Fitch Rates Caesars' Corner Investment (Drai's) Term Loan 'B-/RR2'
Fitch Ratings has assigned a 'B-/RR2' rating to $185 million in proposed term loans being issued by Corner Investment PropCo, LLC (Corner) and assigned a 'CCC' Issuer Default Rating (IDR) to Corner.
Fitch also affirmed Caesars Entertainment Operating Company, Inc.'s (CEOC), Corner's direct parent and the lessee of the project being financed by Corner, at 'CCC', as well as all other ratings related to CEOC, including the ultimate parent, Caesars Entertainment Corp. (CEC; Caesars). See the full list of rating actions at the end of the release.
Proceeds from the $185 million term loan will fund a remodel of Caesars' Bill's Gamblin' Hall and Saloon (Bill's), a 20-month interest expense reserve, working capital, and financing costs. The remodel is budgeted at $146 million, about a third of which will fund a development of Drai's night/day club at Bill's managed by Drai Management Group (DMG).
The balance will fund room renovations, a casino floor remodel, new F&B outlets and a new parking garage as well as other enhancements. The casino and hotel remodel are scheduled to be complete by year-end 2013 and the club will open by April 2014. Bill's will be re-branded (brand remains undetermined) upon completion and the new property will join Caesars' Total Rewards loyalty program.
The term loan will be secured by the remodeled property, including the casino, hotel and night/day club (collectively the Property) and guaranteed by Corner. The cash flows that will be retained by Corner include lease payments from CEOC and a portion of the cash flows generated by Drai's. CEC will also provide a $20 million completion guarantee.
As part of the transaction, Bill's will be transferred from CEOC to Corner and CEOC will lease the non-club components of the Property for $23.5 million once it opens. The lease agreement is for seven years, after which CEOC has the option to extend. The lease payments step down ($15 million is the floor) based on cumulative EBITDA generated by Drai's, which pledges 100% of its EBITDAM to Corner until approximately $70 million of the term loan is repaid. Thereafter, 25% of Drai's EBITDA will be pledged to the lenders, with 50% going to DMG and 25% to CEOC. Drai's management fee will consist of an occupancy fee paid to CEOC (5% of revenues) and a 5% revenue/10% EBITDAM fee paid to DMG.
The loan amortizes by 1% per annum following two full quarters after the project opens and matures seven years after the closing date. Corner has to use 100% of Drai's generated excess cash flow to make offers to purchase the loan at par until the amount of the loan allocated to the Drai's expansion (approximately $70 million) is repaid. In addition, Corner has to use 75% of its consolidated excess cash flow to make purchase offers at par with the percentage scaling down based on leverage (goes to 50% if leverage is less than 3.25x or 25% if less than 2.75x).
Corner's consolidated cash flows include CEOC lease payments and Drai's income remaining at Corner minus Corner debt service, maintenance capex, permitted restricted payments and certain other adjustments. Of the amount earmarked for loan repayment that lenders reject, Corner may dividend up to CEOC 50% of the excess cash.
Maintenance covenants include a 5.25x senior secured leverage test (first measured after four full quarters following the project opening), which is measured net of cash and steps down to 4.75x thereafter over several quarters. There is also a minimum EBITDA test for the first three full quarters. The term loan credit agreement allows Caesars ample opportunity to provide equity cures. Additional debt is permitted so long as net leverage remains below 5x but there are certain carveouts, including a $20 million general debt incurrence carveout. Restricted payments are subject to a $15 million starter basket, which increases by EBITDA minus 1.4x interest expense (subject to other adjustments).
The 'CCC' IDR reflects Fitch's circumspect view of the project's ability to ramp up to the extent that it will be able support Corner's debt service on a stand-alone basis as well as the weak credit profile of CEOC, the lessee. Fitch rates CEOC's IDR 'CCC' with a Negative Rating Outlook. (See Fitch's rating commentary and report dated Sept. 5, 2012 for detailed analysis of CEOC and related entities; available at www.fitchratings.com).
Fitch believes that CEOC will opt to affirm the lease with Corner in the event that CEOC enters bankruptcy if the project's cash flows are accretive to CEOC in excess of the lease payment. Alternatively, CEOC may opt to reject the lease if the project proves unsuccessful.
Fitch expects casino/hotel performance to improve upon the project opening as a result of the property being plugged into Caesars' Total Rewards and the significant amount of capital invested into the property. Management's base case forecast shows value accruing to CEOC from operating the casino/hotel and fees from the club well exceeding the $23.5 million lease payment.
However, the project is subject to significant execution risk. Given the novel nature of the project (i.e. boutique hotel/casino on the Strip) and significant overhaul of target customer demographic, Fitch believes any forecast is subject to considerable variance.
In addition to the lease payments, Corner lenders will benefit from cash flow generated by the club. However, Fitch believes that after the allocated amount of the loan is repaid, 25% of the club's EBITDA will be insufficient to service Corner's debt and debt service support may depend largely on the CEOC lease payment.
