$15 Billion Purchase of Harrah's faces Challenges

On October 2, 2006 two hedge funds, Apollo Management and Texas Pacific, together made an unsolicited, all-cash offer to buy Harrah's Entertainment, the world's largest casino company, for $15.05 billion or $81 per share, which was a 22% premium above its price of $66 a share on that Monday. Since that date the two hedge funds have increased their offer to $15.5 billion or $83 a share. Harrah's set up a special board committee to evaluate the deal and has only commented that it hasn't determined if it's in the shareholders' best interests. Wall Street doesn't appear to believe the deal will happen, based on the midmonth closing price of $75 for Harrah's stock which is below the current $83 bid price. Two writers from Businessweek, Christopher Palmeri and Jane Sasseen, wrote that the deal has too many risks without enough of an upside gain to make it likely to happen. Besides the logistical and regulatory hurdles, there are some questions as to whether this deal makes financial sense.

Peggy Holloway, an analyst at Moody's Investors Services covering gaming and hotels, estimates that the hedge funds would have to put in a 20% equity stake, or roughly $5 billion of the purchase price of $26 billion ($15 billion equity and $11 billion assumption of debt). Harrah's would end up with debt over eight times its estimated 2006 cash flow of $2.4 billion (new debt of $10 billion plus $11 billion of current debt). If the deal was financed at an interest rate of 8%, the cash flow would cover just one and a half times its interest payments. With so little margin for error, Holloway questions whether Harrah's would have the capital to upgrade the properties, which is required to stay competitive in the gaming industry. The new operators would sell properties to pay off some of the debt; however, there's not a lot of room for error and it's not clear what the "upside" incentive is. Maybe there's too much money in the pockets of the hedge funds. As of October 2006, 436 new hedge funds had raised a record $300 billion worldwide, according to industry tracker Private Equity Intelligence.

Others speculate that this offer was a ploy by Gary Loveman, CEO of Harrah's, to set up a management buyout. A lawsuit filed in October by two investors calls it "a camouflaged management buyout", alleging that Loveman encouraged the offer so that he could follow up with an offer of a management buyout. Management-owners of a business would know more about a business than anyone else, and would conceivably know the right time to make an offer.

Harrah's is operating as if nothing unusual is happening and is working on a $521 million offer for English-based London Clubs. At this time management is keeping its cards close to its chest in this high stakes game of poker.

John Laub is the president of the CEO-CFO Group

1. "Private Equity: A Bid Too Far? Why Wall Street has doubts about the offer from Apollo and Texas Pacific for Harrah's." Christopher Palmeri and Jane Sasseen. Businessweek.online.com. October 16, 2006.

2. "Buyouts Often Shortchange Shareholders." Rachel Beck. Associated Press. October 14, 2006.

3. "Harrah's Gets $15 Billion Buyout Offer: Casino Company Harrah's Gets Buyout Offer of $15 Billion, or $81 Per Share." Ryan Nakashima, AP Business Writer. Associated Press.October 2, 2006.

4. "Harrah's bid of $83.50 still insufficient to cinch deal: WSJ." Robert Daniel. Market Watch. October 12, 2006.