$15 Billion Deal for Harrah’s May Put Other Casinos Into Play

NY Times October 3, 2006

$15 Billion Deal for Harrah’s May Put Other Casinos Into Play
By PETER EDMONSTON and MICHAEL J. de la MERCED
Their pockets bulging with cash, private equity firms have found a new business where they can place their multibillion-dollar bets: gambling.

Harrah’s Entertainment, the largest casino operator in the world, said yesterday that Apollo Management and the Texas Pacific Group had offered to acquire it for $15.05 billion in cash, or $81 a share. The announcement ignited speculation that the United States gambling business, whose thicket of regulations has traditionally kept investment firms at bay, could attract more such proposals. Share prices of many casino companies surged.

Combined with Harrah’s long-term debt of nearly $10.7 billion as of June 30, the proposal carried a value of $25.7 billion, which would make it the third biggest buyout in the United States this year, after deals for HCA and Kinder Morgan, according to Thomson Financial.

Shares of Harrah’s, which operates casinos under the names of Harrah’s, Caesars and Horseshoe in Las Vegas, Atlantic City and elsewhere, surged 14 percent, to $75.68.

In a statement, Harrah’s said it had formed a special committee of directors to evaluate the offer. The committee has hired UBS and the law firm of Kaye Scholer as advisers.

The board of Harrah’s made no recommendation on the buyout offer, and some analysts said a competing offer could emerge.

Jeffrey Logsdon, an equity analyst who covers the gambling business for BMO Capital Markets, noted that Aztar, the owner of the Tropicana hotels and casinos, was the subject of a heated bidding war before it agreed to be bought by Columbia Sussex for $2 billion this year.

Until several years ago, casino operators were generally considered off limits to buyout firms. That is because, with limited exceptions, Nevada regulations required every person holding equity in a private gambling company — and those holding more than 10 percent of the voting securities of a publicly traded one — to get a license to own or operate casinos. These licensing requirements would have forced not only members of private equity firms, but possibly those firms’ investors, including pension funds, to go through the licensing process.

The red tape alone would have made such a deal impossible, casino lawyers say.

In the late 1990’s, however, the buyout firm Colony Capital established a new ownership structure that opened the door to private equity investment. In buying Harveys Casino Resorts, a publicly traded company, Colony caused Harveys to issue two classes of stock, one with voting rights and one with the economic interest but no voting rights. The two principals who controlled Colony owned the voting shares of Harveys, so they were the only individuals required to have a license.

Since then, several private equity investments using that structure, or variations of it, have won approval in Nevada, a vital jurisdiction in casino mergers and acquisitions, as well as other jurisdictions.

But yesterday’s proposal to acquire all of Harrah’s is by far the largest and most ambitious private equity deal in the United States casino industry, said P. Gregory Giordano, a partner at Snell & Wilmer of Las Vegas and a chief of the corporate securities division of the Nevada State Gaming Control Board from 1989 to 1993.

“After hitting a few singles,” Mr. Giordano said, private equity firms “have decided to go for the home run.”

The Wall Street Journal, which reported the offer for Harrah’s yesterday, mentioned Colony as one firm involved in the discussions with Harrah’s. But when Harrah’s announced the proposal in the morning it did not mention Colony. Colony Capital declined to comment.

Given that Colony paved the way back in 1999, why have most buyout firms held off on buying casino companies until now?

For one thing, such a deal still requires top members of the acquiring firm — or firms — to submit to the scrutiny of the gambling regulators.

“These investigators will go and look at the contents of your home safe and your safety deposit box,” Mr. Giordano said. If the licensing process hits a snag, some of the facts uncovered by investigators can be revealed at public hearings. “It’s very intrusive.”

In the Harrah’s transaction, the top principals of both Apollo and Texas Pacific will need to obtain licenses in the jurisdictions where the new entity runs casinos, said Frank A. Schreck of the Las Vegas law firm of Schreck Brignone, who developed the Colony structure and will be representing the two firms in the regulatory aspects of the deal.

What may have tipped the scales is simply the amount of money that private equity firms have to invest, and the attractiveness of the gambling business.

Buyout firms “are looking for quality companies with stable cash flow,” said John O’Neill, head of the private equity practice at Ernst & Young. Gambling companies are known for their hefty cash flows, which often hold up even in economic downturns.

And the United States gambling business also stands to benefit from a law passed over the weekend by Congress that would make it illegal to process payments for gambling done on Web sites.

Private equity investors would normally be interested in online betting companies because of the healthy cash flows, a private equity banker in London said, but they have not touched the companies that do business in the United States because of the legal issues.

The privately traded BetFair, an online gambling company based in London which says it does not do any business with gamblers in the United States, is backed in part by private equity money.

Harrah’s has struggled to catch up with its competitors in overseas expansion. It lost the contest to gain a gambling license in Singapore to the Las Vegas Sands, and its toeholds in Europe have been limited so far to Spain and Slovenia.

If a deal is completed, it could limit Harrah’s future growth, said Jake Balzer, a leisure and entertainment analyst with Guzman & Company, saying that a buyout could divert Harrah’s cash to servicing its debt rather than fueling its expansion efforts in Europe and Asia.

Rod Petrik, an analyst with Stifel Nicolaus, said that Harrah’s solid cash flow and well-run operations made it a highly attractive takeover target.

“They’re the McDonald’s of the gaming industry,” he said. “It’s a very well run company, so this isn’t private equity coming and buying a company that’s broken and then fixing it.”

Heather Timmons contributed reporting.