Debt of casino giants cut to junk status

David Strow

Tuesday, Jan. 15, 2002 | 10:46 a.m.

The debt of Las Vegas Strip hotel-casino giants MGM MIRAGE and Park Place Entertainment Corp. received a junk rating from Moody's Investors Service Monday, as the agency cited concerns about a continuing slowdown in the Las Vegas market.

The move affected a whopping $13 billion in debt held by the two companies.

The move left Harrah's Entertainment Inc. the sole Las Vegas gaming company that still carries an investment grade rating from Moody's. The agency confirmed Harrah's credit ratings Monday.

Both Park place and MGM MIRAGE had carried "Baa3" long-term and short-term ratings, a rating considered borderline investment grade. Moody's, which had placed the companies on review Sept. 25, reduced both companies to "Ba1," a high-yield or "junk" rating, meaning investing in the debt is more risky than investing in investment-grade bonds.

The move affects $7.8 billion in debt held by MGM MIRAGE and $5.2 billion held by Park Place, Moody's said.

Standard & Poor's, the other major credit rating agency, also has the companies under review, but has taken no action yet. S&P still has investment grade ratings assigned to MGM MIRAGE and Park Place.

MGM MIRAGE reacted with annoyance, while Park Place expressed disappointment over the loss of the prized investment grade label. Neither was surprised, however, given the review launched in late September.

"I don't believe Moody's has a very good grasp of the gaming industry," said Jim Murren, chief financial officer of MGM MIRAGE. "Their bias against Las Vegas is well documented, so the financial community doesn't pay them much heed when they make their decisions."

"We've seen the recent debt changes across a wide variety of industries during this period, so it's not a surprise to us," said Matt Maddox, Park Place's executive director of finance. "To me, this is an outgrowth of 9/11. Had that not happened, this would have not happened. It was really due to events out of our control."

In its research note issued Monday, Moody's said MGM MIRAGE's downgrade "reflects the deterioration in the company's already weak debt protection measures due to the negative impact of the events of Sept. 11, 2001, and the likelihood that credit statistics may not improve significantly for some period of time given the company's exposure to Las Vegas."

"Although visitation to Las Vegas has continued to improve since 9/11, uncertainty with respect to the impact of the economic downturn, and lingering safety concerns on the levels of both business and leisure travel in 2002 could result in a slow rebound in earnings," Moody's research note said. "Since (MGM MIRAGE) relies on Las Vegas for more than 70 percent of its (cash flow), it is more vulnerable than some of its peers to earnings volatility caused by additional attacks or unfolding political events."

Murren responded that the decision to downgrade was ill-timed.

"I feel that waiting four months after 9/11 to come out with a downgrade, when just about every datapoint has been positive ... is counter to sound financial analysis," Murren said.

Moody's cited deteriorating "debt protection measures" at Park Place following Sept. 11 and "difficult market conditions in the Mississippi markets."

Leisure travel to Las Vegas may be hurt by safety concerns and declines in discretionary income, while corporate budget cuts may hurt Park Place's group business, Moody's said.

"We expect (Park Place's) debt protection measures to improve as a result of improving trends in Las Vegas, as well as the company's decision to reduce capital expenditures, and share purchases in order to allocate more cash flow to debt repayment," Moody's wrote. "However, despite these factors, credit statistics are likely to remain under pressure through 2002."

"We are a very strong company, with very diverse and stable revenues," Maddox said. "We're going to generate significant free cash flow in 2002, just like we did in 2001, and we're going to continue to deploy that cash to strengthen our company and pay down our debt."

Credit downgrades can have a negative financial effect on a company. With a lower rating, companies can find it more difficult to raise capital, and may pay higher interest rates.

However, both companies insist the Moody's downgrade will have little or no financial fallout, though for different reasons.

"I view it as an unscientific and prejudiced view against our city, not one based on sound analysis, and I think the financial community will agree with me," Murren said. "This will not have any bearing on the pricing of our existing indebtedness, or on my ability to raise future capital."

Maddox said the downgrade was "pretty much a non-event" for Park Place, as the company has $1.3 billion available on existing credit lines for its capital needs.

"In the end it really doesn't cost us much, and won't hurt us in any way," Maddox said.

With the downgrades, Moody's has an investment grade rating assigned to just one major gaming company, Harrah's. Harrah's was also on review for possible downgrade, but Moody's reaffirmed its "Baa3" rating Monday.

The move "reflect(s) the company's strong rebound from the initial negative impact of the terrorist attacks ... that was supported by its geographic diversity, as well as its marketing database and its loyalty program, Total Rewards," Moody's said. "The confirmation considered the progress Harrah's has made with its integration of Harveys (Casino Resorts) that was acquired in August 2001, as well as its stable performance despite more challenging industry conditions prior to the events of 9/11."

It wasn't the only favorable news for Harrah's Monday. In separate actions, CIBC World Markets and UBS Warburg hiked their fourth-quarter earnings estimates on Harrah's. Both cited very strong growth in gaming revenues in midwestern riverboat markets and Atlantic City.

CIBC gaming analyst William Schmitt raised his fourth-quarter earnings estimate from 32 cents per share to 40 cents per share, his cash flow estimate from $216.1 million to $232.2 million, and his price target from $40 to $43. UBS gaming analyst Robin Farley raised her earnings estimate from 27 cents to 34 cents per share.

Schmitt said his optimism about Harrah's extends to its Las Vegas properties, the Rio and Harrah's Las Vegas.

"In our opinion, Harrah's is the strongest casino operator catering to the mid-market slot customer, as opposed to the high-end table player," Schmitt wrote. "As such, we believe Harrah's is capturing market share at the expense of its competitors in Las Vegas."

Farley, however, was far more cautious on her outlook.

"Adjusting for the impact of the poor weather in the prior-year period ... and the contribution of Harveys ... that implies zero same-store sales growth and less than a 15 percent (return on investment) on new capital projects," Farley wrote. "Therefore, when Harrah's gets past the easy comparisons this quarter, we maintain that the stock's cash flow multiple (to stock price) of more than eight times may seem ahead of itself."