A buyout of Harrah’s could shuffle casino giant’s focus

By Liz Benston

Monday, Oct. 9, 2006 | 7:29 a.m.

News that two giant investment funds are offering $15 billion to acquire Harrah's took the nation's gambling capital by surprise.

But the prospect didn't startle Wall Street insiders or even insiders at Harrah's Entertainment, a company with plenty of reasons to go private.

While it's unclear whether Harrah's executives helped cultivate the offer that Apollo Management and Texas Pacific Group brought to the table, experts say the company's shareholders and management, who would benefit significantly from the deal, would be motivated to consummate the takeover.

Harrah's stock has shot up 15 percent since the deal's announcement, a price that could edge closer to the companies' $81 per share offer in the coming days and a milestone that could have taken months or years for the company to achieve on its own.

But not everyone stands to benefit under a potential shake-up. The prospect raises uncertainty for tens of thousands of rank-and-file workers and middle management employees at Harrah's, the world's largest casino company.

If consummated, the transition could mean much more than shifting the company's Las Vegas-driven interests to New York or Texas where these firms are based.

Apollo and Texas Pacific Group, well-known firms that have completed multibillion-dollar deals with some of the world's largest investment banks, have more flexibility to pursue profitable strategies than many public companies. They demand returns that are much higher than their publicly traded counterparts on behalf of clients who include wealthy and prominent individuals. The strategies they use to achieve those profits, in many cases, are dramatic and include laying off employees, spinning off assets, shutting down product lines and appointing new management.

Should the deal go through, experts say it's likely that Harrah's top management would stay with the company, which is considered efficiently run by Wall Street standards.

But several projects could be in jeopardy. Those include multibillion-dollar redevelopment projects planned for Las Vegas and Atlantic City as well as other expansion deals in Europe, where the company hopes to build casinos under the luxury Caesars brand. Harrah's has already announced that it will scrap the company's bid for a resort in Singapore. Analysts say growth plans could be put on hold or among many short-term sacrifices made to pump up profit - a prospect that wouldn't be welcomed by the employees or government tax collectors who stand to benefit from growth. The potential deal also would throw into question the future of the company's broad-based casino empire.

While other operators stuck closer to home, Harrah's has aggressively been building casinos around the country. While that strategy made sense in the 1990s when gambling was a fledgling industry, intensifying competition and regulatory hurdles in some states have made those feeder markets less profitable. Wall Street has been underimpressed with the company's returns in these low-rent casino markets while competitors such as Wynn Resorts Ltd. and Las Vegas Sands Corp. rake in big money from higher-end casinos in Las Vegas and Macau, which will eclipse the Las Vegas Strip in gambling revenue this year.

Beginning with Macau and Singapore, Asia is poised to further welcome U.S. casino resorts, offering more-profitable expansion opportunities than exist at home.

One of the reasons Las Vegas Sands Corp. was selected over Harrah's to receive the first of two casino licenses available in Singapore was Harrah's lack of experience developing luxury resorts.

To reposition Harrah's, private owners could spin off the company's less profitable properties outside of Las Vegas and use the profits to pay down debt and take advantage of foreign projects, analysts say. Harrah's could later emerge as a public company with fewer properties and a tighter focus on building more lucrative luxury resorts that could add more incremental profit to the bottom line. The company could even split up its operations, forming separate, more-efficient entities organized under certain brands or locations.

Such drastic changes are easier for private companies to accomplish beyond the scrutiny of federal regulators and the public markets.

The private investors also could do little to change the status quo. In that case, simply sitting on the company's casinos while land prices rise could generate a nifty profit for owners, allowing Harrah's to wait out the current building frenzy on the Strip for the next wave.

Either way, going private could help Harrah's solve a delicate math problem the company faces over the next couple of years.

The timing of the announcement is fortuitous.

Private equity firms worldwide are cash flush and looking for attractive investments. Casinos generate steady cash flows that are fairly immune to dips in the economy. That's money that leveraged buyout firms such as those interested in Harrah's can use to pay down the significant chunk of debt they will raise to acquire the company's stock.

Private equity firms such as Apollo "view Harrah's not as a gaming company but as a high-quality real estate company with a significant stream of cash flow that they can acquire at a relatively attractive price," MGM Mirage President and Chief Financial Officer Jim Murren said. "This sends an extraordinarily powerful message that investors have finally embraced what we've been saying, that subjectively we are no different from other companies that operate in real estate."

MGM Mirage and Harrah's each own more than 300 acres of land along Las Vegas Boulevard, one of the most desirable three-plus miles of development in the world.

Publicly traded casino companies have historically been undervalued relative to industries such as hotels and retail chains because gaming is a highly controlled "sin" industry where growth is subject to state regulation rather than the law of supply and demand. As gambling's popularity has spread, casinos have become mainstream entertainment centers with nightclubs and showrooms that also appeal to nongamblers. At the top of this trendy food chain are MGM Mirage and Harrah's, which is No. 2 in size on the Strip but whose Strip properties - with the exception of flagship Caesars Palace - lack the cachet of MGM Mirage's newer and more upscale casinos.