GAMING COMPANIES ON THE BRINK? Cut the surprises, increase the chances
by Rudy J. Cerone Paul Slocomb West
December 2, 2008
Cerone
Times are tough, there are steps to take, however, to make the (temporary?) ride down less bumpy
West
Loan defaults. Credit rating downgrades. Expansion projects on hold indefinitely. Private equity deals dead in their tracks. Gaming stocks trading at record lows while gas prices are at record highs. Smoking bans being implemented or discussed. Today's reality for casinos is surprising to believers of the old saw about gaming’s immunity to recession.
Surprise is also in play in the recent implosion of the financial markets. Despite the early warnings of a pending crisis, the hastily crafted bailout to revive credit markets emerged in an atmosphere of scrambling, panic and confusion. Solutions offered by Washington have not had an immediate positive impact on Wall Street. Only time will tell whether the bailout legislation was the ideal way to provide liquidity to the capital markets.
For now, gaming’s woes are linked inextricably to the economy’s overall poor performance. The key sectors influencing casino revenues and future expansion — real estate, hospitality, tourism and energy — all have been hit hard. Given these factors, casino operators, owners and developers have little ability to reverse the effects of the global economic downturn.
There are steps to take, however, to make the (temporary?) ride down a less bumpy.
Coping with tough times ahead
When viewed against this
backdrop, gaming companies can expect an increase in financial woes. Credit
facilities will remain tight, cash flow will be restricted and more gaming
bankruptcies and insolvencies are certainly a possibility.
Smaller, less diversified
operations, such as some riverboats and racinos, are vulnerable to decreased
local traffic, shrinking revenues and tighter access to capital. They are more
likely to be the first casualties.
Large “market-to-market”
balance sheet adjustments, such as the reported $600 million write-down of the
Harrah’s investment by Apollo and TPG, will continue. Recently, Sheldon
Adelson, whose assets include the Las Vegas Sands, Venetian and Palazzo on the Strip, dug $475 million deep into his family’s money to
avoid breaking banking covenants. Undoubtedly, there will be additional
incidents of big industry players struggling to refinance huge debt loads
incurred when easy credit markets ruled in the very recent past. The search for
capital will become increasingly challenging as the appetite for investment
risk evaporates.
The credit and consumer
spending crunches also will trickle down to casinos and their levels of
services across the boards. As operating budgets tighten, staff reductions in
labor-intensive gaming companies could well follow – a strategy that landed Columbia Sussex
and the Atlantic City Tropicana in some very hot water with New Jersey regulators. Ancillary expansion
projects, such as parking garages and auditoriums, likely will be pushed to the
back burner. Maintenance deferrals could mean delaying such non-essentials as
the replacement of a lobby’s worn rug, which then detracts from the facility’s
attractiveness. In turn, customers begin to drift to the shinier place across
the street, resulting in a further plummeting of revenues.
In this gloomy scenario,
most observers are advocating patience. But while the industry lurches towards
its hunker-in-the bunker phase, there is something that gaming owners can add
to their patient perspective. The avoidance of surprises.
When casino owners see the
early signs of a systemic problem, such as a change in their financial
structure, they can avoid additional problems by informing their regulators
immediately.
Recently, there’s been an
unwelcome spotlight on regulatory authorities in other sectors. Many fingers
pointed to the failure of adequate and preventive regulatory oversight as
contributing to the current meltdown of financial institutions and Wall Street.
The gaming industry, as
one of the most heavily regulated in the country, certainly will feel increased
scrutiny and pressure from its regulatory agencies. There also will be
increasing stress from political interests. Governments are facing fiscal
constraints and budget shortfalls now that the taxes they counted on from local
casinos, riverboats and racetracks are seen as falling short of the mark.
Clearly, both regulators
and gaming companies face unprecedented challenges. As everyone in the gaming business is aware,
there is one thing that regulators dislike more than anything else – surprises.
Regulators can take bad news and always will appreciate a heads up that such
news may be coming. But they loathe being the last to hear about a casino on
their watch breaking a covenant, being unable to refinance bonds or filing for
Chapter 11 protection. Nor do they like discovering that a promised new
property has been mothballed, downsized or delayed. The lesson to be learned?
Got a secret? Don’t keep it from the regulators.
Keeping regulators
informed before a crisis reaches full-blown proportions is one thing in this
environment that casinos can control. Changes in financial circumstances
usually are known in advance. Bankruptcies just don’t appear overnight.
If a casino is in danger
of violating a covenant or falling below dictated ratios, if credit terms are
about to expire or if bonds cannot be financed, do yourself and your
stakeholders a favor: immediately discuss it with the regulators before they
read about it in the newspaper.
Be straight with the
regulators and communicate honestly and frequently. Letting regulators know
what to anticipate, and advising them of your plans for dealing with the
problem, will help gaming companies forge a smoother path for what lies ahead –
restructuring, turnaround or insolvency.
This kind of preventive,
heads-up communication policy and practice also can help in relations with the
regulators, should plans go awry. Gaming
regulators all have a degree of flexibility to be able to waive certain
requirements or grant a company extra time that can help owners dig themselves
out of trouble spots. Additionally, “showing the flag” through personal
appearances by top executives and finance advisors to each jurisdiction is time
and money well-spent.
Another important way to
get ahead of a looming crisis is to put together a team of turnaround,
insolvency and/or bankruptcy advisors before your options narrow or disappear.
It can make all the difference in how the crisis is handled or, better yet,
avoided.
Casino bankruptcies are
not run-of-the-mill Chapter 11 matters. It is important to work with
professionals who are experienced in the unique aspects of casino insolvencies
so the right steps are taken to mitigate risks.
Considerations at play in
casino bankruptcies include the continuation of uninterrupted operations, the
payment of gaming chips, tokens and sports book wagers, managing the tensions that
arise between state gaming laws and bankruptcy laws, and the prevalence of
litigation to determine the dischargeability of debts.
While gaming bankruptcies
are a special breed, no two casino bankruptcies are alike.
Each insolvency has its
own contributing factors and objectives. In some cases, creditors, such as
bondholder groups, may force a company into Chapter 11. In other cases, a
company itself may seek protection voluntarily, with the resulting “breather”
period, while it renegotiates its debt.
Still others may use bankruptcy as leverage to loosen restrictions with
municipal landlords or partners.
Depending on what debtors
are attempting to achieve, each casino bankruptcy will take its own form.
When the credit markets do
open up again (and they will), don’t pop the champagne corks. Caution still
should prevail. The gaming industry is not favored historically by those
extending credit and casinos’ high-risk profile will make them a lower priority
for the capital markets once the flow of financing opens again.
For private equity firms,
companies with unexposed lines and others with cash on hand, there are
opportunities to explore, and it looks likely more opportunities will
proliferate as cash flow and capital remain impaired.
The good news is that
most companies will survive this storm. And there will be a few, depending on
their timely investments at or near the bottom of this current downturn, that
will emerge stronger on the other side. Consider this the silver lining in the
cloud covering the gaming industry — a shiny hope that is a welcome surprise to
the terminal optimist in all of us.
Rudy J. Cerone
is a partner at the law firm McGlinchey Stafford, PLLC where
he is a certified specialist in business bankruptcy law and has represented
bondholders in numerous casino cases.
Paul Slocomb West
is a partner at the law firm McGlinchey
Stafford, PLLC where he has been a legal counselor to casinos and the gaming
industry for the past 15 years.
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