Caesars Palace and Speculative Credit

Speculative credit fills a void in capital markets between safe lending to investment grade governments and companies and equity capital which has the last claim in bankruptcy. Speculative credit was also a market neglected by large investors until attitudes towards the asset class changed, especially in the 1980s. Once this happened, risky ventures found a new means of raising capital, and a large one at that. One of these ventures was the development of Las Vegas, which was, in the second half of the 20th century, one of the fastest growing cities in America. Vegas’s casinos are a legacy of leveraged finance. Several of its megaresorts tell eventful and intriguing financial stories, especially Caesars Palace, which opened to gamblers in 1966 but has grown almost beyond recognition since.

Kerkorian

The story of Caesars Palace begins not with the man who developed it but with Kirk Kerkorian, who cobbled together lots facing South Las Vegas Boulevard on the site of the future casino. Kerkorian was an aviator turned land speculator and developer. During the Second World War, he joined the Royal Air Force Ferry Command in Canada and flew newly completed aircraft to Britain. It was in aviation where he became an entrepreneur. After the war, he started an air charter business and, in the early 1950s, he purchased two damaged Lockheed Constellation aircraft and used the spare parts from each to rebuild an airworthy one. Years later, he sold his charter business to the Studebaker Corporation.

Kerkorian used much of the sale proceeds of his company to acquire forty acres of land across from the Flamingo Hotel in Las Vegas, a town he got to know by flying Los Angeles-based gamblers there frequently. The land cost just under $1 million to purchase yet it was blocked from direct access to the Las Vegas Strip by small residential lots. In the early 1960s, Kerkorian traded larger lots in his forty acre site for those smaller lots, ending up with a property directly on the Las Vegas Strip.

It was here where Caesars Palace would soon be built. Kerkorian would go on to contribute far more to Vegas than amalgamating parcels of land for casino projects. Curiously enough, he later repurchased his airline from Studebaker after the company wanted to exit the business and resold the firm, this time to the Transamerica Corporation, for $85 million, profiting twice from the sale of the same firm. He invested these funds, complemented with $30 million in bank loans, to develop the International Hotel, which later became the Westgate Las Vegas Resort & Casino. He also went on to purchase the Flamingo and founded MGM Resorts International, but all this was well in the future.

Sarno and Hoffa

While Kerkorian furnished land for the project, the developer who secured financing for Caesars Palace and who operated it in its first few years was Jay Sarno. A motel owner, Sarno was en-route to California to search for promising new locations. Passing through Las Vegas, he decided to develop a property there instead. To get the project moving, he secured a $10.5 million loan from the Teamsters Union Central States Pension Fund through his association with Jimmy Hoffa, the union boss and future felon who had funded Sarno’s past motel ventures. Sarno leased Kirk Kerkorian’s site and built Caesars Palace.

Developing the initial Caesars Palace, with 680 hotel rooms, cost $19 million. It opened in 1966 with a grand opening celebration that was rumored to have cost another $1 million by itself. Sarno purchased Kerkorian’s leased land in 1968 for another $5 million, bringing the total project cost to $25 million and delivering Kerkorian a total of $9 million from the rent and sale of the land. In addition to equity money from Sarno and other backers, the construction relied on debt financing from an organized crime linked union boss. This was an era when few banks, or even professional investors of virtually any sort, would touch the casino business. Developers usually had to invest much of their own money or search for atypical sources of financing. Sarno had to finance his next project, Circus Circus, with the early profits from Caesars and more money from Jimmy Hoffa.

Perlmans

Caesars Palace was sold in 1969 to Clifford and Stewart Perlman for $58 million. The Perlmans owned the publicly-traded Florida-based Lum’s restaurants and other ventures. The acquisition of Caesars was partially financed by its past owners, Sarno and company, who agreed to be paid over time. The sale price was split between $30 million in cash to be paid within the first year and $28 million paid over the next four years. However, though less than half the purchase price was funded with this debt, the financing provided by Sarno and his partners had to be renegotiated after an economic downturn threatened Caesars. The $28 million debt was swapped for just $16 million in debt and Lum’s shares worth $12 million.

Despite the early trouble, the Perlmans went on to be long-term owners of Caesars. They left their restaurant business, selling Lum’s to the owners of Kentucky Fried Chicken for $4 million. They also poured new money into Caesars, investing an additional $25 million in the property which went to new towers adding hundreds of additional hotel rooms. In Vegas, there was ever-increasing competition. For one, Kerkorian had gone on to be an owner and developer of several properties. His latest project was the 2,100 room MGM Grand which opened in 1974, built with $106 million partially raised with his sale of the International and Flamingo Hotels to Hilton and partially by new loans.

