Gaming M&A Boom Turns To Bust

Once trumpeted as an industry impervious to the gyrations of the broader domestic economy, gaming tallied unusually feverish M&A activity in 2006 and 2007 as buyers queued up for what seemed like a surefire bet.

The ready availability of financing on attractive terms in recent years that buoyed domestic buyouts across a range of industries also gave gaming M&A a marked lift. However, as the domestic economy retrenched this year, it dealt a losing hand to many casino companies, which are increasingly reeling under the strain of declining financial results and outsized leverage. A golden age of gaming dealmaking, punctuated by several landmark multi-billion dollar take-private transactions, has given way in 2008 to a noticeable decline in the number and size of announced domestic gaming deals, making this a fitting time to take stock of the chief factors that guided gaming M&A activity during the 2006-07 period and to explore the opportunities and challenges that will create new winners and losers in the coming months.

Stampeding To The Strip

One prominent feature of the 2006-07 period was the frenzied quest for increasingly scarce land on the Las Vegas Strip, the premier domestic gaming corridor. Buyers employed several strategies, including the purchase of companies whose assets include aging properties situated on the Strip as well as the acquisition of undeveloped or under-developed tracts in prime areas.

Perhaps the most closely watched real estate-motivated gaming play during the 2006-07 period was a bidding war culminating in May 2006 for Aztar Corp., which then held Tropicana branded casinos in Las Vegas and Atlantic City. Aztar’s crown jewel was a choice 34-acre site at the heart of the Strip occupied by its aging Tropicana property, which presented a tempting development opportunity. Pinnacle Entertainment Inc. initially signed a deal to acquire Aztar for $38 per share only to see Colony Capital LLC, a Los Angeles private equity firm with a focus on real estate and gaming assets, Ameristar Casinos Inc., and Wimar Tahoe Inc., an affiliate of hotelier Columbia Sussex Corp., each use the “fiduciary out” provision contained in the Aztar–Pinnacle merger agreement to submit competing offers. When the dust settled, Aztar’s board agreed that Wimar Tahoe’s $54 per share all-cash offer was superior to Pinnacle’s last bid for the company and terminated its merger agreement with Pinnacle. Including the assumption of $676 million in debt, Wimar Tahoe’s acquisition of Aztar was worth about $2.75 billion.

In August 2007, furthering the trend, Elad IDB Las Vegas, a joint venture between New York-based Elad Group and Property & Building Corp., a subsidiary of Israeli-based IDB Holdings Corp., acquired the New Frontier and its 34.5-acre site on the Strip from Phil Ruffin in exchange for a reported $1.24 billion in cash. Although the acquirers announced plans to develop a $5 billion luxury complex under The Plaza flag featuring a hotel, private residences, and retail and gaming amenities, they have since suspended the project owing to the tight conditions in the credit markets.

Using the strategy of accumulating well-situated strips of land to supplement existing holdings, Las Vegas casino and hospitality heavyweight MGM Mirage Inc. announced that it had entered into two separate agreements to purchase several parcels equaling roughly 34 acres in the northern zone of the Strip for $575 million. The land includes frontage on the Strip, which MGM is expected to deploy as part of future development projects.

Mega-Deal Jackpots

The ownership of casinos is subject to pervasive state-level regulation. In order to acquire a substantial interest in a casino, proposed owners must submit to and pass a searching qualification investigation conducted by state gaming authorities.

For years, these formidable regulatory barriers kept private equity buyers, whose investments are typically “owned” by a large number of limited partners, from seeking control positions in gaming concerns as they feared the regulatory review would produce unpredictable results while plunging them into a bureaucratic morass. However, in a pioneering 1998 transaction, Colony Capital acquired Harvey’s Casino Resorts, becoming the first private equity firm to obtain ownership control of a casino company. In that transaction, Colony Capital convinced the Nevada gaming authorities that only certain of its general partners, a small pool of professionals designated to control Colony Capital’s investment in Harvey’s and voting shares of its stock, should be required to obtain gaming licenses while its large number of limited partners, holding non-voting stock of Harvey’s representing only an economic interest in the company, should be spared elevated regulatory scrutiny.

Colony Capital and its Los Angeles-based peer, Oaktree Capital Management, strung together a number of successful acquisitions utilizing this innovative regulatory structure, although most other private equity firms sat on the sidelines for years. With the announcement in December 2006 of Texas Pacific Group’s and Apollo Advisors’ $27.8 billion deal to acquire Harrah’s Entertainment, Inc., however, this pattern changed dramatically and an era of domestic mega-deals was ushered in as private equity firms signaled that they would endure considerable regulatory scrutiny in order to wage a bet on domestic casino assets. The Harrah’s transaction made this point emphatically as the acquirers had to undergo gaming regulatory review in nearly every jurisdiction in which the geographically sprawling casino empire operates before they could complete their acquisition.

Station Casinos Inc., the Las Vegas locals casino powerhouse and prodigious developer of innovative gaming properties, followed suit in February 2007, announcing an $8.8 billion deal to be taken private by Colony Capital and Station management. In April 2007, Carl Icahn’s American Real Estate Partners LP announced that it would sell its Nevada casino operations for $1.3 billion to Whitehall Street Real Estate Funds, a private equity affiliate of Goldman Sachs Group, Inc.

