Class of 2019 | armghana@wharton.upenn.edu
This past month, an agreement was finally reached between Apollo & TPG Capital—the two private equity firms that controlled a majority stake in Caesars Entertainment—and its largest creditors. This deal marked the end of what has been an extremely contentious and often ugly series of lawsuits and failed negotiations in a bizarre tale of a Wall Street players going head-to-head. The clear winners of the new agreement are second-lien bondholders including David Tepper’s Appaloosa Management and Oaktree Management, amongst others, which held just under $900 billion in bonds at one point.
Under the new agreement, Apollo and TPG will see their stake in the company reduced from 60 percent to about 16 percent in order to allow the company to emerge from Chapter 11 with fewer debt—a humbling conclusion after a series of attempts by the firms to salvage their investment. In return, executives from Apollo and TPG will be insulated from lawsuits seeking to hold them responsible for Caesars’ bankruptcy. This marks a rare case of private equity firms giving up ground in order to settle what has been a truly extraordinary tale of twists and turns centered on the Vegas strip.
Apollo and TPG acquired Caesars (at the time named Harrah’s) in a $31 billion buyout in December 2006. The deal did not close until January 2008, largely due to the lengthy background checks regulators conducted on both private equity partners. The timing of the buyout unwittingly sowed the seeds of its demise; the partners had piled on debt right before the economy was about to take a nosedive, and the company’s losses in turn led to the degree of leverage almost doubling by the end of the year—from 7 to almost 14.
At this point, a clear option would have been to exit the situation, handing the company over to its creditors, and writing off its losses. But Marc Rowan of Apollo refused to give in. While TPG continued to give major input, Apollo took the lead on the restructuring process. What followed in the next few years were a series of over 50 increasingly complex financial transactions, everything from shifting assets between subsidiaries, converting junior debt into equity, and buying an Israeli gaming company to try and replace lost revenues.
By 2013, despite Apollo’s best efforts, the situation was looking dire. Gambling revenues were terribly low, junior debt was trading as low as 10 cents on the dollar, and Caesars’ auditors were threatening to give a qualified opinion that would mark the company as unable to continue “a growing concern”—something that would quickly lead to bankruptcy. Apollo began to negotiate with creditors, agreeing to pay off senior creditors at par, while outlining a plan that called for the original guarantee of the principal and interest payments on the subsidiaries’ debt to be released—a move that enraged many of the junior creditors, many of which were hedge funds that bought up the struggling company’s debt at a discount and were expecting to cash in.
By late 2014, lawsuits had started flying. Bondholders sued Caesars and both private equity firms, claiming that Caesars stripped the operating company of valuable assets and that the parent company reneged on a promise to pay the units notes. “This is a case of unimaginably brazen corporate looting and abuse perpetrated by irreparably conflicted management,” one suit began. Caesars, Apollo and TPG all denied the claims and said their actions were a legitimate attempt to restructure the unit.
In January of 2015, buried under $18 billion of debt, Caesars filed for Chapter 11. Negotiations later that year between Caesars and its creditors quickly reached an impasse, with Caesars offering $4 billion towards reorganization, while creditors claimed a value of $12 billion and pursued the lawsuits accusing the parent companies of mismanagement. To the ire of many, Caesars did not seek financial assistance from either of its parent companies In August 2016, Caesars finally sent a $990 million plea to Apollo and TPG to exit bankruptcy—which was promptly refused. U.S. Bankruptcy Judge A. Benjamin Goldgar, expressing astonishment that the company waited until early August to seek help from its indirect owners, exclaimed “We’re 20 months into this. How could this not have occurred to somebody until just in the past few weeks?” Later that month, Goldgar lifted a legal shield delaying lawsuits against Caesars, Apollo, and TPG, giving them until October 5 to reach an agreement, which was finalized late September.
The saga of Caesars is one that will be remembered for years to come; Apollo and TPG have been two of the most successful firms in the industry, and their defeat is one that must certainly give some pleasure to many players in the financial world. There is then the case of the tug-of-war between creditors and the firm that resulted in the humbling of these two institutions; as Alex Bumazhny, a senior director of corporate ratings at Fitch, remarks “The bondholders were pretty aggressive…we didn’t think they were going to be this aggressive.”The victory of the junior bondholders—which include some of the savviest hedge fund investors today—could also mark a shift in the balance of power in the larger financial industry.
On another note, the actions of Goldgar and the harder stance taken against both firms demonstrates a clear regulatory position: firms will be much more sternly dealt with in the cases of mismanagement and financial meltdowns. Coupled with the shift in public opinion regarding financial markets in much of the country, this ruling could have potentially major consequences for the industry going forward—both in terms of practice and legal challenges. For the first time, the private equity firms and their executives seemed to be in danger of having to face the charges leveled against them—a precedent that will certainly strengthen regulators and place more limits and lend more caution to the rest of the industry.
And then of course, there is the perfectly simple final takeaway: even the most sophisticated financial reengineering cannot rescue an investment if its core business is failing.
Figure 1: Caesars Restructuring and Key Players. Source: BloombergBriefs.com