However, by the 1970s, the days of shady lenders like Hoffa being indispensable to the industry were gone. Banks began to finance casino development after Nevada passed a Corporate Gaming Act in 1967 which made it easier for corporations with large shareholder count to operate casinos. The old rules that Sarno and Kerkorian previously had to play by required a background check of all the shareholders of each operator, effectively locking out large corporate operators with publicly traded or otherwise widely distributed ownership.

Megaresort

In a sense, the original MGM Grand was ahead of its time. In the late 1980s and 1990s, it would be joined by several new resorts with 2,000 or more hotel rooms. These years brought the need to compete with new properties, like Steve Wynn’s 3,000 room Mirage, in a business where adequate was not good enough. As it happens, more than two decades earlier, Wynn himself had stayed at Caesars on its opening day. Now, he had a property of his own directly adjacent to Caesars Palace.

During the 1980s, Caesars had expanded as well. The Fantasy Tower added 600 rooms in 1980 and new convention space was later built. A racetrack was added in 1981 but was short-lived, replaced later in the decade with the Forum Shoppes, an idea of the new Caesars CEO Henry Gluck. The shopping mall was built over the racetrack and featured 240,000 square feet of retail space, built with $100 million. It would later be expanded further.

The Las Vegas megaresort was the product of three trends. First was growing demand and rising occupancy rates. In 1970, Las Vegas welcomed 6.7 million visitors, by 1979 this had risen to 11.7 million and would exceed 30 million in 1997. Second, the 1980s brought the ability of developers and operators to sell junk bonds to finance their projects. Steve Wynn relied on the junk bond financier Michael Milken himself to raise $535 million for his casino project, The Mirage, which had cost $630 million all said and done. Lastly, this was a period when larger national and international hotel firms began to enter the Las Vegas market in full force, building and acquiring their own properties.

This last trend manifested in the sale of Caesars Palace to ITT-Sheraton in 1995 for $1.7 billion. By now, Caesars had grown beyond the Las Vegas megaresort, with new properties added in Atlantic City, New Jersey and elsewhere. ITT-Sheraton was likely pressured by Hilton’s success in Vegas which encouraged other hotel operators to enter the market. To compete with the several new resorts built in the 1990s, ITT-Sheraton spent $650 million on further improvements to Caesars, including the construction of Palace Tower, with 1,100 new rooms.

Mergers and Reorganizations

With the Perlmans gone, stable ownership was a thing of the past; amalgamations and restructurings were the new paradigm. To start, ITT-Sheraton were short lived owners; Starwood Hotels & Resorts acquired the casino in 1997. Then Starwood itself sold the property after just another two years to Park Place Entertainment which owned other Las Vegas casinos and hotels. Under Park Place, new money continued to be poured on the property. They created the 4,500 seat Colosseum Theater, replacing an 800 seat theater that had been original to the property.

In 2004, Park Place changed its name to Caesars Entertainment, Inc. and was acquired by Harrah’s Entertainment, a casino operator since 1937, for $10 billion in 2005. Harrah’s itself was then acquired in a leveraged buyout in 2008 by private equity firms TPG Capital and Apollo Group Management. To finance the purchase, a $31 billion loan was arranged. However, the timing proved poor; the 2008-09 financial crisis brought about large declines in visitor traffic to Vegas.

Under the weight of its debts, Caesars Entertainment filed for bankruptcy in 2015. At the time of its bankruptcy filing, the company held $24 billion in debt, most of it split roughly equally between first-lien loans, first-lien bonds, and second-lien bonds. For a while, it seemed that the second-lien bondholders would see pennies on the dollar in recoveries.

However, multiple lawsuits accused the owners of stripping the company of assets sold to related parties at prices below their valuation and the bankruptcy court favored creditors. As part of its restructuring, the company moved its real estate assets into a new real estate investment trust, VICI Properties, in order to capture favorable tax treatment. In the end, the company’s private equity sponsors lost most of their equity in the business while even junior creditors saw the value of their bonds trade back to par value. The company’s stock soared and Caesars prospered as Vegas visitor traffic grew once more.

Lesson

Caesars Palace had the trajectory of many speculative companies leveraging the value of their hard assets. An initial phase of debt fueled growth or a leveraged acquisition gives way to slower growth, or even a downturn, which prompts a restructuring. The company, still possessing real assets with real value, inevitably exits bankruptcy somewhat intact. Leveraged finance did not just enable the growth of Caesars Palace but it facilitated the tremendous growth of Las Vegas altogether. Consider that in 1980, the Las Vegas metropolitan area had a population of well under 500,000; today, it stands at over 2.2 million. The destination city’s visitor count and hotel capacity have exhibited similar growth, built on lending with a high tolerance for risk.

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