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August 18, 2022

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Betting it all on bankruptcy?

Strict regulation of industry, high earnings potential, make Chapter 11 a desirable option


Steve Marcus

Herbst Gaming, which owns Terrible Herbst casinos, is the furthest along in the bankruptcy reorganization process of any of the major Las Vegas gaming companies. The Herbst family will own 90 percent of a new company that operates slot machines, with bank lenders owning 10 percent.

Finally, a bit of good news for Las Vegas: Our casino behemoths might seek Chapter 11 bankruptcy protection.

Taking a dire step like that conjures up images of companies failing in dying industries. But Las Vegas is nothing of the kind. Profits are down by more than 20 percent, but that’s hardly enough to kill off the world’s biggest gaming companies.

The problem is that those companies built their future on an assumption of strong growth. They overextended themselves with huge debts. Seeking Chapter 11 protection would allow them to restructure those debts and build new business models based on the realities of today’s economy.

Successful bankruptcy reorganizations avoid worst-case scenarios in which companies have run out of money and must close their doors, selling assets at fire-sale prices to pay creditors. If launched early enough, reorganizing debt allows businesses that are still making money and have long-term growth prospects — such as casinos — to continue operating, with their workforces intact.

Among the companies that may be considering Chapter 11 filings are MGM Mirage, Harrah’s Entertainment and Las Vegas Sands. Station Casinos and Herbst Gaming have indicated they will file for bankruptcy protection.

Casinos can emerge from bankruptcy in stronger financial shape because they are cash cows thanks to a product — recreation — that may be less popular these days, but is hardly obsolete.

Like overmortgaged consumers who built and acquired homes on cheap credit, casino companies accumulated more than $50 billion in debts during the boom to finance growth. Collectively, their casinos are now worth less than the money owed by their companies. Like many homeowners underwater on their mortgages, these companies can significantly reduce their debts by seeking bankruptcy protection.

And yet, there’s one major difference between casinos and businesses in other industries that works to casino owners’ benefit.

Unlike other kinds of businesses, casino owners must undergo background checks by state regulators. So it’s less likely there is less danger that a lender will want to seize a casino’s assets if it first must be licensed by state gaming regulators.

Casino lenders generally aren’t eager to foreclose on a property because many banks and other investors don’t want to go through the lengthy and burdensome licensing process, bankruptcy experts said. Nevada law allows passive investors to control up to 15 percent of a company without being licensed.

In a sense, many casino companies are operating as if they are in bankruptcy. They have cut costs by hundreds of millions of dollars — an industry record — and have laid off thousands of workers.

Extreme cost-cutting by Strip giants in this recession — while a prudent move in troubled times — will hurt Las Vegas long-term by depressing the value of casino properties and taking a toll on customer service, Dennis Farrell, a bond analyst with Wachovia Capital Markets, said in a research note to investors last month.

Better that companies seek bankruptcy protection, he and others said, because, shielded from creditors, company revenue could be applied to operations and property enhancement.

A casino, like any other business in Chapter 11, might also secure additional new financing through bankruptcy court.

As a general rule, lenders don’t want to end up owing casinos, but rather want to get paid and move on. So negotiations between some casino companies and banks to restructure debt are under way.

This round of restructuring, resulting from the worst downturn in the modern casino era, will likely be different from past business cycles where casinos have simply changed hands between known casino operators, experts say.

That’s because of a lack of available financing and a dearth of buyers with the means to put up significant cash.

While private equity investment firms have been licensed as part-owners of casinos — think Harrah’s and Station — these groups usually take a back seat to experienced casino operators, who are involved in day-to-day management.

And yet, with lenders seeking the best return on their money, many believe this recession will result in a significant number of lender groups, especially banks, taking ownership in casino companies — at least in the short term.

Here’s why: Casino companies still generate tens of millions, if not hundreds of millions, in cash a year. Last year lenders would have been more sympathetic in a global downturn, hopeful that these giants would recover by the end of 2010.

Now, the prospect of recovery is farther off, and the recession is likely to worsen in the near term.

That leaves the highest-leveraged casino companies running out of viable options, such as selling casinos, because there are few cash-rich and gutsy buyers in today’s market.

This leaves lenders considering casino ownership as the best option to recoup their investments.

That prospect concerns some longtime casino executives, who wonder whether banks or other lender groups that end up owning chunks of gaming companies will make decisions in the best interest of Nevada’s gaming industry and its economy. Banks taking casino profits back to New York, for example, might be less interested in reinvesting that wealth in Las Vegas.

Herbst Gaming, the farthest along in the bankruptcy reorganization process of any major Las Vegas gaming company, offers an example of what may come for others. This month lenders agreed on a plan to take control of Herbst’s casino properties, with the Herbst family owning 90 percent of a new, separate company that operates slot machines in small locations such as gas stations and grocery stores. Bank lenders would own the remaining 10 percent.

The lenders may find resistance, though, from original equity owners who tend to be company founders or longtime gaming families who hold a big chunk of the company’s equity, bankruptcy attorneys said.

As a result, owners often strike deals with lenders at the top of the pyramid — the ones who get paid first in bankruptcy — allowing owners to retain control of certain properties in exchange for reduced or forgiven debts. Lenders farther down the pyramid, such as bondholders, often get cents on the dollar in bankruptcy and may be more willing to negotiate with companies outside of bankruptcy court. That’s what Harrah’s has done with certain bondholders.

So the question playing out in Las Vegas boardrooms is how much control casino owners should relinquish to lenders through bankruptcy protection to save their companies — or whether they can survive without giving up any control.

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