The 'RR2' Recovery Rating (RR) is based on Fitch's estimate of 71%-90% recovery for the lenders in an event of default. Fitch attributes about 70% of the value to the casino/hotel component, which should benefit from its prime location on the Las Vegas Strip and the planned remodel, with roughly $100 million of the total project cost being allocated to areas other than the club.
Fitch's recovery value takes into account the Property's small footprint (it sits on approximately four acres) as well as the execution risk associated with operating a boutique casino hotel on the Las Vegas Strip. The execution concern will be partially mitigated by the inclusion of the Property in the Total Rewards program and the established track record of Drai's Afterhours, which has operated at Bill's since 1999 and has an outpost in Hollywood, CA.
From CEOC's Point of View
Fitch views the transactions largely as neutral for CEOC lenders with the benefit of potentially longer-term increased Las Vegas EBITDA accruing to CEOC being offset by notable risks.
--Bill's is being carved out of the CEOC restricted group (although it
is not a major driver of CEOC's Strip profitability);
--CEOC's lease payments to Corner, at least initially, will be sizable relative to the Property's projected EBITDA base;
--The financing will increase CEOC's aggregate interest expense by roughly $20 million, potentially further pressuring CEOC's free cash flow (FCF) if the benefits of the project fall short of management's expectations.
Notable offsets to the above concerns include:
--A $35 million interest reserve, which will mitigate the near-term FCF concern related to the increased interest expense;
--Aggressive excess cash flow sweep provisions, which should reduce Corner's debt outstanding and associated interest expense quickly if the project ramps up as management expects. (Note that Corner has to make offers to repay loan at par but lenders are not required to accept).
Fitch also recognizes the strategic merit of the project as it aims to introduce a younger, more affluent demographic into Caesars' loyalty program and fully attempts to leverage Bill's prime location on the intersection of Flamingo Road and Las Vegas Boulevard (across from Caesars Palace and Bellagio and near Caesars Project Linq development).
Drai's financing is consistent with Caesars' more recent transactions of carving out assets or selling assets from CEOC to fund capex aimed at revitalizing the company's Las Vegas portfolio of assets. In 2011, CEOC contributed Octavius Tower to an unrestricted CEOC subsidiary in a transaction that is similar to this one to finish a moth-balled tower at Caesars Palace. More recently, CEOC is expected to close its sale of Harrah's St. Louis for $610 million in November 2012. A bulk of the proceeds will likely be spent on project capex and ramping up maintenance capex on the Las Vegas Strip.
Fitch will revisit Corner's IDR and RR once the project opens and starts to ramp up. However, upside to Corner's IDR will likely be capped at the low end of the 'B' category reflecting the ownership by CEOC and the risk associated with operating a single-site facility in a relatively saturated market.
In the event CEOC is downgraded, Fitch may maintain Corner's 'CCC' IDR depending on the timing of the downgrade (i.e. development/ramp-up phase of the Project) and the perceived likelihood of CEOC affirming the Corner lease, which in turn will largely depend on the project's success.
Fitch has not assigned a Rating Outlook to Corner as Rating Outlooks are only assigned selectively for 'CCC' IDRs.
Fitch affirmed the ratings below and maintained a Negative Outlook on the IDRs of:
Caesars Entertainment Corp.
--Long-term IDR at 'CCC'.
Caesars Entertainment Operating Co.
--Long-term IDR at 'CCC';
--Senior secured first-lien revolving credit facility and term loans at 'B-/RR2';
--Senior secured first-lien notes at 'B-/RR2';
--Senior secured second-lien notes at 'CC/RR6';
--Senior unsecured notes with subsidiary guarantees at 'CC/RR6';
--Senior unsecured notes without subsidiary guarantees at 'C/RR6'.
Chester Downs and Marina LLC (and Chester Downs Finance Corp as
--Long-term IDR at 'B-';
--Senior secured notes at 'BB-/RR1'.
Caesars Linq, LLC & Caesars Octavius, LLC
--Long-term IDR at 'CCC';
--Senior secured credit facility at 'CCC+/RR3'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' (Aug. 14, 2012);
--'Distressed Debt Exchange' (Aug. 8, 2012);
--'U.S. Leveraged Finance Spotlight Series: Caesars Entertainment Corp.' (Sept. 5, 2012);
--'Fitch Affirms Caesars' OpCo at 'CCC' & Chester at 'B-'; Revises Outlook to Negative' (Sept. 5, 2012);
--'U.S. Gaming Recovery Analyses -- Second-Quarter 2012' (Sept. 12, 2012);
--'2012 Outlook: Gaming -- Market Exposure the Differentiating Factor' (Dec. 13, 2011).
Applicable Criteria and Related Research:
2012 Outlook: Gaming -- Market Exposure the Differentiating Factor
U.S. Gaming Recovery Models -- Second Quarter 2012
U.S. Leveraged Finance Spotlight Series: Caesars Entertainment Corp.
Distressed Debt Exchange
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Parent and Subsidiary Rating Linkage
Corporate Rating Methodology
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