. Instead, CERP took on roughly $4.75 billion in new mortgage debt, and OpCo supposedly received “the right to certain cost savings” – i.e. the theoretical reduction in overhead if CERP were to default. As the book The Caesars Palace Coup recounts, “[t]he only payment [to Caesars OpCo] would be for purely theoretical costs that OpCo would ‘avoid’ if PropCo defaulted… overhead costs [that] would fall back to OpCo. Avoiding a default would be avoiding those costs… and that would be the form of ‘payment.’” . In other words, Apollo was proposing to sell the casinos to itself for no actual consideration, only the promise of “avoided” expense.

This legal sleight-of-hand was made palatable with creative accounting. In internal valuations, Apollo’s advisor Alan Van Hoek assumed enormous cost savings – he pegged OpCo’s avoided overhead at $140 million per year, with a net present value of $1.3 billion, plus another $4.4 billion from scrapping the parent guarantee . By tweaking the spreadsheet inputs, he could make OpCo “whole” on paper. In fact, Van Hoek admitted later that he simply “manipulated the spreadsheet to solve for the desired answer,” cranking the avoided-cost credit up from $1.3 billion to $1.8 billion and reducing the value of the transferred casinos until the math worked . The upshot: Apollo told Caesars’ CEO Gary Loveman that they could in effect “transfer up to $6.2 billion of assets for no consideration” . A Merill Lynch analyst bluntly wrote that these deals were “completely confusing” and essentially allowed Apollo/TPG to swap prime casinos for thin air.

Not content with one PropCo, the sponsors soon launched a second affiliate: Caesars Growth Partners. In early 2014 OpCo agreed to sell four profitable properties – Bally’s, Cromwell and the Quad in Las Vegas, plus Harrah’s New Orleans – to Caesars Growth for just $2.0 billion (taking on an extra $200 million in debt) . Once again Apollo and TPG were on both sides of the deal. As one examiner’s report wryly notes, “the conflict was obvious. OpCo’s equity was worthless, and any profits the sponsors had at Caesars were tied up in Caesars Growth and CERP. As such, Apollo and TPG’s objective was to have Caesars Growth pay as little as possible… while OpCo creditors would want as much cash as possible.” . In effect, every dollar of value these deals generated flowed up to the two PE firms, and none back down to Caesars OpCo. One Phoenix lawyer later observed that in each transaction OpCo “would not get any say in the transaction…and the valuation would have to be convincing on paper” . But the paper was thin: credit-rating agencies warned that these maneuvers “will create confusion in the near term” and likely mask the underlying weakness of Caesars’ financial condition.

By the end of 2014, the so-called “restructuring” deals were anything but. They had drained nearly $3 billion in revenues (about $700 million EBITDA) from Caesars OpCo through 2016, while relieving only $185 million of debt . On the contrary, leverage spiked. Analysts calculated that debt/EBITDA would jump from roughly 14× (already high) to 18× – a catastrophe by any standard (even 6× is usually considered dangerous) . In short, the cures inflicted by Apollo/TPG turned out to be poison.