Harrah’s So Far A Bad Bet For Apollo, TPG

The capital structure of one of the last of the mega-buyouts is showing some cracks.

Harrah’s Entertainment Inc., acquired in late January by Apollo Management and TPG for roughly $31 billion, is looking to swap out up to $2.1 billion of its debt in exchange for new second-lien notes. As part of the acquisition the company assumed about $12.4 billion in debt and about $1 billion in acquisition costs. Both Moody’s Investors Service and Standard & Poor’s are weighing in with downgrades in the wake of the move.

Each ratings agency believes that gaming demand is likely to suffer longer than previously expected as the slowdown in the wider economy continues to deepen. That scenario could be crippling for Harrah’s, which recently reported widening losses and declines in revenue and adjusted EBITDA for the first nine months of 2008.

Moody’s took its corporate family rating on the company to ‘Caa1’ from ‘B3,’ and its probability of default rating to ‘Ca’ from ‘B3.’ The moves affect $16 billion of rated debt, Moody’s said. The agency said it views the swap as a distressed exchange and plans to change its probability of default rating to ‘Caa1/LD’ upon closing of the transaction, an event it plans to classify as a limited default.

The agency acknowledged that the swap in and of itself would likely improve matters slightly but it believes credit metrics would remain too weak to justify the ‘B3’ rating.

S&P went to ‘CC’ from ‘B’ on its corporate credit rating for Harrah’s, a drop of two notches, and lowered its ratings on the company’s secured loan to ‘B+’ from ‘BB-‘ and its senior unsecured and subordinated debt issues to ‘C.’ It also kept all ratings on CreditWatch with negative implications. S&P also sees the logic of the swap but it’s just not optimistic about the timing.

“We recognize that the post-exchange capital structure would eliminate, or at least substantially reduce, Harrah’s debt maturities over the next few years, in addition to meaningfully lowering the company’s outstanding debt,” the agency said in a statement. “However, Harrah’s ability to successfully service its debt obligations over the intermediate term would still rely on a substantial moderation of declines recently observed in the gaming sector.”

By the looks of its latest numbers, it’s going to be rough sledding for Harrah’s from here. For the nine months ended Sept. 30, the company posted a net loss of $415.2 million, down from a profit of $667.2 million in the same period a year earlier. Revenue fell 4.3 percent to $7.85 billion for the latest nine months from $8.2 billion for the comparable period in 2007. Adjusted EBITDA tumbled 13.7 percent to $1.89 billion for the nine months from $2.19 billion a year earlier.

Gary Loveman

, Harrah’s chairman, president and chief executive officer, attributed the weakness to economic upheaval and was cautious about predicting a turnaround. “While we’re hopeful the federal government’s recent actions to restore order to the financial markets may lead to an eventual economic recovery, there is no certainty as to its timing,” said Loveman. “As a result, we believe it’s prudent to ensure our costs remain aligned with reduced levels of business activity and that we conserve cash.”

Harrah’s has reportedly been scouting around for ways to shore up its balance sheet in recent months. The Wall Street Journal said in late October that the company was looking to sell some assets but didn’t receive any suitable offers. That report also said that a co-investor in the deal, GoldenTree Asset Management, had already written down its investment in Harrah’s by 75 percent.