(The following statement was released by the rating agency)
-- Las Vegas-based gaming operator Caesars Entertainment Corp. (CEC) announced plans to finance a redevelopment of Bill's Gamblin' Hall & Saloon on the Las Vegas Strip through an indirect wholly owned subsidiary.
-- We are assigning borrower Corner Investment Propco LLC our 'B-' corporate credit rating and the proposed $180 million term loan our 'B' issue-level rating.
-- The negative rating outlook is aligned with our current outlook on CEC and reflects our view of the linkage between Corner Investment Propco and Caesars.
Rating Action On Oct. 5, 2012, Standard & Poor's Ratings Services assigned Corner Investment Propco LLC (hereafter referred to as Caesars Drai's) its 'B-' corporate credit rating. The company is an indirect wholly owned subsidiary of Las Vegas-based Caesars Entertainment Corp.
The rating outlook is negative.
At the same time, we assigned Caesars Drai's proposed $180 million senior secured term loan due 2019 our 'B' issue-level rating (one notch higher than the 'B-' corporate credit rating), with a recovery rating of '2', indicating our expectation for substantial (70% to 90%) recovery for lenders in the event of a payment default. The proposed term loan will not be guaranteed by direct parent Caesars Entertainment Operating Co. Inc. or the ultimate parent, Caesars Entertainment Corp.
The company will use proceeds from the term loan to fund construction costs associated with the redevelopment of Bill's, fund an interest reserve and working capital, and pay fees and expenses.
Our corporate credit rating on Caesars Drai's reflects our assessment of the company's financial risk profile as "highly leveraged" and our assessment of the company's business risk profile as "vulnerable," according to our rating criteria.
Our assessment of Caesars Drai's financial risk profile as highly leveraged reflects the aggressive financial policy and weak credit profile of the ultimate parent, Caesars Entertainment Corp. (CEC). Although the borrower is structured as an unrestricted subsidiary of CEC, we believe its credit quality is linked to that of CEC. We believe that a bankruptcy at CEC could cause a bankruptcy at Caesars Drai's, if management decides it is in its best interest to include it in a broader bankruptcy proceeding.
Beyond the structural linkage related to CEC's controlling position, Caesars Drai's will also rely on approximately $23.5 million of fixed lease payments from the direct parent Caesars Entertainment Operating Co. Inc. (CEOC). These lease payments comprise the majority of the cash flows available to service debt each year under our performance expectations, although the payments can step down based on leverage at Caesars Drai's. While these lease payments offer steady cash flow streams sufficient to meet debt service needs, given CEC's weak credit profile (including operating lease-adjusted debt to EBITDA of about 12x and EBITDA coverage of interest of just 0.9x as of June 30, 2012), we believe this level of fixed-lease payment could challenge CEOC's ability to meet its own debt obligations in the event performance trends across the Las Vegas Strip deteriorate or cash flows from this project fail to reach at least that level.
Our assessment of Caesars Drai's business risk profile as vulnerable reflects the entity's reliance on a single property for cash flow, its position in a highly competitive market with many casino and nightclub operators, and risks associated with redeveloping and turning around an underperforming property, including attracting a new customer demographic. The project is a redevelopment of Bill's Gamblin' Hall & Saloon, which will add a Drai's designed and managed nightclub and dayclub, upgrade the casino, and remodel and convert the hotel into a boutique hotel. While the renovation project faces construction and execution risks, these risks are lower than those of a new build, in our view. Our business risk assessment also takes into account the property's favorable location on the Las Vegas Strip, which lends itself to significant foot traffic, management's significant experience in operating casinos and nightclubs, and the inclusion of the property in Caesars' Total Rewards network.
Our forecast for Caesars Drai's incorporates the lease payment that CEOC will make to Caesars Drai's. The lease payment begins at $23.5 million and can step down to $20 million and $15 million upon reaching certain leverage triggers. We also expect that the club at the property will generate about $15 million to $20 million in EBITDA. These cash flows will be available to service debt at the property, and we expect that these combined cash flows will more than cover fixed charges. Any excess cash flow generated by the club (EBITDA less interest, taxes, and maintenance capital spending associated with the club) must first be offered as a prepayment to term loan lenders until the cumulative club excess cash flow equals the initial amount of principal and interest allocated to the club's construction (approximately $70 million). In the event that lenders do not accept the full amount of excess cash flow as a prepayment, Caesars Drai's may make restricted payments in an amount equal to half of that excess cash flow.
