Regulators, analysts ponder deal

By Liz Benston

Friday, July 16, 2004 | 11:01 a.m.

Hours after Harrah's Entertainment Inc. officials announced a deal Thursday to buy Caesars Entertainment Inc., executives began making calls to state and federal regulators -- high-ranking entities that now stand between Harrah's and its ability to create the largest gaming company in the world.

Shareholders of both companies also must vote on the blockbuster deal, which is expected to close in about a year. Both companies also are preparing proxy statements, but no specific dates for a vote have yet been set, Harrah's spokesman Gary Thompson said.

Company officials said Thursday their boards signed a definitive agreement to complete the transaction, meaning that there are no other outstanding issues to be resolved besides regulatory and shareholder approvals.

Number crunchers emerged Thursday and today with mixed views while shares of both Harrah's and Caesars continued to decline.

In early trading today, Harrah's shares fell less than $1, or less than 2 percent to $47.02. Caesars shares fell a few cents, or less than 1 percent to $15.

Many experts are lukewarm, saying the deal won't boost earnings in the near term for the combined entity and could even mean an earnings hit. Others cut their stock ratings on Harrah's or removed their ratings altogether, saying bettors will move the stock regardless of how the business is faring.

In a research note Thursday, Bear, Stearns & Co. analyst Mark Abramson said the deal could dilute 2005 earnings unless the entity generates cost savings of about $194 million -- more than the "conservative" estimate of $80 million the company expects to save in its first full year of operation.

But Abramson said the company could help close the earnings gap by selling assets, borrowing more cheaply than anticipated and improving efficiency at underperforming casinos.

Carol Levenson of bond research firm Gimme Credit said the costs and benefits of the merger would "essentially cancel each other out" for a neutral effect on earnings.

"Caesars' high-roller clientele, more variable cash flow and less predictable results" would greatly offset any potential benefit the combined company would receive from exporting its Total Rewards slot club program to Caesars' properties, Levenson said.

Even analysts who support the deal expressed concern about acquiring more casinos in Atlantic City given the city's increasing competition from emerging gambling opportunities in neighboring states such as Pennsylvania, New York and even Maryland, which has considered slot machines.

"While we think the longer-term outlook for Atlantic City is bright, we think near-term that Atlantic City is vulnerable to competition in Pennsylvania and a combined (company) may be more vulnerable," Fulcrum Global Partners analyst Joe Greff said in a report.

Prudential Securities analyst Bill Lerner echoed that view Thursday, calling consolidation in Atlantic City a "bad bet."

Lerner also downgraded Harrah's shares to a "sell" on news of the deal, saying the combined company's growth prospects could deteriorate while its market risk increases.

Harrah's Chief Executive Charles Atwood said he couldn't estimate the deal's effect on Harrah's earnings per share. The combined companies are expected to generate about $2.55 billion in cash flow per year before cost savings and carry about $11.3 billion in combined debt. Even after estimated capital expenditures of $1 billion for the two companies in 2005, Harrah's expects the company to have "significant free cash flow" to help reduce debt, Atwood said.

That wasn't enough to clear the air for analysts, who still questioned a variety of issues from regulatory hurdles to the lack of a price cap for Harrah's stock, leaving the value of the deal dependent on Harrah's share price.

"Most mergers look for less overlap," said Ray Cheesman, a bond analyst with Jefferies & Co. "This is one of the most overlapping group of assets I have ever seen. The puzzle pieces dont seem to fit together."

Cheesman said he also questions Harrah's appetite for running a the high-end table business at Caesars Palace and other Caesars resorts nationwide.

"Harrah's wants something that is dependable and low risk," he said.

Another concern was that Caesars Chief Executive Wally Barr and well as other Caesars executives didn't attend Thursday's conference call, which suggests that Harrah's may not keep upper management, Jane Pedreira, a Lehman Brothers bond analyst, said.

Thompson said Barr had stayed up all night to hammer out a deal and was too tired to attend the 6 a.m. call, while Caesars Chairman Stephen Bollenbach was traveling in Europe at the time.

"The people who are looking for holes in this deal simply don't see the value of this transaction," he said. "They will ultimately realize the value but now they don't understand it."

When asked about analysts' concerns, Caesars spokesman Robert Stewart today said the agreement "speaks for itself."

"Our CEO, Mr. Barr, is a member of our board of directors and has been reported, the vote to approve the acquisition agreement by our board was unanimous."