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Best of Liz Benston

Gaming Guru

Liz Benston

Sale could cut Harrah's plans short

19 December 2006

With word that the board of directors at Harrah's Entertainment will accept a private buyout offer at $90 per share, observers say the company has reached a crossroads and may sacrifice long-term prospects in favor of short-term gains.

Private equity firms like those buying Harrah's attract money from pension plans, endowments and other investors who measure profits over years versus, say, hedge funds and other investors that jump in and out of stocks every few months.

But there's a potential downside to a private equity buyout of Harrah's. These firms, who buy companies with an eye toward selling them in five to seven years, are typically loath to invest in projects that may take longer to come to fruition. Harrah's is currently pursuing just that sort of project, having announced plans to revamp its center Strip properties by remodeling, expanding and touching up casinos to create a more unified neighborhood.

Harrah's purchasers, Apollo Management and Texas Pacific Group, make money by buying out public companies and then taking them public again in five to seven years - generating returns based on the difference between the cost of cheap debt raised to buy out the company and the value of that company a few years later. Rather than embarking on major improvements, private equity firms generally improve profit by selling off assets and trimming operating costs.

Either strategy could be problematic for Harrah's, whose enviable Total Rewards gambler loyalty program makes the company worth more as a big chain than the sum of its parts, one analyst says.

"A highly leveraged Harrah's appears to have limited growth possibilities, while a breakup would appear to eliminate significant synergies," stock analyst Jake Balzer of Guzman & Co. said in a research note to investors Monday. "In addition, this is not a company that we believe has significant opportunities to improve operations via management changes."

Some observers say private equity firms such as Apollo and Texas Pacific Group would be unwilling to take on the potential risk of major investments when they can make money relatively easily by paying down debt using existing casino cash flow.

A slow-growth strategy could be a positive for a company such as Station Casinos, which is considering an internal buyout offer from top executives who may intend to keep the company for years rather than flip it for relatively quick profit in a few years. Station is under stockholder pressure to improve its already-dominant position by building more casinos on land it owns around town.

Harrah's, by contrast, faces more intense competition on the Strip, where competitors are building luxury resorts such as MGM Mirage's $7 billion Project CityCenter. If Harrah's holds off on its previously announced redevelopment of its center-Strip casinos, the company will have more difficulty competing when new properties begin to open beginning in 2009 on the Las Vegas Strip.

"Leveraging the company and using cash flow to service debt instead of growth makes little sense to us," Balzer wrote.

Harrah's might choose a middle ground, by expanding the brand overseas instead of undertaking a disruptive remodeling of its Strip properties.

Bond analyst Dennis Farrell of Wachovia Securities agrees that Harrah's may invest less than previously anticipated in Las Vegas as a result of going private.

The more debt the company takes on, the more difficult it will be for Harrah's to spend money using traditional bank and bond financing, he said.

While Apollo and Texas Pacific Group may not want to make major investments on the Strip, they may feel pressure to improve the properties to justify the price they are paying - a price that assumes that the company will be worth a lot more years from now, said Brian Gordon, a principal with Applied Analysis.

Sale could cut Harrah's plans short is republished from