An Unpleasant Reminder to Shareholders of Caesars Entertainment Corp

An Unpleasant Reminder to Shareholders of Caesars Entertainment Corp

Earlier today, shares of Caesars Entertainment Corporation fell more than 12% on news that the company was issuing $1 billion of first lien bonds at an 8% yield, on top of $1.15 billion of second lien bonds at an 11% yield. Perceiving that this news could indicate deteriorating fundamentals, Mr. Market effectively punished the company through the form of a share sell-off. However, the question that should be asked is whether the company deserved to be punished in such a way or if the market is overreacting such that a prospective investor can pick up shares at a substantial discount to their intrinsic value.

To determine which scenario is likely the case, one needs to look at the company's history of profitability and outline a few key metrics that should provide some insight for Foolish investors.

Income Statement Data
From the perspective of the company's income statement, we immediately come across some disturbing data; over the past five fiscal years, from 2008 through 2012, the company's revenue has declined by 15.2% from $10.13 billion to $8.59 billion, respectively. In juxtaposition, two large competitors of Caesars, Las Vegas Sands and Wynn Resorts , have seen their revenue increase by 153.5% from $4.39 billion to $11.13 billion, and by 72.2% from $2.99 billion to $5.15 billion, respectively.

On top of declining revenue, Caesars is also suffering from declining profitability. Its net income, for instance, has been negative in four of the past five years, with the company losing almost $1.5 billion in 2012 alone. When placed next to Las Vegas Sands, which has seen its net income rise from -$163.6 million in 2008 to $1.52 billion in 2012, and with Wynn Resorts more than doubling from $210.5 million in 2008 to $502 million in 2012, it takes very little guesswork to determine which casino operator is suffering and which ones are flourishing.

Digging a bit deeper, the reasons behind the company's apparent fall from grace has to do with two primary factors; first, it's costs of selling, general and administrative expenses (SG&A) (essentially its cost of employee compensation, advertising, etc...) as a percentage of revenue at 27% for 2012 is more than twice as high as that of Las Vegas Sands at 12.7% and almost three times higher than Wynn Resorts at 9.4%. Second, and most important, is the company's significant debt load.

Balance Sheet Data
With debt as of its most recent fiscal quarter of just under $28 billion and a negative book value (all assets, less liabilities) of around -$850 million, Caesars solvency is already in serious doubt. As a result of the company's debt load, it already pays interest of $2.1 billion each year. Looking at it from another perspective, we conclude that the company pays 24.5% of its revenue (using 2012 data) toward servicing its debt load.

In contrast, Las Vegas Sands only pays about 2.1% of its revenue toward debt servicing, while Wynn Resorts pays a slightly higher, but nonetheless healthy 5.4%. What this implies is that Caesars is primarily unprofitable due to its higher debt load. So, by adding $2.15 billion onto the company's balance sheet, even at interest rates that probably aren't outlandish, Caesars appears to be remaining in the whole it has dug.

Cash Flow Data
However, GAAP earnings and debt may not be all that relevant to one another you might say. Instead, we may want to look at each company's cash flows to determine if it is capable of paying off said debt because net income incorporates accrual accounting, whereas cash flows involve the actual amount of cash flowing into and out of a corporation. With this thought in mind, let's delve into the company's cash flows a bit more and found something scary.

In addition to posting net losses, Caesars has also posted negative free cash flow (cash flow from operating activities, less capital expenditures used to grow and/or maintain current operations) regularly. Although sporadic, the company has posted negative free cash flow for at least the past five years, with its deficit ranging between -$63.4 million in 2010 to -$772.5 million in 2008. Even looking at the company's free cash flow of -$481.2 million in 2012, we see that the company's situation is terrible to say the least.

However, even if we were to remove its capital expenditures and assume that it could do without the acquisition of property, plant, equipment, etc... the picture is still grim, with cash flows from operating activities declining every year from a five-year high of $534.5 million in 2008 to $26.5 million in 2012.

Foolish Takeaway
Fundamentally, the picture at Caesars is bad and getting worse. Perhaps the company has some grand plan in mind where it can leverage the assets it currently possesses and muster a turnaround, but at the moment, it appears as though it's traveling down the road that Border's took by borrowing more debt just to buy it time before concluding in bankruptcy.

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