hile casino bonds comprise only 3.8% of the Merrill Lynch High Yield Master II index, borrowers from the industry printed 7.1% of the junk debt sold through mid-August, according to data from Fitch Ratings.
The biggest change from the last wave of casino issuance in 2006-2007 is that investors are demanding security and steeper interest rates to keep playing at the table. Small wonder given the roster of casinos that sought bankruptcy protection in recent years, including brand names like Trump Entertainment and Tropicana Entertainment as well as middle-market players like Greektown Casino and Legends Gaming.
More supply is waiting in the wings with Mohegan Sun and a variety of regional projects as potential issuers of new bonds. Judging by softening secondary markets and the lukewarm response to MGM Mirage’s recently proposed debt exchange, borrowers will need to keep offering security packages to lure investors in.
The surge in gaming deals this year doesn’t necessarily reflect increased confidence in the sector. It just shows that investors know a bargain when they see it. “It’s a buyer’s market,” Jeff Heimann, a Director at Innovation Capital, a Los Angeles-based boutique investment bank, told Debtwire.
Eight casino-hotel operators issued roughly us$ 5.47 billion in bonds since 1 May. Tellingly, seven of the 10 bonds those borrowers sold were secured, representing us$ 4.1 billion of the notional amount printed. Only three of the eight issuers serve the overcrowded Las Vegas and Atlantic City markets and all of those had to put up collateral to attract buyers. “If it’s in Nevada, it has to be senior secured,” said one portfolio manager who buys gaming bonds. “I’m comfortable with certain assets making it, but not a lot of pure play Vegas [credits]. I’m focused on the regionals.”
Recent earnings back up that approach. Despite the deepening national recession, regional outfits Pinnacle Gaming, Penn National and Ameristar Casinos all reported revenue gains in second quarter 2009 and were able to upsize the high yield bonds they brought to market.
In addition to their bias towards regionals and meatier collateral packages, the latest vintage of gaming deals offered fatter yields. The weighted average yield of casino bonds issued this year is 11.3% compared to 10.6% for all high-yield deals and to 8.6% for gaming deals issued in 2006-2007, according to data from Fitch.
And while yields rose on average in new deals this year, implied risk declined. The weighted average leverage multiple of all 10 gaming bonds issued in 2009 was 5.64x with secured deals averaging about one-turn higher at 6.5x. That compares favorably to the 6x-8x range plumbed by private equity firms that fed the LBO craze earlier this decade, said one industry banker.
So far, casino bonds paid out this year. The gaming segment of the Barclays Capital High Yield Index returned 46.5% year-to-date compared with a broader index return of 39.5%. Gaming bonds make up roughly 4% of the overall index.
MGM Mirage ushered in the bullrun this May when it priced us$ 1.5 billion of senior secured notes – and us$ 1 billion of equity – as part of a massive restructuring. The casino chain hocked its crown jewels - the Bellagio and Mirage Resorts - to back the bonds and offered hefty yields of 11.125 %-11.625 % to ensure smooth syndication.
“We saw a window and took advantage of that window in terms of raising capital,” said MGM Mirage CFO Dan D’arrigo. “We were in a very unique position. All of our debt was unsecured and we had the ability to provide security.” “In addition to restoring investors’ confidence in MGM Mirage, the transaction opened the market to other gaming issuers,” said Innovation Capital’s Heimann.
Ameristar, Harrah’s Entertainment, MTR Gaming, Peninsula Gaming, Pinnacle, Penn and American Casino & Entertainment all tested their luck in succession. Notably, the Las Vegas/Atlantic City casinos offered higher yields and collateral to get their deal done.
MGM’s and Harrah’s relatively high leverage in the mid 7x range justified pricey terms but American paid through the nose despite offering net leverage of 3.9x pro-forma a private loan restructuring. The operator of locals casinos in Nevada pitched investors a yield of 16.2% courtesy of an 83 OID to get the deal done.
The premium charged to casinos in the two hub markets reflects real risk. Trump Entertainment Resorts, Tropicana Entertainment, Station Casinos, Herbst Gaming and Fontainebleau Resorts all filed for bankruptcy protection in the past two years.
While most gaming enterprises suffered from reduced consumer spending in that time period, the mortgage crisis hit locals casinos dependent on Las Vegas residents particularly hard, while the growth of gaming in Pennsylvania and Connecticut cannibalized the Atlantic City market.
Those factors remain unchanged and without the lure of collateral, bond investors will look far less favorably at new supply from casinos in the two cities. Case in point - the lukewarm reception last week to MGM’s proposed swap of bonds due 2010 for longer-dated unsecured notes.
The casino chain offered to exchange the notes at a 17.5 % premium but the transaction’s prospects look dim, according to research by the Street. “It is unclear if the transaction will generate significant bondholder interest,” Barclays Capital stated in a recent report, pointing out that the new notes would be subject to secondary market risk. “It will be too early for us to gauge the market reaction to the bond exchange until after the holiday, since the early tender on the deal is next Thursday (10 September),” said an MGM spokesperson.
Even new supply from the regionals will likely include collateral. Mohegan Tribal Gaming Authority, owner of the Mohegan Sun Casino in Uncasville, Connecticut, is one candidate. The company inked an amendment with its lender group in December that allowed it to issue up to us$ 225 million in either second lien debt or senior unsecured notes. Given the ongoing restructuring of another tribal casino, Foxwoods, buyers might be skittish about investing in high yield debt underlying Native American gaming, said one buyside source.
Other areas of issuance could come from the growing number of jurisdictions that are seeking to have gaming in their jurisdictions. Ohio has an initiative on its 3 November elections to get casinos in four cities: Toledo, Cleveland, Cincinnati and Columbus, Ohio. The state of Kansas now has awarded one gaming license in the state to Butler National Corporation which opens up in December and is currently deciding between the Cordish Co-led joint venture and Penn National on a second license.