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| Monday, July 31, 2006 |
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Private equity will complicate gamingJust like that musical heroine, "Thoroughly Modern Millie," the Gaming Commission realizes that everything today makes yesterday slow. Regulators are on top of the big issues like mobile gaming devices and computerized counting of the drop. Changes in finance, though, are harder to get their arms around. The modern corporate system of gaming regulation was invented back when Grant Sawyer was governor and, as the story goes, he managed to bring in the Wall Street money and drive out the mob money. So far, so good. The whole regulatory scheme, though, could be facing its biggest challenge since the 1960s.
The big change is in capital markets. Large sums are no longer raised by making a public offering. The big money these days is private equity, and big companies need no longer be listed on the exchange. It used to be that private equity was a game only for real players. It was the ultimate insider's racket because you had to be able to recognize an undervalued company, know how to manage it so that real value would be added and have the connections on Wall Street to be sure that you could turn things around and head for the exits with plenty of the value you'd added. Investment bankers are still looking for undervalued assets. D.E. Shaw, for example, has stakes in the Sahara and Archon, the company that owned the Wet 'n Wild site on the north end of the Strip. Things changed in 1988, though, with the buyout of RJR Nabisco. That conglomerate had been assembled on the theory that conglomerates create "synergies" and economies of scale or marketing. Every other decade or so, the wisdom is reversed and concentrating on core business is all the rage. In the late 1980s, the core business guys were winning the argument. Despite the billions invested to take RJR private, though, the big bet did not pay off. Most of the businesses they bought were mature businesses and it was hard to add much value to consumer products like cigarettes and cookies. Breaking up the conglomerate and selling off the pieces did not add the value the MBAs had all predicted. Nowadays, pension funds and others want a piece of the action, so there is no shortage of private equity money. One group recently raised $15 billion for equity deals and funds worth $100 billion are a real possibility some day soon. And CEOs see real benefits in throwing off a lot of regulatory oversight and ridding themselves of those pesky investors demanding a profit every three months. What has this got to do with gaming regulation? Think of the $32 billion deal that took HCA Inc. private last week. The hospital company looks a lot like major gaming companies. It has very substantial assets, particularly in real estate. The growth trajectory for both industries is strong. And, above all, there is a very strong cash flow to pay back debt. Why is that important? Well, look at the HCA deal. Private equity investors are putting $5.5 billion into the deal and assuming another $11 billion in debt. But the rest of the money will be borrowed against the company's assets. PE funds get to control a $32 billion company for a fraction of that so long as there is money to pay the loans. That's why the cash flow thing is crucial. And there's one more wrinkle: Many leveraged buyouts cost the dealmakers almost nothing. A big company can borrow lots of money which provides an exit strategy with little or no risk. Last week, for example, the Wall Street Journal reported on the deal that took Burger King private. The three PE firms paid themselves $22.4 million when they took over management of the burger outfit. They continued to charge management fees while they owned the corporation and just before the IPO, they paid themselves a dividend of $367 million as the owners. None of this was illegal, but it does present new challenges for gaming regulators. The major listed gaming companies all have a great cash flow to pay down debt. And they own real and solid assets. If the likes of the Carlyle Group, Bain and Company, Texas Pacific Group and Kohlberg Kravis Roberts can raise tens of billions of dollars for HCA, Hertz, Burger King and Weight Watchers, they won't have much trouble raising the odd or $12 billion or $14 billion for MGM or Harrah's. The gaming industry's best defense is family ownership. Large chunks of companies like Wynn, Boyd and Stations are controlled by the founder or his heirs. And Kirk Kerkorian owns a substantial majority interest in MGM Mirage. Still, it's only a matter of time before a PE consortium makes stockholders an offer they can't refuse. What can regulators do if a major gaming company is set to be milked by private equity investors before it's re-launched with a big debt burden? Of course, the last pronouncement from the Gaming Commission on this issue was to give representatives of Goldman Sachs a free ride on licensing because, well, mainly because they were from Goldman Sachs, a Wall Street firm with an impeccable record. If you don't think a private equity deal can happen here, think about how attractive it might be to institutional investors who won't have the patience to watch billions of dollars sunk into CityCenter or Echelon Place. imylchreest@lvbusinesspress.com | 702-871-6780 x319 |
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