The wave of private equity gaming deals crested in June 2007 when Centerbridge Partners LP and Fortress Investment Group LLC agreed to a buyout of casino and horse racing track operator Penn National Gaming Inc. in a leveraged deal worth approximately $8.8 billion. In July 2008, confronted by various regulatory challenges and the bleak reality of a materially worse lending environment than prevailed when the deal was signed, the sponsors walked away and the transaction unceremoniously failed. In exchange for agreeing to terminate the deal, Penn national received a $225 million breakup fee and a $1.25 billion investment in the company’s preferred stock.

Another notable trend to emerge in the 2006-07 period was the growing appetite of foreign investors for domestic gaming assets. In addition to the sale of the New Frontier to Israeli investors in August 2007, United Arab Emirates-controlled Dubai World snapped up a nearly 10 percent stake in MGM and paid $2.7 billion for a 50 percent equity position in MGM’s CityCenter project, a luxury mega-resort which is currently being developed on the Las Vegas Strip.

In December 2007, Australian gaming operator Crown Ltd. announced that it had agreed to acquire Las Vegas-based Cannery Casino Resorts LLC and its four casino properties for approximately $1.8 billion from Millenium Gaming Inc. and Oaktree Capital. The transaction will enable Crown, which operates or is developing casinos in Australia, Great Britain, Macau, and the United States, to further diversify its casino portfolio.

Snake Eyes

With the capital markets faltering over the past year, the generous conditions in the lending markets has vanished, ushering in an era of diminished domestic gaming M&A activity. Financial buyers, whose determination to ante up in a big way was one of the key sub-plots in the 2006-07 storyline, have been less visible in the gaming space of late. Although private equity firms will continue to be buyers at the right prices, their comparatively lower profile is likely to persist in the near term, with the fate of the Penn National deal serving as a reminder of the difficulties presented by the tight credit market.

In the face of the scarce availability of credit for refinancing transactions and the sagging operational fortunes of many casino companies, several deals announced in recent months were designed to strategically reposition, or reduce the leverage of, companies feeling the pinch of heavy debt loads. This March, Tropicana agreed to sell its Casino Aztar riverboat and hotel complex in Evansville, Indiana for up to $245 million in a combination of cash, seller paper and potential earn-out payments. Tropicana, which has since filed for bankruptcy, announced at the time that the proceeds of the sale would be used to retire debt. In May 2008, Trump Entertainment Resorts Inc. agreed to unload its Trump Marina Hotel Casino in Atlantic City to an affiliate of Coastal Marina LLC for $316 million. Trump Entertainment, which is highly leveraged, said at the time that the transaction would enable it to “master plan the future path of [the] company in the midst of an overall transformation,” which it indicated might include paying down debt. As debt burdens becoming increasingly oppressive for casino companies suffering from shrinking revenues and cash flow, transactions of this sort stand poised to multiply in the near term, presenting chances for opportunistic buyers.

The Las Vegas Strip, a magnet for deal-makers in 2006 and 2007, showed relative resilience in the first several months of this year, turning in revenue numbers that were only several percentage points below revenue achieved in the corresponding periods in 2007. However, in May 2008, that period of apparent stability came to an end as Strip revenues plunged by more than 16 percent from revenues recorded in May 2007, suggesting that the Strip is far from invulnerable to the gaming downturn. In addition, the prospect of a glut of casino resort capacity is taking on greater urgency in light of the recent completion or continuing development of a number of mega-resorts on the Strip, such as the Las Vegas Sands Corp.’s expansion project, the Palazzo; Wynn Resorts’ latest full-scale resort project, Encore; Boyd Gaming’s new hotel-casino-shopping complex, Echelon Place; and MGM’s CityCenter casino resort complex. As a result, although the Strip will remain a compelling draw for buyers willing to make a long-term investment, we can expect furious bidding wars for land on the Strip to go out of style for some time and deal volume involving Strip assets over the next year to remain below the elevated levels witnessed in 2006 and 2007.

By contrast, foreign buyers and sovereign funds—also important participants in the 2006-07 gaming M&A boom period—should be emboldened by the simultaneous weakness of the dollar and depressed gaming industry valuations. They are likely to find irresistible buying opportunities in the coming months and will be well positioned to capitalize on them.

In sum, after several decades of nearly continuous growth, 2008 has tested and found wanting the thesis that the domestic gaming industry is recession-proof. M&A activity in the gaming space has followed the industry’s general financial performance, declining from the unusually heightened level on display in 2006 and 2007. This new phase in the deal-making cycle has demonstrated that several of the key drivers fueling buyouts during the 2006-07 period—a spirited scramble for land on the Las Vegas Strip and unprecedented interest in gaming assets among financial buyers—have faded. However, another important driver of activity during the boom period—serious attention from foreign buyers —appears poised to continue. In addition, M&A deals meant to afford heavily leveraged gaming companies relief from their debt or a chance to strategically reposition themselves have figured prominently thus far this year, a trend that seems likely to further take root in the coming months. Thus, while the gaming M&A juggernaut of 2006 and 2007 has undoubtedly slowed this year, opportunities continue to present themselves for buyers to roll the dice on domestic casino assets.

Adam R. Moses is an attorney in the Global Corporate Group of Milbank, Tweed, Hadley & McCloy LLP, resident in the firm’s Los Angeles office.