Investors Roll Dice on Gaming Industry
October 25, 2012
Investors desperate for yield are scrambling to pocket whatever noninvestment-grade bonds and loans they can, even as terms become more favorable to borrowers, and that includes debt from hotel and casino operators that have made near-miraculous recoveries since the dog days of the Great Recession. The ease with which some deals are getting done may belie the challenges facing the U.S. gaming industry, but for now its debt offers high returns and—unexpectedly—some of the strongest investor protections.
Caught in the middle of a debt-fueled growth spurt, the gaming industry was hit hard by the credit crisis starting in 2007, and deals all but disappeared in 2009 and 2010. Since then, record low interest rates and a recovering economy have bolstered their fortunes.
“It’s really evolved from a solvency story to more of a deleveraging story. We’ve seen margin expansion that’s helped bring down debt leverage,” said David Sekera, bond strategist at Morningstar.
Gaming companies remain heavily leveraged, most with ratings below BB-minus. But if the U.S. economy and employment continue to improve, the gaming industry’s outlook is likely to as well, as consumers celebrate improved financial conditions with a trip to a casino.
Ron D’Vari, chief executive of NewOak Capital, said the combination of low rates and much tighter spreads on higher rated high yield debt has resulted in most of “the low hanging fruit having been picked.” Gaming industry debt may be riskier, but the business is cash intensive and, like sectors including home builders and high-end retail, it can rapidly adjust to the environment, D’Vari said, adding, “These sectors go down faster and come back faster. They’re more of a beta play.”
That’s incentive for investors willing to take on risk to jump ahead of the pack. It also helps that many gaming bonds pay equity-like returns, enamoring to investors in a historically low-interest environment.
Investor interest partly stems from many gaming companies’ successful efforts to deleverage. Sekera points to MGM Resorts International as a poster child for the deleveraging story; the company has extended its debt maturities at lower rates and has also benefitted from improved Ebitda as the economy recovers that’s been used to pay down debt. In fact, Morningstar bumped up by a notch its ratings for MGM as well as Wynn Resorts to B-minus and BB-plus, respectively, earlier this year.
Although MGM has $13.4 billion in long-term debt, the second largest in the industry behind Caesar’s Entertainment, it priced $1 billion in unsecured bonds in September that pay a coupon of 6.75%, and in March it issued the same amount of 10-year bonds for a coupon of 7.75%, at that time the lowest interest rate the company had seen since 2007.
Sean Snipes, managing director in leveraged finance capital markets at Bank of America Merrill Lynch, compared those returns favorably to the period between 2008 and 2010, when MGM issued secured bonds paying between 9% and 13%. He attributed the cheaper financing to the improved financial performance of MGM and other gaming companies, but said investors’ hunger for yield is also a factor.
“You can see how the world has changed over a short period of time,” Snipes said, adding, “The institutional loan and high-yield markets are flush with liquidity and those dollars are chasing yield.”
Aggressive deals are occurring on the loan side as well. Snipes pointed to Station Casinos’ $575 million term loan, inked in September, which priced at 425 basis points over Libor—approximately 5.5% all-in—even though the single-B-rated company was still highly levered after emerging from bankruptcy two years earlier. In addition, Snipes said, the deal’s covenants “were loosened considerably,” reflecting a broader trend to give issuers more flexibility to incur additional debt to make acquisitions and investments.
Other issuers of such deals include Revel Entertainment, SLS Las Vegas, and The Graton Economic Development Authority. The latter inked a $375 million leveraged loan paying 9.5% and a $450 million high-yield bond paying 9.625%—both secured transactions—to support the construction of a new casino on native American tribal land outside of San Francisco.
“We raised money against a piece of land and a business plan,” Snipes said. “To give a sense for how hot things are, the $825 million was raised for a tribe, its own sovereign entity, for which bankruptcy rules and U.S. laws do not apply in the same fashion.”
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