While the lease payment by CEOC is fixed starting at $23.5 million, our current forecast is that the casino and hotel components of the property will generate $15 million to $17 million in EBITDA in the first few years of operations. Although this represents a meaningful improvement over current levels of performance, this level of EBITDA is below the expected lease payment over the next few years. Given restrictions limiting CEC's access to the cash flow generated at the club and its weak credit profile, we believe the inability of the casino and hotel components to generate a level of cash flow closer to or in excess of the lease payments over the intermediate term could bring into question Caesars' willingness and ability to make the required lease payments.
Under our performance expectations and based on the terms of the financing, we believe Caesars Drai's has an "adequate" liquidity profile, according to our criteria. Our assessment of the company's liquidity profile incorporates the following expectations and assumptions:
-- We expect the company's sources of liquidity over the next 12 to 18 months to cover uses by about 1.2x, incorporating the proposed financing and expected construction costs.
-- We believe that net sources would be positive during the first full year of operations, even if EBITDA were to be 15% lower than our current expectations.
The financing includes a prefunded 20-month interest reserve, which will support interest payments throughout the construction period and three months post opening. While we would normally view this as a thin interest reserve, the contractual nature of the Caesars lease payment, which we expect will be sufficient to cover debt service and amortization payments under the term loan, largely mitigate this risk. Additionally, given that the project is a renovation, rather than a rebuild, and considering its strong location and brand in the market, we believe the interest reserve sufficiently addresses construction and ramp up risks. Furthermore, we expect Caesars Drai's will enter into a guaranteed maximum price contract for construction, which along with a modest construction contingency (about 4% of construction costs) and a $20 million completion guarantee (14% of construction costs) provided by Caesars, should cover any potential cost overruns.
The financial maintenance covenants will include a minimum EBITDA covenant for the first year post opening and a maximum net first-lien leverage covenant following that. We do not yet know the levels of these covenants, but expect they will be set with some cushion to management's forecast. The credit facility will also contain an equity cure provision, and we expect that in the event of a potential covenant violation, the owners will step in to cure a covenant default.
Debt maturities are minimal, consisting solely of term loan amortization of 1% beginning two quarters after the property is open, until the term loan matures in 2019. The financing also includes mandatory offers to prepay term loan balances with excess cash flow (defined as club EBITDA less interest on the portion of the term loan allocated to the club, taxes, and maintenance capital spending) generated by the club, until the cumulative excess cash flow generated by the club equals the initial amount of principal and interest allocated to the club's construction.
Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Caesars Drai's to be published on RatingsDirect as soon as possible following the release of this report.
Our rating outlook is negative, reflecting our view of the linkage between the credit quality of Caesars Drai's and CEC, despite our belief that the financing package and other liquidity enhancements, including a 20-month interest reserve, provide sufficient liquidity to meet debt service obligations over at least the next few years.
We could lower the ratings on CEC, and in turn on Caesars Drai's, if Caesars' weak performance trends experienced in the second quarter continue, or if we no longer believe that Caesars' EBITDA will grow at least modestly in 2013 and that positive momentum will start to build again in the Las Vegas region. Without growth in 2013 and an expectation for positive operating momentum to continue into 2014, we believe CEC could otherwise be challenged to meet fixed charges while servicing its current capital structure and might again seek to restructure its debt obligations. Given CEC's very weak credit measures and limited capacity for debt repayment, a revision of the outlook to stable or positive rating momentum would require meaningful outperformance relative to our forecast.
In addition, we could lower the rating if the casino and hotel EBITDA underperforms our expectations and we no longer expect it to ramp up to a level of cash flow closer to or in excess of the lease payments made by CEOC. Given CEC's limited ability to access additional cash flow generated at Caesars Drai's beyond the casino and hotel components, failure of the property to generate sufficient cash flow to offset the lease payment could bring into question Caesars' willingness and ability to make these payments.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings List New Rating Corner Investment Propco LLC Corporate Credit Rating B-/Negative/--
$180M sr secd term loan due 2019 B
Recovery Rating 2
(Caryn Trokie, New York Ratings Unit)